Course introduction for 723G33

Risk Management and derivatives

(former 723g14 International Finance)

Yinghong.chen@liu.se
YH Chen, Doctor in Financial Economics

yinghong.chen@liu.se 1
 Contents
1. Couse introduction for 723G33
2. Main Book, Other Reference books, chapters
3. Detailed schedule
4. Theories of international trade: comparative
advantage and competitive advantage
5. Homework 1
6. Assignment: preparation of Case Porsche
changes tack
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 LiU: Campus Valla
Library

Class location

Exam
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Main book: Multinational Business Finance
by Eiteman, Stonehill and Moffet

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 Other Reference books, chapters

International Business: Environment and Operations,

John D. Daniels, Lee H. Radebaugh & Daniel P. Sullivan;
12th edition, for cultural aspect of International
business of MNEs

Corporate Finance Foundations: Global Edition, by Hirt,

Block and Danielsen, 14E, McGraw-Hill. Chapter 19 and
21
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Vecka 18, 2012 Moment Location Preliminary Contents

13:15- Course Outline, Important Topics In

Tue May 715:00 L1 T15 International Corporate Finance, chapter 1

May 813:15- L2, ESM:chapter 2-3, Case: Porsche Changes

Wed p26
17:00 seminar 1 Tack
Homework: end of chapter 1, question 1-5

May 13:15- L 3 ESM: Chapter 5, 6, 7 Foreign Exchange

Tue T11
14 15:00 Market and parity conditions

May 13:15- L4 ESM:chapter 8, 9 currency derivatives,

Wed P26
15 15:00 Exchange rate

May 13:15- ESM: Chapter 10, 11, 12: exposure

Thu 16 15:00 L 5 P26 management
Booking data Brssal The Use Of The Datastream. Collect Data
17 ?
underway system instructor For Exchange Rate Theory Test

May 13:15- Seminar 2 T15

Tue Exercise 4-12, Questions session
21 15:00
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 ESM: chapter 17, 19: Risk management:
May 13:15-
Wed L6 T11 an integrated risk approach. Financial risk,
22 15:00 operational risk, macroeconomic risk,
country risk, etc

Project presentation (by group)

May 13:15- Final
Wed Seminar T15 Group A, B, C, D
29 15:00 Discussant group (E, F, G, H)

Project presentation (by group)

15:15- Final Group E, F, G, H discussant group (A, B,
T15
17:00 Seminar C, D)

May 13:15-
Thu L7 T15 Review. Old exam questions, etc
30 15:00

exam preliminary 4 juni

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 Obligatory
1. Obligatory lectures and seminars.
2. Obligatory Lab exercise on testing the Equilibrium Theory of
Exchange Rate (exercise to be handed in before 25 of May,
according to lab instructions)
3. Group presentation is obligatory on 29th of may. Discussant group
will be picked later.
Topics can be chosen from major areas of the course. Deadline, 27 th
of May. Send to both your discussant group and
yinghong.chen@liu.se Instructions on website.

4. The exam is set preliminarily on the 4th of June. (account for 80%
of the total points)

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 Introduction: importance of risk
management of MNEs
1. Globalization is a fact of life.
I define globalization as producing where it
is most cost-effective, selling where it is
most profitable, and sourcing capital where
it is cheapest, without worrying about
national boundaries.
Narayana Murthy, President and CEO, Infosys

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 Importance of risk management of MNEs

2. There are unique risks and opportunities involved

in running international firms compared to purely
domestic firms. They are foreign exchange risk,
operating risk, country specific risk, laws and
regulations, cultural aspect of multinational
firms, etc.
3. Derivative securities such as options and futures
are used by corporate financial managers of MNEs
for hedging activities. Case in point: Porsche

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Various aspects of International Business

The Cultural Environments Facing Business

The Political and Legal Environments Facing
Business
The Economic Environments Facing Businesses
Globalization and Society

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 Theories of international trade
Theory of Comparative advantage (Factor
Endowment: land, labor, location, natural
resources, population)
International Trade and Factor-Mobility
Theory
Porters theory of competitive advantages of
nations of International trade (chapter 17)
Rationales of Foreign direct investment, FDIs

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 The theory of comparative advantage

The theory of comparative advantage provides a basis for explaining

and justifying international trade in a model world assumed to enjoy:
free trade;
perfect competition;
no uncertainty;
costless information; and
no government interference.

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The theory of comparative advantage

Absolute advantage and comparative advantage, opportunity costs

Firms in Country A specialize in making products that can be produced
relatively efficiently, given Country As endowment of factors of
production, that is, land, labor, capital, and technology
Firms in Country B do likewise, given the factors of production found
in Country B
In this way the total combined output of A and B is maximized

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Exhibit 1.3 Global Outsourcing of
Comparative Advantage

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 Comparative advantage vs. Competitive
advantage
Although international trade might have approached the
comparative advantage model during the nineteenth century,
it certainly does not today, for the following reasons:
Countries do not appear to specialize only in those products that could
be most efficiently produced by that countrys particular factors of
production (as a result of government interference and ulterior
motivations)
At least two factors of production capital and technology now flow
directly and easily between countries

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 The Porter's Diamond model for the
competitive advantage of nations (chapter 17)
Sources of competitive advantage:
Factor Conditions: nation's position in factors of
production, such as natural resources, climate, skilled
labors, infrastructure, technology, etc
Demand Conditions: of home buyers needs - their
sophistication
Suppliers and Related Industries: clusters of
related/supervising industries.
Firm Strategy, Structure and Rivalry: attitude,
willingness to succeed, domestic rivary.
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Four Determinants of National Competitive
Advantage

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 Pricing of foreign exchange
International parity conditions: Relationship
between Interest Rates and, spot and forward
exchange rates, inflation, changes in spot rate
Arbitrage principle: The law of one price, normally
we use home currency value per dollar, direct
quote.
Indirect quote: 1 = 1,5 $

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 The law of one price and Exchange Rates

If the identical product or service can be:

sold in two different markets; and
no restrictions exist on the sale; and
transportation costs of moving the product
between markets are equal, then
the products price should be the same in both
markets.
This is called the law of one price.
7-20
Exhibit 7.11 International Parity Conditions in Equilibrium
(Approximate Form)

7-21
Exhibit 1.1 Global Capital Markets

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 What is Different About International Financial
Management of MNEs?

Exhibit 1.4 summarizes the differences.

Culture and history differ among countries
Corporate governance
Greater levels of foreign exchange and political
risks
Financial theory and applications are modified in
the global versus domestic marketplace
Specialized and complicated financial instruments
become tools of the trade

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Exhibit 1.4 What Is Different About International
Financial Management?

ESM: 13th edition 24

 Market Imperfections: A Rationale for the Existence of
the Multinational Firm

MNEs strive to take advantage of imperfections in national

markets for products, factors of production, and financial
assets.
Imperfections in the market for products translate into market
opportunities for MNEs.
Large international firms are beter able to exploit such
competitive factors as economies of scale, managerial and
technological expertise, product differentiation, and financial
strength than their local competitors.

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 Market Imperfections: A Rationale for
the Existence of the Multinational Firm
Strategic motives drive the decision to invest abroad and
become a MNE and can be summarized under the following
categories:
Market seekers
Raw material seekers
Production efficiency seekers
Knowledge seekers
Political safety seekers
These categories are not mutually exclusive.

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 The Globalization Process
Stage I: early domestic phase growing into the
international trade phase (Exhibit 1.5)
Stage II: A successful firm will continue to grow
from simple international trade to the
multinational phase characterized by production
and investment both at home and abroad (Exhibit
1.6)
Growth may be limited by the twin agency
problems of corporate insiders and the rulers of
sovereign states (Exhibit 1.7)
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Exhibit 1.5 Trident Corp: Initiation of the Globalization
Process

ESM: 13th edition 28

Exhibit 1.6 Tridents Foreign Direct
Investment Sequence

ESM 13th edition 29

Exhibit 1.7 Potential Limits of Financial
Globalization

ESM: 13th edition 30

 Homework
Chapter 1: problems 1 to 5. Recardian theory
of Comparative advantages . China and
France, due on Tuesday, 14th. Hand in by
group or individually

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 Assignment: Prepare the Porsche
case before Wednesdays
workshop
Form two groups A and B: one will present the Porsche
Changes Tack case. The other asks questions, Preparation
needed.
The Case is to be found on course homepage under
course notes. htp://www.iei.liu.se/fek/frist/723G33?l=en
Discussion of the class follows: various risk management
aspects of Porsche. Ownership, management style,
synergies, financial risks, performance, etc.
Other info: Porsche Homepage htp://www.porsche-
se.com/pho/en/

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 The holding structure of Porsche SE as of
May 3rd, 2012.

voting rights
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 Some concepts before the case of Porsche
Changes Tack
Ownership structure and corporate governance
Owner control vs. Management control
Family ownership (concentrated ownership: common in
Continental Europe
Shareholder oriented governance structure, or
stakeholder oriented governance structure
The conflicts of interests: shareholders verses other
constituents (stakeholders: debt holders, labor unions,
governments, etc),
Performance measures, ROA, ROE
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Mini-Case Questions: Porsche Changes Tack

1. What strategic decisions made by Porsche over the years

1999 to 2004 had given rise to its extremely high return on
invested capital?
2. Vesilina D. wondered if she might have to distinguish
between the Porsches ability to generate results for
stockholders versus its willingness to do so. What do you
think?
3. Is pursuing the interest of Porsches controlling families
different from maximizing the returns to its public share
owners?

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Exhibit 1 Porsches Growth in Sales, Income,
and Operating Margin

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 Exhibit 2 Return on Invested Capital
(ROIC) for European Automakers, 2004

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Exhibit 3 Porsches Velocity (capital
turnover), Margin, and ROIC

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 Useful links for today
Main Book homepage for Multinational Business Finance ,
13th, 12th ed. Both are ok.
htp://wps.pearsoned.co.uk/ema_ge_eiteman_mbf_13/
htp://wps.pearsoned.co.uk/ema_ge_eiteman_mbf_12/
Corporate Finance Foundations: Global Edition, by Hirt,
Block and Danielsen, 14E, McGraw-Hill. Chapter 19 and 21
htp://highered.mcgraw-hill.com/sites/0073530727/studen
t_view0/index.html
htp://highered.mcgraw-hill.com/sites/0073530727/student
_view0/video_clips.html
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 Practical help
How to get around Linkping University?
1. English version of the University:
htp://www.liu.se/?l=en
2. Need help? book a Librarian for information
searching and database, etc.
htp://www.bibl.liu.se/?l=en
3. School map:
htp://www.liu.se/om-liu/till-liu/kartor?l=en
Search a location, reserve a room etc.
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