(2015-S1) - FINS3616 - Tutorial Slides - Week 02 - Introduction + Global Financial System + FX Systems

INTERNATIONAL
BUSINESS FINANCE
FINS3616
Tutorial
Week2
TheGlobalFinancialSystem&ExchangeRateSystems
CONTACT DETAILS
YourTutor&TutorinCharge:
PeterAndersen
peter.andersen@unsw.edu.au
Besuretocheckyourstudentemailaccountlotsthroughoutthe
semester,asIllbesendingyoumyslidesandlotsofothermaterials.
4
FINS3616 PeterKjeldAndersen(2015S1)
ASSESSMENTS
ASSESSMENT
DATE
HOWMUCH
TutorialAttendance&
Participation
Everyweek
10%
Midsemester
Examination
Week7(inLecture)
30%
Group Project
Weeks11+12
25%
Final Exam
Exam Period
35%
6
CLASS PARTICIPATION CLARIFICATION

Classparticipationmarksaredesignedforyoutodemonstratethat
youhaveprepared theassignedtutorialhomeworkmaterialprior
toclass.
Therewillbenewquestions giventoyouinclass,whichyouwill
completeinyourassignmentgroups.Doingthesenewquestionsin
atimeefficientmannerwillrequireyoutohavecompletedthe
homeworkpriortoclass.
Afteranallottedamountofworkingtime,groupswillbechosenat
randomtoteachoneofthequestionstotherestoftheclass.
Everybodyinthegroupmustgetuptopresentaportionofthe
groupsassignedquestion.
7
LETS BEGIN
8
THE GLOBAL FINANCIAL SYSTEM
TUTORIAL QUESTION 1
Q.
Defineglobalization.Howhasitproceededintradeingoodsandservices
versuscapitalmarkets?
A.
Globalizationreferstotheincreasingconnectivityandintegrationofcountries
andcorporationsandthepeoplewithinthemintermsoftheireconomic,
political,andsocialactivities.
Becauseofglobalization,multinationalcorporationsdominatethecorporate
landscape.
TUTORIAL QUESTION 2
Q.
Describefourwaysthatacompanycansupplyitsproductstoaforeign
country.Howdotheydiffer?
A.
AnMNCcansupplyaforeignmarketthrough:
Licensing
franchisinglocalfirmsabroadtomanufacturethecompanysproducts
Settingupajointventurewithaforeigncompany,
orbyforeigndirectinvestment.
TUTORIAL QUESTION 3
Q.
WhatpercentageownershiptypicallydefinesFDI?
A.
Foreigndirectinvestment(FDI)occurswhenacompanyfromonecountry
makesasignificantinvestmentthatleadstoatleasta10%ownershipinterest
inafirminanothercountry.
TUTORIAL QUESTION 4
Q.
Whatistheagencyproblem?Howdocompaniesovercometheconflictof
interestbetweenmanagersandshareholders?
A.
Agencyproblemsarisebecausetheownersofthefirmdonottypically
managethefirm,anditdeviseswaystoresolvetheseproblems.Thisisoften
calledtheseparationofownershipandcontrol.
Amanagerofafirm,inparticularthechiefexecutiveofficer(CEO),isviewed
asanagentwhocontractswithvariousprincipalsmostimportantlythe
firmsshareholdersbutalsothefirmscreditors,suppliers,clients,and
employees.
Theprincipalsmustdesigncontractsthatmotivatetheagenttoperform
actionsandmakedecisionsthatareinthebestinterestsoftheprincipals.
TUTORIAL QUESTION 5
Q.
Whyisownershipmoreconcentratedinemergingcountriesthanthatin
developedcountries?
A.
Inmanydevelopedcountries,theruleoflawisstrongenoughtodiscipline
managersthroughlegalmeans,forexamplebytakeoversandproxycontests
orthroughcontractualcompensationplans.
Concentratedownershipisonewayinwhichagencyproblemsaremitigatedin
developingcountries.Ablockofstockisheldbyeitherawealthyinvestor,a
family,orafinancialintermediary,whichmightbeabank,aholdingcompany,
ahedgefundorapensionfund.Thelargeshareholderclearlyhasavested
interestinmonitoringmanagementandhasthepowertoimplementchanges
inmanagement.
Negativeaspectsofthisapproachincludepossiblecollusionbetweenthelarge
shareholderandthemanagementtoexpropriatewealthfromsmaller
shareholdersandthefactthatthestockmaybemoredifficulttotradeonthe
stockmarketifasubstantialblockofsharesiswithdrawnfromthemarketbut
isstillavailabletobesoldshouldthelargeshareholderwanttosell.
TUTORIAL QUESTION 9
Q.
Whatisaninstitutionalinvestor?Alongwithindividualinvestors,whatdo
theydetermine?
A.
InstitutionalInvestorsareorganizationsthatinvestpoolsofmoneyonbehalf
ofindividualinvestorsorotherorganizations.
Examplesincludebanks,insurancecompanies,pensionfunds,mutualfunds,
anduniversityendowments.
Institutionalinvestors,togetherwithindividualinvestors,determinetheprices
ofbondsandstocksimplicitlydeterminingtheexpectedratesofreturnon
theseassetstherebysettingtheMNCscostofcapital.
Thecostofcapital,inturn,affectsprojectvaluations,whichdeterminesa
companysinvestments.
TUTORIAL QUESTION 12
Q.
Whatdoesitmeanforacountrytoexperienceacapitalinflow?
A.
Whenacountryexperiencesacapitalinflow,foreignresidentsareinvestingin
domesticassetsanddomesticresidentsaresellingforeignassets.
Thesetransactionsarecreditsonthebalanceofpaymentsbecausethe
countryiseffectivelyexportingassets.
TRUE OR FALSE
Q.
MNCshaveinvestmentorfinancialoperationsinmorethanonecountry.
A.
True
Q.
Thetermsstakeholderandshareholderaresynonymous.
A.
False
Q.
TheMNCfacesgreaterconstraintsthanthedomesticcorporationinthe
timingandlocationofitsinvestments.
A.
False
Q.
Politicalriskistheriskthatthebusinessenvironmentinahostcountrywill
changeunexpectedlyduetopoliticalevents.
A.
True
TRUE OR FALSE
Q.
Thedomesticfinancialmanagermustbeknowledgeableinseveralareas
withinfinance,whereasthemultinationalfinancialmanagerusually
specializesinasinglearea,suchascorporatefinance,investments,or
financialmarkets.
A.
False
Q.
Theworldsfinancialmarketsarebecomingincreasinglysegmentedaslarge
internationalcommercialbanksachievemoreandmoreeconomicpower.
A.
False
Q.
Purchasesandsalesofforeignassetsbydomesticresidentswouldappearin
theofficialsettlementsaccountofthebalanceofpayments.
A.
False
Q.
Theexportandimportofeducation,insurance,consulting,
telecommunications,androyaltiesonfilmsshouldbeenteredinthe
unilateraltransferssubcategoryofthecurrentaccount.
A.
False
MCQ EXAMPLE 1
Q.
Corporatestakeholdersincludeeachofa.d.except____.
a)
Creditors
b)
Customers
c)
Managers
d)
Shareholders
e)
Eachoftheaboveisastakeholderinthefirm
Theanswerise).
MCQ EXAMPLE 2
Q.
Whatisthenamefortheshiftingofnonstrategicfunctionstospecialist
firmstoreducecosts?
a)
outsourcing
b)
multinationalcompany
c)
globalization
d)
import
e)
alloftheabove
Theanswerisa).
MCQ EXAMPLE 3
Q.
Whichofthefollowingwascreatedinanefforttopromotefreetrade?
a)
WorldTradeOrganization
b)
IMF
c)
Multilateraldevelopmentbanks
d)
TheOrganizationforEconomicCooperationandDevelopment
e)
Alloftheabove
Theanswerisa).
MCQ EXAMPLE 4
Q.
Whichoneofthefollowingisthemostcommonmethodofovercomingthe
agencyprobleminemergingcountries?
a)
concentratedownership
b)
independentboards
c)
hostiletakeovers
d)
foreigndirectinvestment
e)
shareholderactivism
Theanswerisa).
MCQ EXAMPLE 5
Q.
The____oftheIMFsBalanceofPaymentsStatisticsmeasurescrossborder
transactionsassociatedwithchangesinownershipofassetsandliabilities.
a)
Currentaccount
b)
Capitalaccount
c)
Tradeaccount
d)
Investmentincomeaccount
e)
Noneoftheabove
Theanswerisb).
MCQ EXAMPLE 6
Q.
Itistherightgiventofirmstoproducespecificproductsinexchangefora
________fee.
a)
Jointventure
b)
FDI
c)
Licensing
d)
Noneoftheabove
e)
Alloftheabove.
Theanswerisc).
EXCHANGE RATE SYSTEMS
25
TUTORIAL QUESTION 1
Q.
Whatislikelytohappenifacentralbanksuddenlyprintsalargeamountof
newmoney?
A.
Whereastherearetheoriesthatpredictthatchangesinthesupplyofmoney
haverealeffectsontheeconomyintheshortrun,itislikelythatifthecentral
bankshowerstheeconomysuddenlywithmoney,theonlyresultwillbe
higherinflation.
Thisisbecausethedemandformoneyultimatelydependsontheamountof
realtransactionsintheeconomyandhowmuchmoneyisneededtofacilitate
thesetransactions.
Additionalsupplyofmoneyisunlikelytomakepeopleconsumemoreorwork
harder.
TUTORIAL QUESTION 2
Q.
Howcanyouquantifycurrencyriskinafloatingexchangeratesystem?
A.
Tocharacterizetheriskofacurrencyposition,youmusttrytocharacterizethe
conditionaldistributionofthefutureexchangeratechanges.Withfloating
exchangerates,historicalinformationprovidesusefulinformationaboutthis
distribution.
Forexample,youcanusedatatomeasuretheaveragehistoricaldispersion
(standarddeviationorvolatility)ofthedistribution.Thehigherthisvolatility,
theriskierarepositionsinthiscurrency.
Finally,weshouldpointoutthatvolatilityisanadequateindicatorofrisk
whenexchangeratechangesareapproximatelynormallydistributed.
Inreality,thedistributionofexchangeratechangesdisplaysfattails,evenin
floatingexchangeratesystems,andthisincreasestheriskofcurrency
positions.
TUTORIAL QUESTION 3
Q.
WhatwastheBrettonWoodscurrencysystem?
A.
IntheBrettonWoodsSystem,inplacebetween1944and1971,the
participatingcountriesagreedtoanexchangerateregimethatlinkedtheir
exchangeratestothedollar.
Theycouldfluctuateina1%bandaroundafixedparity.Thedollaritselfhada
fixedgoldparity($35perounce).
Whenacountryranintoatemporarybalanceofpaymentsproblem(acurrent
accountdeficit)thatthreatenedthecurrencypeg,itcoulddrawonthe
lendingfacilitiesoftheIMF,alsoestablishedatBrettonWoodsin1944,tohelp
itdefendthecurrency.
Countrieswerealsoallowedtochangetheirparitieswhentheirbalancesof
paymentswereconsideredtobeinfundamentaldisequilibrium.
Thesystembrokedownin1971.
TUTORIAL QUESTION 4
Q.
Describetwodifferentcurrencysystemsthathavebeenintroducedin
countriessuchasHongKongandEcuadortoimprovethecredibilityof
peggedexchangeratesystems.
A.
HongKonghasacurrencyboardsystem.
Acurrencyboardisamonetaryinstitutionthatissuesbasemoney(notesand
coins,andrequiredreservesoffinancialinstitutions)thatisfullybackedbya
foreignreservecurrencyandfullyconvertibleintothereservecurrencyata
fixedrateandondemand.
Hence,thedomesticcurrencymonetarybaseis100%backedbyassets
payableinthereservecurrency.
Inpracticalterms,thisrequirementbarsthecurrencyboardfromextending
credittoeitherthegovernmentorthebankingsector.
EcuadorinsteadhasofficiallyadoptedtheU.S.dollarasitscurrency.
Thisisanexampleof(Official)dollarization,whichoccurswhenaforeign
currencyhasexclusiveorpredominantstatusasfulllegaltenderinaparticular
country.
TUTORIAL QUESTION 5
Q.
Whatisthedifferencebetweenatargetzoneandacrawlingpeg?
A.
Inatargetzone,thecurrencyisallowedtofluctuateinapercentageband
aroundacentralvalue.
Onecanviewapeggedsystemasatargetzonesystemwithaverynarrow
band.
Inacrawlingpegsystem,thefixedrateorbandisadjustedovertime,typically
inapredeterminedwayasafunctionoftheinflationdifferentialbetweenthe
crawlingpegcountryandthecountrytowhosecurrencythepegisset.
Suchasystemisoftenusedindevelopingcountries,wherethecrawlofthe
bandpreventsthecountryfromlosingtoomuchcompetitivenesswhenits
inflationrateishigherthanthatofthebenchmarkcountry.
TUTORIAL QUESTION 6
Q.
WhatwastheEMS?
A.
EMSstandsforEuropeanMonetarySystem,atargetzonesystemthat
operatedinEuropebetween1979and1999.
Exchangerateswere,formostofthetime,maintainedbetweenbandsof
2.25%aroundcentralrates.
ThecountriesparticipatingintheEMSwereagraduallyincreasingnumberof
EuropeanUnioncountries.
TUTORIAL QUESTION 7
Q.
WhatdidtheMaastrichtTreatytrytoaccomplish?
A.
The1991MaastrichtTreatymappedouttheroadtoeconomicandmonetary
unionwithintheEuropeanUniontobefinalizedby1999.
TheTreatycalledforeliminatingallremainingrestrictionsonthemovementof
capitalandpaymentsbetweenmemberstatesandbetweenmemberstates
andthirdcountries;thecreationofaEuropeancentralbank,andthe
introductionofanewcurrency,theeuro,in1999.
Themonetaryunionwasindeedestablished(butnotallEUcountries
participate).
TUTORIAL QUESTION 8
Q.
DoyoubelieveitsmonetaryunionwillbebeneficialforEurope?
A.
ThegainsarealreadybeingrealizedthroughoutEuropeforexample,car
priceshavedecreasedandconvergedacrossEurope.
Academicresearchdocumentssizableeconomicbenefitsfollowingthe
introductionoftheeurointermsofpriceconvergence,lowercostsofcapital,
andincreasedtrade.
Forexample,theEuropeanCommissionhasestimatedthemicroeconomic
gainsofmonetaryuniontoamountto0.5%ofGDPoftheentireEUa
substantialsum.
Ontheotherhand,thesovereigndebtcrisesinGreece,Ireland,andPortugal,
andpotentiallyinSpain,andthepersistenthighunemploymentratesinthese
countrieswhileGermanythrivessuggestthatasymmetricmacroeconomic
adjustmentcostsarepresentandarecausingstrainwithinEurope.
TUTORIAL QUESTION 9
Q.
WhatfactorscontributedtotheMexicanpesocrisisof1995andtotheAsian
crisesof1997
A.
Ineachinstance,thegovernmenttriedtomaintainthevalueofthelocal
currencyatartificiallyhighlevels.
Thisdepletedforeigncurrencyreserves.
Localbusinessesandgovernmentswerealsoborrowinginnonlocal
currencies(primarilythedollar),whichheavilyexposedthemtoadropinthe
valueofthelocalcurrency.
TUTORIAL QUESTION 10
Q.
WhatisthemoralhazardofIMFrescuepackagesforemergingmarkets
whichexperiencedcrises?
A.
Moralhazardoccurswhentheexistenceofacontractchangesthebehaviors
ofpartiestothecontract.
WhentheIMFassistscountriesindefendingtheircurrencies,itchangesthe
expectationsandhencethebehaviors oflenders,borrowers,and
governments.
Forexample,lendersmightunderestimatetherisksoflendingtostruggling
economiesifthereisanexpectationthattheIMFwillinterveneduring
difficulttimes.
TRUE OR FALSE
Q.
Theexchangeratesysteminwhichacountryallowsthevalueofthe
currencytobedeterminedbythemarketforcesofsupplyanddemandis
knownasapeggedexchangeratesystem.
A.
False
Q.
Inthepeggedexchangeratesystem,thecurrencyhaslimitedflexibilityand
therateiskeptwithinafixedband.
A.
False
Q.
Decreasesincurrencyvalueswithinafloatingratesystemarecalled
devaluations.
A.
False
Q.
IMFloanstotroubledeconomiesareunlikelytochangethebehaviors of
investors,becauseinvestorscanassesstherisksofmoralhazardfor
themselves.
A.
False
TRUE OR FALSE
Q.
Currencyincirculationshouldbeincludedintheassetsectionofacentral
bankbalancesheet.
A.
False
Q.
Officialinternationalreservesconsistofthemajorcomponentslikegold
reservesandforeignexchangereserves
A.
True
Q.
Capitalcontrolmeansthesetofregulationspertainingtoflowsofcapital
intoandoutofacountry
A.
True
Q.
Ifacentralbanksuddenlyprintsalargeamountofnewmoney,itmayresult
inhighinflation
A.
True
MCQ EXAMPLE 1
Q.
Whichofthefollowingcurrenciesiscurrentlylinkedtothepriceofgold?
a)
Britishpound
b)
Japaneseyen
c)
U.S.dollar
d)
Alloftheabove
e)
Noneoftheabove
Theanswerise)
MCQ EXAMPLE 2
Q.
Commonelementsinmanycurrencycrisesincludeeachofthefollowing
except:
a)
afixedexchangeratesystemthatovervaluedthelocalcurrency
b)
alargeamountofforeigncurrencydebt
c)
asteepdropinthevalueofthelocalcurrency
d)
IMFinterventiontoprovideshorttermassistance
e)
Alloftheabovearecommonduringcurrencycrises
Theanswerise)
MCQ EXAMPLE 3
Q.
WhichaccountshouldNOTbeincludedintheassetsectionofacentralbank
balancesheet?
a)
depositsofprivatefinancialinstitutions
b)
officialinternationalreserves
c)
domesticcredit
d)
governmentbonds
e)
Alloftheaboveshouldbeincluded
Theanswerisa)
MCQ EXAMPLE 4
Q.
Whatisthenegativesideeffectonthemoneysupplyofanonsterilized
foreignexchangeintervention?
a)
Ahighermoneysupplyeventuallyleadstolowerinflation,andthe
foreignexchangeobjectiveoftheIMF'spolicymayconflictwithits
abroadgoalofpricestability.
b)
Ahighermoneysupplyeventuallyleadstohigherinflation,andthe
foreignexchangeobjectiveoftheIMF'spolicymayconflictwithits
domesticgoalofpricestability.
c)
Ahighermoneysupplyeventuallyleadstolowerinflation,andthe
foreignexchangeobjectiveofthecentralbank'spolicymayconflict
withitsdomesticgoalofpricestability.
d)
Ahighermoneysupplyeventuallyleadstohigherinflation,andthe
foreignexchangeobjectiveofthecentralbank'spolicymayconflict
withitsdomesticgoalofpricestability.
e)
Noneoftheabove
Theanswerisd)
MCQ EXAMPLE 5
Q.
Whenacentralbankbuysforeigncurrency,itsinternationalreserves
________.
a)
decrease
b)
increase
c)
remainunchanged
d)
aredifficulttodetermine
e)
Alloftheabovearepossible
Theanswerisb)
MCQ EXAMPLE 6
Q.
Whatisthemostlikelyoutcomeifacentralbanksuddenlyprintsalarge
amountofnewmoney?
a)
nochangeintheinflationrate
b)
higherinflation
c)
recession
d)
prosperity
e)
nothingwillbechanged
Theanswerisb)

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INTERNATIONAL

CLASS PARTICIPATION CLARIFICATION

THE GLOBAL FINANCIAL SYSTEM

EXCHANGE RATE SYSTEMS

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