IF EXAM Flashcards
Why’s it important to understand international finance?
Investors: make decisions based on exch rates etc
G.ments: make changes and dont repeat mistakes
MNC’s : manage money and risk internationally
recent IF trends
MNC’s rising, conducting business in multiple countries. Free trade agreements such as EU, single market and NAFTA helped with this
what is triangular arbitrage?
an arbitrage process involving three currencies
Problems from investing internationally
euro restricted greek and italian governments ability to respond to economic problems. Western companies (MNC’s) take advantage of cheap labour overseas. Causes lack of employment in mid west america and northern england.
If currency weakens e.g. 5%
Current currency * 95%
Chinas current account
Surplus. Exports are competitive but currency is undervalued. High prices for chinese consumers.
Future it may be pressured to revalue as other countries feel its exch rate puts their own products at a competitive disadvantage
UK’s Current account
Deficit. increasing debt, which is unsustainable/ increasing foreign ownership of domestic assets. Could cause problems in the future due to potential for capital flight.
what does a premium mean for the forward and spot price
premium in forward market means forward market price is LARGER than spot price
ways to combat a forced devaluation
sell reserves
raise interest rates
use capital controls
tax/subsidise international trade to influence demand for foreign currency
advantages of fixed exchange rate
provide microeconomic benefits, reduce transaction exch risk, bis asks spreads and uncertainty . May also aid gment in pursuing a policy e.g. export led growth
disadvantages of fixed exchange rate
hamstring monetary policy, lead to macroeconomic policy, require capital controls that are unpopular and difficult to implement
target zone
implies central bank intervention to keep the exch rate within a certain range
crawling peg
implies central bank intervention to keep the exch rate movements below a certain level
optimum currency area
the region that best balances the microeconomic benefit of a SINGLE currency w/ the macroeconomic problems.
downsides of optimum currency area
small currency area is costly
large currency area can cause severe regional recessions, especially if theres no political union
inter war gold standard
abandoned due to monetary policy being implemented to sustain international monetary systems. Governments chose instead to carry out monetary policy to suit their own best interests.
eurozone future
Eurozone similar to gold standard.
If no political union countries may leave as it wont serve their best interests.
Italy and Greece want to leave.
impossible trinity of exchange rate systems problem
only 2 / 3 are possible
perfect capital mobility
fixed exchange rates
domestic monetary autonomy
impossible trinity of exchange rate systems explained
perfect capital mobility requires a floating exchange rate or use of monetary policy to fix exch rate.
monetary autonomy requires leaving exch rate
rodriks political trilemma problem
democracy
national sovereignty
deep global economic integration
rodriks political trilemma explained
economic integration requires EU to be federal like US, this means no national sovereignty. National sovereignty means making own laws. Democracy, means people vote for their own interests.
a straight bond
fixed coupon payment and final payment at maturity
floating rate note
floating interest rate varies w/ short term libor
convertible bonds
allow holder to convert the bonds into a stock and have an option feature
managers inclined to hedge foreign currency risk?
want to avoid downside risk as if bankruptcy occurs they lose their jobs
M&M argument hedging is irrelevant
say shareholders can make or undo hedge according to their own preference
violation of M&M hedging theory
hedging reduces the risk of bankruptcy costs (admin and legal costs) hedging also gives tax benefits
burst of an international finance bubble cause problems for domestic banks
causes asset prices to drop, creates BS problems for banks (L>A). Causing a bankruptcy chain on other banks.
Gment may increase pressure by raising interest rates.
one segment of international bond market
foreign bond market
subject to local regulations
foreigner issues bonds in a domestic bond market
second segment of international bond market
eurobond market
bonds issued simultaneously in various markets
not subject to any regulation
public bourse
gment appoints brokers and ensures a monopoly (deregulation in 80s/90s means most bourses are private)
private bourse
owned and operated by a corporation for trading securities
price driven system
dealers stand ready to buy at a bid price and sell at an ask price
order driven system
share prices are determined in an auction using S and D of shares
advantages of cross listing shares
lower cost of capital
improve liquidity
better corporate governance
provide access to foreign capital
one reason for int banking reg
central banks need a framework to make sure good level of capital is maintained. (bank failures = financial crisis)
another reason for int banking reg
diff national regulations gives advantages to other countries. Int reg creates an even playing field for competition.
consequences of currency crises
devaluation led recovery
financial crisis
recession
why do currency crises vary
based on vulnerability of domestic banking sector.
domestic governments management of currency.
info to determine appreciation or depreciation of a floating currency
empirically, the forward rate.
Also PPP rates and expected inflation.
usefulness of technical analysis of international parity
Not useful.
information on previous rates doesn’t help predict accurately future rates.
three methods of predicting exchange rates
Technical analysis
PPP
Market based
predicting exch rates TA
attempting to find patterns in previous movements
predicting exch rates PPP
assume that market exch rate will tend towards PPP
predicting exch rates MB
look at the forward rates to predict
market forces preventing PPP in real economics
adjustment for inflation
sticky prices
variation in forex rates
differential taxes, tariffs and transaction costs
what is relative PPP
theory suggest exch rates adjust in response to differences in inflation rates
URIP definition
links expected exch rate and interest rate differentials
CIRP definition
links forward rates, spot rates and interest rate differentials
URIP Vs CIRP
CIRP is more likely to hold because all aspects are observable and so arbitrage can be exploited
order driven vs price driven
order driven is easily automated and uses a computer to determine equillibrium price
disadvantages of hedging equity risk
spread reduced due to long hedge
benefits for risk management are small
advantages of hedging equity risk
tax benefits
losses can be offset
law of one price
an ideal market where everything costs the same everywhere
violations of law of one price
tariffs and quotas
transaction costs
noncompetitive markets
sticky prices
peso problem
possibility that infrequent or unprecedented event may occur affects asset prices
forward>spot
premium
forward less than spot
discount
premium/discount rate %
forward-spot/spot * 360/n *100
$/E spot value date
2 days
settlement of contracts
+ 1 day
forward rates 50/48
when first is > then you subtract
forward rates 48/50
when first is smaller then you add
home bias
investors have not fully internationally diversified.
heavily invested in own stock markets
decline of home bias
no barriers to international investment
home bias re emergence
2008/9 financial crisis caused austerity and increased home bias
