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Course introduction for 723G33

Risk Management and derivatives(former 723g14 International Finance)

Yinghong.chen@liu.seYH Chen, Doctor in Financial Economics

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Contents

1. Couse introduction for 723G332. Main Book, Other Reference books, chapters3. Detailed schedule4. Theories of international trade: comparative

advantage and competitive advantage5. Homework 16. Assignment: preparation of Case Porsche

changes tack

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LiU: Campus Valla

Class location

Library

Exam place

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Main book: Multinational Business Finance by Eiteman, Stonehill and Moffett

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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

Tue May 713:15-15:00 L1 T15 Course Outline, Important Topics In

International Corporate Finance, chapter 1

Wed May 813:15-17:00

L2, seminar 1 p26 ESM:chapter 2-3, Case: Porsche Changes

Tack

Homework: end of chapter 1, question 1-5

Tue May 14

13:15-15:00 L 3 T11 ESM: Chapter 5, 6, 7 Foreign Exchange

Market and parity conditions

Wed May 15

13:15-15:00 L4 P26 ESM:chapter 8, 9 currency derivatives,

Exchange rate

Thu May 16

13:15-15:00 L 5 P26 ESM: Chapter 10, 11, 12: exposure

managementBooking underway 17 ? data

system Börssal instructor

The Use Of The Datastream. Collect Data For Exchange Rate Theory Test

Tue May 21

13:15-15:00 Seminar 2 T15 Exercise 4-12, Questions session

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Wed May 22

13:15-15:00 L 6 T11

ESM: chapter 17, 19: Risk management: an integrated risk approach. Financial risk, operational risk, macroeconomic risk, country risk, etc

Wed May 29

13:15-15:00

Final Seminar T15

Project presentation (by group)Group A, B, C, DDiscussant group (E, F, G, H)

15:15-17:00

Final Seminar T15

Project presentation (by group)Group E, F, G, H discussant group (A, B, C, D)

Thu May 30

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

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, 27th 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

• Porter´s 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 A’s 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 country’s 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.

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Exhibit 7.11 International Parity Conditions in Equilibrium (Approximate Form)

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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

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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 better 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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• 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.

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

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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

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Exhibit 1.6 Trident’s Foreign Direct Investment Sequence

ESM 13th edition

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Exhibit 1.7 Potential Limits of Financial Globalization

ESM: 13th edition

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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 Wednesday’s

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. http://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 http://www.porsche-se.com/pho/en/

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

¹ 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 Porsche’s ability to generate results for stockholders versus its willingness to do so. What do you think?

3. Is pursuing the interest of Porsche’s controlling families different from maximizing the returns to its public share owners?

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Exhibit 1 Porsche’s 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 Porsche’s 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.http://wps.pearsoned.co.uk/ema_ge_eiteman_mbf_13/ http://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 21http://highered.mcgraw-hill.com/sites/0073530727/student_view0/index.htmlhttp://highered.mcgraw-hill.com/sites/0073530727/student_view0/video_clips.html

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Practical help

How to get around Linköping University? 1. English version of the University:

http://www.liu.se/?l=en 2. Need help? book a Librarian for information

searching and database, etc.http://www.bibl.liu.se/?l=en

3. School map:http://www.liu.se/om-liu/till-liu/kartor?l=en Search a location, reserve a room etc.