Part 7 interlaken finance class summer 2010 forum nexus
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Transcript of Part 7 interlaken finance class summer 2010 forum nexus
Class #7Interlaken, switzerland
Brian David ButlerProfessor of international finance and global entrepreneurship with Forum-Nexus Study Abroad. Guest lecturer with the IQS Business School of the Ramon Llull University in Barcelona, and the Catholic University of Milan. Previously, Brian taught finance, economics and global trade courses at Thunderbird’s Global MBA program in Miami, and worked as a research analyst with the Columbia Business School in New York City. Brian currently lives in Recife, Brazil where he is teaching classes at the university Faculdade Boa Viagem.
A global citizen, Brian was born in Canada, raised in Switzerland (where he attended international British school), educated through university in the U.S., started his career with a Japanese company, moved to New York to work as an analyst, married a Brazilian, and has traveled extensively in Latin America, Asia, Europe and North America.
LinkedIn/briandbutler
Skype: briandbutler
Brian Butler is a specialist in international economic analysis, and is founder of the prestigious “GloboTrends“ (www.globotrends.com) online economics site, which has been featured as syndicated content on Nouriel Roubini’s RGE Monitor, Emerginvest.com, Business Week Exchange, Wikinvest.com, and other leading news outlets.
http://globotrends.pbworks.com/ , http://blog.globotrends.com/
Find my slides:
www.slideshare.net/briandbutler
Lecture Schedule*
* Does not include professional visits, *Subject to change, modification without warning
•Tues 22th – boat to Greece
•Mon 26th – Athens
•Tues 27th – Rhodes•Wed 28th – Rhodes•Thurs 29th – Rhodes EXAM
Review
European Map question – name 2 major Eastern European countries that are NOT part of the Eurozone, but have floating exchange rates. Name 2 that are fixed (but not part of the eurozone)?
http://en.wikipedia.org/wiki/Enlargehttp://en.wikipedia.org/wiki/International_status_and_usage_of_the_euroment_of_the_eurozone
Pegged (“fixed”) to the EURO
Free floating EU members – the rest•The BIG 2 -- Poland and the Czech
Republic:•Benefit during crisis:
▫“Poland’s real effective exchange rate, allowing for differences in unit labour costs, fell by almost 20 per cent between 2008 and 2009. That speedy boost to competitiveness helped it to become the only European Union state to evade recession last year
▫Who can explain this?http://www.ft.com/cms/s/0/54fdc05e-6692-11df-aeb1-00144feab49a.html
If you expect inflation (or hyper inflation) in the near future, would you save or spend today?
What is inflation?
•What is inflation? why is it a problem? why do central banks fight it? what tools do they use?
Inflation – why bad
•Group assignment:▫“why is inflation bad?”
(a) from a savers perspective? (b) from a banks perspective?
On the other hand…
• why is inflation good for the borrower?
Inflation = 2nd biggest fear?
•What is #1? Why?
Deflation
http://futureproofkilkenny.org/?page_id=907
Review…
•What is a “twin crisis”? Why is it so harmful?
http://globotrends.pbworks.com/history-of-economic-crisis-and-currency-devaluations
Review…
•In class we discussed the danger of pegging a currency artificially HIGH (as compared to pegging artificially LOW). Who can explain? (give examples) Which situation results in accumulation of reserves?
http://globotrends.pbworks.com/history-of-economic-crisis-and-currency-devaluations
Series of crises - Key event
•What was the key event (occurred in the 1990’s) that fundamentally changed finance? What countries were involved? What changed? Why?
Series of Crises – 1990’s• Critical event: SE Asia Crisis 1997-1998
▫ Leading up to event: currencies were “pegged” to dollar
▫ Interest rates much lower in the US▫ Investors bet that peg would last▫ Borrow money abroad at low interest rates▫ Invest in SE Asia at higher rates▫ Make bigger returns, use money to pay back loans
abroad▫ Great way to make money!
• Unless….
• Group assignment: what is risk, what do you think happened?
http://globotrends.pbworks.com/history-of-economic-crisis-and-currency-devaluations
http://thebodegablog.files.wordpress.com/2009/12/asean-map.gif
Review…
•What lessons were learned after ‘97 Asian crisis? (how did finance fundamentally change)?
http://globotrends.pbworks.com/history-of-economic-crisis-and-currency-devaluations
Question
•How does the “Asian Crisis of ‘97” lead to…▫Modern world of international finance▫Strange situation where money flows from poor to rich? From China to USA
Series of Crises – 1990’s• Critical event: SE Asia Crisis 1997-1998
Lessons learned:▫ Dangers in borrowing abroad▫ Danger s in Relying on Foreign capital ▫ Must be free from Current Account deficits!
Current account deficits = dangerous!
Martin Wolf book, “Fixing Global Finance”
Current account deficits = dangerous!
▫Since financial liberalization: countries that run current account deficits = crisis
Martin Wolf book, “Fixing Global Finance”
Lesson: “Foreign capital is dangerous… so send it back!”•“…we now see the phenomenon of capital markets trying to put money into emerging economies even as the governments of these economies, with even greater determination, recycle the funds in the form of foreign currency reserves”
Martin Wolf, Fixing Global Finance, p56
Ok, but how?
•How do you “reject” international capital?
▫Dynamics of “how” will be covered in “Balance of Payments” discussion… (current account / capital account)
Current Account / Capital Account
•Terms to learn…
▫Current Account▫Capital Account▫Reserves▫Balance of Payments….
Lessons…
•“current account deficits have come to mean crisis”!
•“policy makers are (now) frightened of running current account deficits”
Martin Wolf, Fixing Global Finance, p40
Current Account:• Approx:
▫ Exports – imports▫ in a basic sense, its exports - imports....▫ If its negative, then you are importing more than
exporting...and you need to finance that deficit.
• So, if you have more imports than exports▫ Deficit▫ Must be “financed” by “capital account”
• Globally, must balance▫ If some countries run surplus, then others must run
deficits
Current Account•From an economic standpoint…•A current account could also be described
as:
▫the current account surplus is determined by the gap between savings and investment
deficit: more aggregate spending than output. to get rid of a deficit...need to reduce aggregate
spending in relation to output a surplus is = more savings, than investment
Current Account Deficit
•How does the country finance this excess spending?
Current Account Deficit• How does the country finance this excess
spending? ▫Answer: It borrows.
▫Q: what do we do when we spend more than we earn?
▫A: we use a credit card (borrow money that has to be paid later).
• The current account shows (indirectly) the amount of international lending or borrowing.
From the book…
•“If a collection of people spend more than their income on goods and services, they must be receiving loans or investment from elsewhere, to finance the excess of their imports over their exports”.
Martin Wolf, Fixing Global Finance
Country’s Balance Sheet:
•Some details…about how a country “finances” its current account deficit:
•First need to understand basic national accounts…
National “Balance Sheet”
•above the line: “must” balance
▫Current account Flow of goods and services, Roughly= exports - imports
▫Capital account Money flows in/ out of country Think of “Paying for the current account” Example: US government sells treasury bills
Martin Wolf book, “Fixing Global Finance”
But….
•What if they don’t balance? (as they should) what then?
National “Balance Sheet”
•3rd part
▫Reserves Foreign currency, gold, etc Used to finance gap between current &
capital accounts “below the line”
Martin Wolf book, “Fixing Global Finance”
National “Balance Sheet”• 3 Important parts
▫Current account Flow of goods and services, Roughly= exports -
imports
▫Capital account Paying for the current account - Money flows Example: US government sells treasury bills
▫Reserves Foreign currency, gold, etc Used to finance gap between current &
capital accounts “below the line”
Martin Wolf book, “Fixing Global Finance”
What is a “current account deficit?
▫Group assignment: write down the answer to this:
▫What is a “current account” When is it in “deficit”?
▫What is a “capital account” When is it in “deficit”?
National “Balance Sheet”
•Current Account ▫Goods, services
(imports / exports, goods, services, gifts)
•Capital Account ▫Money
(financials, treasury bonds, IBM shares, etc).
Group Question
If current account deficit,
then… by definition…
▫capital account = “must” have (______________) ?
National “Balance Sheet”
•Key: must “balance”
If “current account” deficit,
then… by definition…
▫“capital account” = surplus
National “Balance Sheet”
•GROUP:
▫So…If imports are > exports… what must be happening in the “capital account”?
National “Balance Sheet”
•GROUP:
▫Does USA have capital account surplus? or deficit? (over past 20+ years)
Answer…
SURPLUS!!Money must be coming in from abroad to finance the current account deficits!
Remember…Current Account:• Approx:
▫Exports – imports▫in a basic sense, its exports - imports....so, if its
negative, then you are importing more than exporting...and you need to finance that deficit.
• So, if you have more imports than exports▫Deficit▫Must be “financed” by “capital account”
• Globally, must balance▫If some countries run surplus, then others
must run deficits
Group Question
• If you have a current account deficit, you must have a capital account (_______)?
•But, do foreigners HAVE to send you money? (do they need to buy US treasuries)?
•What happens if foreigners decide NOT to send you money? (what must happen to the current account)? When?
To cut a current account deficit:
You must… cut imports vs exports Or, boost exports vs. imports
▫ QUESTION: this sounds easy… but HOW does a country do this? (GROUP – what are 2-3 ways a country could do this – cut a current account deficit?)
Answer:
1. Local prices must come down relative to foreign prices
A. Currency devaluation – fast(er), painful (why, for whom?)
B. Wage cuts - slow, painfulC. Efficiency gains - slowD. Productivity gains - slow
Currency devaluation
FAST Makes imports more expensive Makes exports more competitive
Medium Term Over time…. Exports rise, imports fall…
current account goes back to balance
But, why is it not immediate? How long do you think it takes?
Time to adjust
•Supply chains•Factories fixed•Move location•Ramp-up local production•Change local buying patterns
•Example: If US currency crashed tomorrow, how long would it take for US to start producing all toys, furniture, etc (rather than importing from China)?
Group assignment…▫What happens if you do NOT have money
coming in from abroad
▫Note: just because you have a “current account” deficit… that doesn’t mean foreigners will pay the bill…
▫Group assignment: What happens? What must you do? (hint: 3rd part of national
accounts mentioned before)…
Answer:
▫You must then dip into the Reserves (if you have any) and pay the difference… (gold, foreign currency)
Follow up question:▫What if you don’t have enough reserves? Then what? What can you do?
(What happens if you are running a current account deficit, and if foreigners SUDDEN STOP supplying capital, but… you do not have enough reserves to pay the bill?)
http://thetruthorthefight.files.wordpress.com/2009/04/imf-trapping-countries-in-debt.jpg
Hedging problems
Hedging problem (Account Payable): fear = you will owe MORE than expected…
•Assume that you are a Mexican shoe manufacturer, and that you borrowed money abroad in order to finance expansion of your shoe factory. In 1 year, you will owe $1 million USD to repay that loan. ▫In 15 words or less, describe the foreign
exchange risk (what are you afraid of?)
Hedging problem (Account Payable): fear = you will owe MORE than expected…
Answer: Mexican Peso Depreciates …or…
US dollar appreciates
▫Assume that the exchange rate today is 10 Mexican Pesos to $1 US dollar, how many Mexican Pesos would you owe if the exchange rate were to remain the same in 1 year?
▫If the exchange rate were to change and become a new rate of 13 Mexican Pesos per $1 US dollar, how many Mexican Pesos would it take for you to pay off your loan in 1 year?
▫Assume that the exchange rate today is 10 Mexican Pesos to $1 US dollar, how many Mexican Pesos would you owe if the exchange rate were to remain the same in 1 year? 10 MM Pesos
▫If the exchange rate were to change and become a new rate of 13 Mexican Pesos per $1 US dollar, how many Mexican Pesos would it take for you to pay off your loan in 1 year? 13 MM Pesos
▫Assume that you want to borrow abroad: in 20 words or less, describe one way you could limit this foreign currency risk?
▫Assume that you want to borrow abroad: in 20 words or less, describe one way you could limit this foreign currency risk? Forward contract, future, options
Buy dollars, sell pesos Other answers : deposit hedge (but doesn’t make business sense)
Lecture Schedule*
* Does not include professional visits, *Subject to change, modification without warning
•Tues 22th – boat to Greece
•Mon 26th – Athens
•Tues 27th – Rhodes•Wed 28th – Rhodes•Thurs 29th – Rhodes EXAM
Start studying for the exam now!! Find my slides:
www.slideshare.net/briandbutler
Team Project
•Due date: last class before Final Exam▫3 week – Tues July 20th ▫4 week – Wed July 28th
How to turn in:- either (hand written, neatly!) or computer, email:
Resources:1. Lectures2. Text Book: “An Introduction to Global Financial Markets”
(Valdez), chapter 11, “European Economic and Monetary Union” 2007, (suggested focus: p. 287-305). Pay special attention to “EMU – the benefits” – p 287, and “The counter arguments” – p289
3. Handout article: “Holding Together, A special report on the euro area”, from the Economist, June 13th 2009 (p 1-16)
*Grad Students only:▫ Read handout: “Country Forecast, Economies in Transition,
Eastern Europe”, from EIU, May 2009 (p. 5-10)
Group Project, “The Euro Zone – before, during and after the Global Economic Crisis”
Grading:• 30% of final grade for course• comparative (one team compared to others)
• there is no “right answer”, but grading will be based upon:
▫ Cover all required topics▫ Answer the questions asked▫ Additional insights▫ Strength of arguments (pro / con)▫ Depth of analysis▫ Be concise! ▫ Ability to capture “heart” of issue
Group Project, “The Euro Zone – before, during and after the Global Economic Crisis”
Assigned Readings
•Martin Wolf book
▫First three Chapters
▫Plus…other mini readings to be assigned later
• Finance book▫ Chapter 9 – foreign
exchange ▫ Chapter 11 - European
Economic and Monetary Union
▫ Switzerland – p 288▫ Euro – p 289, p304
• Optional additional reading▫ Chapter 2 – banking
background p30-38▫ Chapter 6 – the money and
bond markets▫ Chapter 12 – traded options▫ Chapter 13 - Futures