Global Finance Na Pamatay
Global Finance Na Pamatay
Global Finance Na Pamatay
to global
finance
Introduction
Today’s MNEs depend not only on the
emerging markets for cheaper labor, raw
materials, and outsourced manufacturing, but
also increasingly on those same emerging
markets for sales and profits
“
○ BRIC (Brazil, Russia, India, and China)
○ BIITS (Brazil, India, Indonesia, Turkey,
South Africa, which are also termed the
Fragile Five)
○ MINT (Mexico, Indonesia, Nigeria, Turkey)
The Global Financial Marketplace
○ Business—domestic, international, global—
involves the interaction of individuals and
individual organizations for the exchange of
products, services, and capital through
markets.
○ The global capital markets are critical for the
conduct of this exchange.
Assets, Institutions, and Linkages
○ Assets
○ Financial assets at the heart of the global
capital markets are the debt securities issued
by governments
○ The health and security of the global financial
system relies on the quality of these assets.
Assets, Institutions, and
Linkages
○ Institutions
○ Central banks, commercial banks, other
financial institutions
○ The health and security of the global financial
system relies on the stability of these financial
institutions
Assets, Institutions, and
Linkages
○ Linkages
❑ Gresham’s law
❑ “bad” (abundant) money drives out
“good” (scarce) money
Classical Gold Standard: 1875–1914
international gold standard
1. gold alone is assured of unrestricted
coinage
2. there is two-way convertibility
between gold and national currencies
at a stable ratio
3. gold may be freely exported or
imported
Classical Gold Standard: 1875–1914
• The exchange rate between any two
currencies will be determined by their
gold content
• Example:
• Price of gold (Britain) = GBP6.00/ounce
• Price of gold (France) = FRF12.00/ounce
• Exchange rate: 12/ 6 = FRF2.00/GBP
Classical Gold Standard: 1875–1914
• Price-specie-flow mechanism
• Automatic correction of trade imbalances
through price
• Price-specie-flow mechanism
Net Exports
Britain > France
• Economic nationalism
• Halfhearted attempts and failure to
restore the gold standard
• Economic and political instabilities
• Bank failures
Interwar Period: 1915–1944
Characteristics, cont.
• Established IMF
• IMF generated set of rules and
international monetary policies and a
mechanism for enforcement
• Established IBRD (World Bank)
• A dollar-based gold-exchange standard
Bretton Woods System: 1945–1972
• Triffin paradox
• SDR
SDR
Currency Unit Currency amount Exchange rate U.S. dollar equivalent
Chinese yuan 1.01740 6.47950 0.15702
Euro 0.38671 1.21055 0.46813
Japanese yen 11.90000 106.32500 0.11192
U.K. pound 0.08595 1.39250 0.11968
U.S. dollar 0.58252 1.00000 0.58252
USD per SDR 1.43927
USD1.00 = 0.694797
* RMB and JPY currency per USD
the rest are in terms of USD per unit of the currency
The Flexible Exchange Rate Regime: 1973–
Present
Jamaica Agreement
• Flexible exchange rates were declared
acceptable to the IMF members
• Gold was officially abandoned as
international reserve
• Greater access to IMF fund were given to
non-oil and less-developed countries
The Balance of
Payments
The Balance of Payments
B. Capital Account
Capital transfers related to the purchase and sale of
fixed assets such as real estate
Generic BOP
C. Financial Account
1. Net foreign direct investment
2. Net portfolio investment
3. Other financial items
Financial Account and Components
Generic BOP
A. Current Account
1. Goods trade and import of good
2. Services trade
3. Income
4. Current transfers
4-14
The Capital/Financial Account
▪ Capital account
▪ Financial account
▫ A. Direct investment
▫ B. Portfolio investment
▫ Other investment assets/liabilities
4-15
Net Errors & Omissions/Official
Reserves Accounts
4-16
The BOP in Total — Surplus
▪A surplus in the BOP implies that the
demand for the country’s currency
exceeded the supply
4-17
The BOP in Total — Deficit
▪A deficit in the BOP implies an
excess supply of the country’s
currency on world markets
4-18
The BOP Interaction with Key
Macroeconomic Variables
4-19
The BOP and GDP
▪A nation’s GDP can be represented by
the following equation:
GDP = C + I + G + X – M
4-20
The BOP and Exchange Rates
▪A country’s BOP can have a significant
impact on the level of its exchange rate and
vice versa
▪The relationship between the BOP and
exchange rates can be illustrated by use of a
simplified equation that summarizes BOP
Data (see next slide)
4-21
‘t repos
BOP and Exchange Rate Regimes/ Systems
Fixed Exchange Rate Countries
▪ If the sum of capital and current account is
>0, there’s a surplus demand for the
domestic currency
▪ Gov’t must sell domestic currencies for
foreign currencies
4-23
BOP and Exchange Rate Regimes/ Systems
Fixed Exchange Rate Countries
▪ If the sum is ─ , excess supply of domestic
currencies exists
▪ Gov’t must buy the excess supply of its
currency in the world market by using its
forex reserves
4-24
BOP and Exchange Rate Regimes/ Systems
Floating Exchange Rate Countries
4-26
The BOP and Interest Rates
▪ Relatively low real interest rates should
normally stimulate an outflow of capital
seeking higher rates elsewhere
4-27
BOP and Inflation Rates
▪ Imports have the potential to lower a
country’s inflation rate
4-28
Trade Balances and Exchange Rates
▪ transmission mechanism
▪ changes in exchange rates change relative
process of imports and exports, and
changing prices in turn result in changes in
quantities demanded through the price
elasticity of demand
4-29
Trade Balance Adjustment to Exchange Rate Changes: The J-
Curve
4-30
The J-Curve Adjustment Path
4-31
The J-Curve Adjustment Path
4-32
The J-Curve Adjustment Path
4-36
Capital Mobility
4-37
Exhibit 4.9 A Stylized View of Capital Mobility in
Modern History
4-38
Capital Flight
4-39
Mechanisms to move capital
1. Transfers via the international payments
mechanism
2. Transfer of physical currency by bearer
3. Cash is transferred into collectibles of precious
metals
4. Money laundering
5. False invoicing of international trade transactions
4-40
Mini-Case Questions: Turkey’s Kriz (A)
Created using
Outline
Exchange-
Function and The Traded
Structure of The Spot Forward
the FX Currency
Market market Funds
Market
01 02 03 04
INTRODUCTION
● 10 most traded
currencies in 2020
(https://www.ig.com/)
Function and Structure
of the FX Market
Structure of FX Market
FX brokers Central
banks
The Spot Market
Indirect
Direct
Foreign Exchange rates and Quotations
CUR1 / CUR2
If this is smaller
than the first
number, it must
be subtracted
from the spot
The Forward Market
Forward Point Quotations
─ ─
Forward Quotations in percentage Terms
Forward premium: Foreign Currency Terms
Forward Quotations in percentage Terms
Forward premium: Home Currency Terms
Premium or Discount on the Forward Rate
The difference between the forward rate (F) and the
spot rate (S) at any given time is measured by the
premium:
Premium or Discount on the Forward Rate
Given quotations for the spot rate and the forward rate at
any point in time, the premium can be determined by
rearranging the previous equation:
Premium or Discount on the Forward Rate
03 04
Forecasting
Fisher Effects
Exchange Rates
INTRODUCTION
15
16
Covered Interest Arbitrage (CIA)
17
Covered Interest Arbitrage (CIA)
18
Uncovered Interest Arbitrage (UIA)
19
Uncovered Interest Arbitrage (UIA):
The Yen Carry Trade
20
Purchasing Power
Parity
Prices and Exchange Rates
Law of one price: product’s price is the
same in all markets
Prices and Exchange Rates
Suppose the market between Japan and US
are competitive and efficient and that there are
no other costs associated with moving
products across these countries. Good X costs
¥183 in Japan while in the US, it is $2.05.
What is the expected spot ER under the law of
one price?
Absolute purchasing power parity
27
BIG MAC INDEX
Have fun with the BIG MAC INDEX
Exchange
Country Currency code Local Price rate
United Arab Emirates AED 14.75 3.6732
Argentina ARS 320.00 85.3736
Australia AUD 6.48 1.3000
Bahrain BHD 1.50 0.3770
Peru PEN 11.90 3.6207
Philippines PHP 142.00 48.0925
Poland PLN 13.08 3.7226
United States USD 5.66 1.0000
Determine the price of BIG MAC in USD, implied PPP, and Over/Under valuation
of foreign currencies against the USD
Big MAC: good candidate for the
application of the law of one price
● the product itself is nearly identical in
each market
● the product is a result of predominantly
local materials and input costs
30
Big MAC: good candidate for the
application of the law of one price
● Limitations:
● Big Macs cannot be traded across
borders, and costs and prices are
influenced by a variety of other factors in
each country market, such as real estate
rental rates and taxes
31
Exchange Rate Pass-Through
32
Exchange Rate Pass-through: Example
● Assume that the price in U.S. dollars and Euros of a BMW
automobile produced in Germany and sold in the United States at
the spot exchange rate is calculated as follows:
● If the euro were to appreciate 20% versus the U.S. dollar, from
$1.00/€ to $1.20/€, the price of the BMW in the U.S. market should
theoretically rise to $_____? Suppose the price of BMW rise to just
$40,000, then the price increase is
33
Exchange Rate Pass-through: Example
● Exchange rate pass through then is
14.29
● Exchange rate pass through = = 0.71 or 71%
20
34
Exchange Rate Pass-Through: Example
where
i = nominal rate of interest,
r = the real rate of interest
π = expected rate of inflation over the period of time for which funds are
to be lent
The Fisher effect
The approximate form is
Where
id = domestic nominal interest rate
if = foreign nominal interest rate
The International Fisher effect
Future spot exchange rate is approximated by
St /S0 = (1 +id)/(1+if)
Where
St = spot exchange rate in the future
S0 = current spot exchange rate
The International Fisher effect
Suppose the IDR/USD spot rate is 14,000,
and the US interest rate is 2.0%, while
Indonesia is 6.0%. What would be future spot
rate for the USD?
Forecasting Exchange Rates
1. Efficient Market Approach
Another model:
Noise
Offsetting a Forward Contract. In some cases, an MNC may desire to offset a forward contract
that it previously created.
EXAMPLE: On March 10, Green Bay, Inc., hired a Canadian construction company to expand its office and agreed
to pay C$200,000 for the work on September 10. It negotiated a six-month forward contract to obtain C$200,000
at $0.70 per unit, which would be used to pay the Canadian firm in six months. On April 10, the construction
company informed Green Bay that it would not be able to perform the work as promised. Therefore, Green Bay
offset its existing contract by negotiating a forward contract to sell C$200,000 for the date of September 10.
However, the spot rate of the Canadian dollar had decreased over the last month, and the prevailing forward
contract price for September 10 is $0.66. Green Bay now has a forward contract to sell C$200,000 on September
10, which offsets the other contract it has to buy C$200,000 on September 10. The forward rate was $0.04 per unit
less on its sale than on its purchase, resulting in a cost of $8,000 (C$200,000 x $0.04).
If Green Bay, Inc., negotiates the forward sale with the same bank with which it negotiated
the forward purchase, then it may be able to request that its initial forward contract simply
be offset. The bank will charge a fee for this service, which will reflect the difference between
the forward rate at the time of the forward purchase and the forward rate at the time of the
offset. Thus, the MNC cannot ignore its original obligation; rather, it must pay a fee to offset
that obligation.
Using Forward Contracts for Swap Transactions. A swap transaction involves a spot
transaction along with a corresponding forward contract that will ultimately reverse the spot
transaction. Many forward contracts are negotiated for this purpose.
EXAMPLE: Soho, Inc., needs to invest 1 million Chilean pesos in its Chilean subsidiary for the production of
additional products. It wants the subsidiary to repay the pesos in one year. Soho wants to lock in the rate at which
the pesos can be converted back into dollars in one year, and it uses a one-year forward contract for this purpose.
Soho contacts its bank and requests the following swap transaction.
1. Today. The bank should withdraw dollars from Soho’s U.S. account, convert the dollars to 1 million pesos
in the spot market, and transmit the pesos to the subsidiary’s account.
2. In one year. The bank should withdraw 1 million pesos from the subsidiary’s account, convert them to
dollars at today’s forward rate, and transmit them to Soho’s U.S. account.
These transactions do not expose Soho to exchange rate movements because it has locked in the rate at which
the pesos will be converted back to dollars. However, if the one-year forward rate exhibits a discount then Soho
will receive fewer dollars later than it invested in the subsidiary today. Even so, the firm may still be willing to
engage in the swap transaction so that it can be certain about how many dollars it will receive in one year.
EXAMPLE: Jackson, Inc., an MNC based in Wyoming, determines as of April 1 that it will need 100 million Chilean
pesos to purchase supplies on July 1. It can negotiate an NDF with a local bank as follows. The NDF will specify
the currency (Chilean peso); the settlement date (90 days from now); and a reference rate, which identifies the
type of exchange rate that will be marked to market at the settlement. Specifically, the NDF will contain the following
information.
Assume that the Chilean peso (which is the reference index) is currently valued at $0.0020, so the dollar amount
of the position is $200,000 ($0.0020 x 100 million Chilean pesos) at the time of the agreement. At the time of the
settlement date (July 1), the value of the reference index is determined and then a payment is made from one party
to another in settlement. For example, if the peso value increases to $0.0023 by July 1, the value of the position
specified in the NDF will be $230,000 ($0.0023 x 100 million pesos). Since the value of Jackson’s NDF position is
$30,000 higher than when the agreement was created, Jackson will receive a payment of $30,000 from the bank.
Recall that Jackson needs 100 million pesos to buy imports. Since the peso’s spot rate rose from April 1 to July 1,
the company will need to pay $30,000 more for the imports than if it had paid for them on April 1. At the same time,
however, Jackson will have received a payment of $30,000 due to its NDF. Thus, the NDF hedged the exchange
rate risk.
Suppose that, instead of rising, the Chilean peso had depreciated to $0.0018. Then Jackson’s position in its NDF
would have been valued at $180,000 (100 million pesos x $0.0018) at the settlement date, which is $20,000 less
than the value when the agreement was created. In this case, Jackson would have owed the bank $20,000 at that
time. Yet the decline in the spot rate of the peso means that Jackson would also pay $20,000 less for the imports
than if it had paid for them on April 1. Thus, an offsetting effect occurs in this example as well.
The preceding examples demonstrate that, even though an NDF does not involve delivery, it
can effectively hedge the future foreign currency payments anticipated by an MNC.
Because an NDF can specify that any payments between the two parties be in dollars or some
other available currency, firms can also use NDFs to hedge existing positions of foreign
currencies that are not convertible. Consider an MNC that expects to receive payment in a
foreign currency that cannot be converted into dollars. The MNC may use this currency to
make purchases in the local country, but it may nonetheless desire to hedge against a decline
in the value of that currency over the period before it receives payment. Hence the MNC takes
a sell position in an NDF and uses the closing exchange rate of that currency (as of the
settlement date) as the reference index. If the currency depreciates against the dollar over
time, then the firm will receive the difference between the dollar value of the position when
the NDF contract was created and the dollar value of the position as of the settlement date.
It will therefore receive a payment in dollars from the NDF to offset any depreciation in the
currency over the period of concern.
Source:
Madura, Jeff (2015). International Financial Management, 12th ed. Stamford: Cengage
Learning.
Selected Exercises on Forex Market
1. Restate the following one-, three-, and six-month outright forward European term bid-
ask quotes in forward points:
2. Given the following information, what are the NZD/SGD currency against currency bid-
ask quotations?
Ignoring transaction costs, does Doug Bernard have an arbitrage opportunity based
on these quotes? If there is an arbitrage opportunity, what steps would he take to
make an arbitrage profit, and how much would he profit if he has $1,000,000 available
for this purpose?
4. Compute the forward discount or premium for the Mexican peso whose 90-day
forward rate is $0.102 and spot rate is $0.10. State whether your answer is a discount
or premium.
Linear trend and multiple regression
The equation that describes a straight line through our sample of ordered pairs, known as a linear
equation, takes the form
We will use the following data to manually compute the equation that represents the relationship
between time and exchange rate on the assumption that time is the only determinant of exchange rate.
We will use the ordinary least squares method to estimate the slope and the intercept. The least
squares method is a mathematical procedure used to identify the linear equation that best fits a set of
ordered pairs. The line that best fits the ordered pairs is called the regression line. The procedure can be
used to find the values for b0 (the y-intercept) and b1 (the slope of the line).
Day (x) S1 (y)
1 50.897
2 50.856
3 50.686
4 50.582
5 50.604
6 50.702
7 50.626
8 50.513
9 50.507
10 50.86
11 51.118
12 51.174
13 51.32
14 51.215
15 50.947
From these formulas, it follows that you need to have a (1) column for xy, that is, x multiplied by the
value of y and then getting its sum; (2) a column for x2 and then getting its sum. The n in this case is the
number of paired values of x and y (day and exchange rate, s1).
Your table will look something like this
Day (x) S1 (y) xy x2
1 50.897
2 50.856
3 50.686
4 50.582
5 50.604
6 50.702
7 50.626
8 50.513
9 50.507
10 50.86
11 51.118
12 51.174
13 51.32
14 51.215
15 50.947
Proceed and complete those that are required in the formula: get the sum of x, the sum of y, the sum of
xy and the sum of x2. The first value you can estimate is the value of b 1 because you need to plug this
value in the given formula to calculate the value of b0.
After calculating the value of b1 and b0, respectively, your linear trend equation will be
S = b 0 + b1 x
So, if the estimated b0 and b1, are 0.30 and 0.60, respectively, your equation will be S = 0.30 + 0.60x. You
can now use this equation to estimate the value of S for, say, day 16 in which the value of x is 16.
Now use your estimated b0 and b1 to forecast the exchange rate for day 16.
1. Open your Excel file using the following: Click File, Open data, User file and locate the file in your
computer. Make sure that in the scroll menu All files is chosen so that it can open your excel file
2. When asked about the structure of data, choose Time-series and Time series frequency must be
Other
3. After this is done. Go to Model and click Ordinary least squares. You will then be brought to a
scroll down menu to specify the model. Highlight S1 and click the arrow for the dependent
variable. Highlight Day and click the arrow for regressors.
4. Click Ok. The gretl output generates the value (Coefficients) of the constant and the value for
Day. The constant is your intercept (b0) and the coefficient for Day is your b1. You should check
this against your results using the formulas given above.
5. Use the equation to forecast exchange rate for day 16, day 17, and so on.
References:
Donnelly, Robert A. (2015). Business statistics, 2nd ed. Boston: Pearson Education.
www.bsp.gov.ph
Multiple regression
The model:
ER = α + β1INT +β2CPI + μ
Where
Possible actions
Output
Click tofrom
edit Stata 16
automatic update checking preferences
. import excel "C:\Users\resty\Documents\2nd sem AY2020 2021\ELE04 GLOBAL FINANCE\FX dataset.xlsx", sheet("dataset
> ") firstrow
(3 vars, 36 obs)
Gretl output
References:
Donnelly, Robert A. (2015). Business statistics, 2nd ed. Boston: Pearson Education.
www.bsp.gov.ph