International Corporate Finance 11 Edition

12/09/2020
International Corporate Finance

11th Edition
by Jeff Madura
1 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
3 International Financial Markets

Chapter Objectives
Describe the background and corporate use of the

following International Financial Markets:
 Foreign exchange market
 International money market
 International credit market
 International bond market
 International stock markets
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Technical terms in this chapter
1. Hedge (v) = cover (v)

2. Deposit # Loan
3. Over-the-counter # On an exchange
4. In the money = profit
5. At the money = no profit, no loss
6. Out of the money = Loss.
7. Exercise (v) = conduct the contract
International financial market

structure
International
International
MONEY
BOND market
market
International International
CREDIT STOCK
market market
Foreign
exchange
market
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Foreign Exchange Market
1. Allows for the exchange of one currency for

another.
2. Exchange rate specifies the rate at which one
currency can be exchanged for another.
History of Foreign Exchange
Gold Agreements
Standard Floating
on Fixed
Exchange
(1876 – Exchange
Rate System
1913) Rate
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Who join FX market?
Retailers Foreign
Commercial Central
(Individual exchange
banks banks
Firm) dealers
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© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
History of Foreign Exchange
 Gold Standard
Ex: 1 ounce of gold = 4.24 GBP
1 ounce of gold = 20.67 USD
 20.67 USD = 4.24 GBP
 1 GBP = 4.87 USD.
 Fixed Exchange Rates
Ex: Bretton Woods Agreement+ Smithsonian
Agreement
 Floating Exchange Rates
Ex: Depend on Currency Supply and Demand
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Foreign exchange transactions
 Over-the-counter market with telecommunications

networks
 A global market with 24/24 hours of operation.
 Trading between banks occurs in the interbank
market.
 Largest average daily trading volume
 USD is the currency with the largest trading volume.
Foreign exchange markets
Tokyo EU
Sydney Singapore London Newyork
Hongkong Frankfurt
0 6 12 18 24
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Transactions on FX market?
FX 1. Spot
2. Forward
3. Futures
4. Swaps
5. Options
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Spot Market
1. A foreign exchange transaction for immediate exchange is

said to trade in the spot market. The exchange rate in the
spot market is the spot rate.
2. The U.S. Dollar is the commonly accepted medium of
exchange in the spot market.
3. Spot market time zones - Foreign exchange trading is
conducted only during normal business hours in a given
location. Thus, at any given time on a weekday,
somewhere around the world a bank is open and ready to
accommodate foreign exchange requests.
4. Spot market liquidity: More buyers and sellers means
more liquidity.
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Foreign Exchange Quotations
1. At any given point in time, a bank’s bid (buy) quote

for a foreign currency will be less than its ask (sell)
quote.
2. The bid/ask spread covers the bank’s cost of
conducting foreign exchange transactions
Ask rate  Bid rate

Bid / ask spread 
Ask rate
Factors That Affect the Spread
VIETCOMBANK EXCHANGE RATE 25 June 2020
Mã NT Tên ngoại tệ Bid Ask Spread(%)

AUSTRALIAN
AUD DOLLAR 15669,71 16160,89
CNY YUAN RENMINBI 3244,37 3346,57
GBP POUND STERLING 28356,25 29245,09

JPY YEN 211,35 219,24
KRW KOREAN WON 18,5 20,27
RUB RUSSIAN RUBLE 333,48 371,6
THB THAILAND BAHT 736,98 764,65
USD US DOLLAR 23115 23295
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Exhibit 3.1 Computation of the Bid Ask Spread
S Order costs (+)

P Inventory costs (+)
R Competition (-)
E
Volume (-)
A
Currency risk (+)
D
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Foreign exchange quotations
Direct Indirect
quotation quotation
Direct Quotation Indirect quotation
represents the value of represents the number
a foreign currency in of units of a foreign
dollars (number of currency per dollar.
dollars per currency). Example: €0.7143 per
Example: $1.40 per Dollar
Euro
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated,17 in whole or in part, except for use as
Direct Indirect
quotation quotation
Direct Quotation Indirect quotation 1
1 Foreign = x Home Home = y Foreign
Example: 1 Euro = Example: 1usd =
$1.40 €0.7143
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Direct Indirect
quotation quotation
USD USD
JPY EUR
AUD
VND
NZD
THB
……
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Cross Exchange Rates
1. Cross exchange rate is the amount of one foreign currency

per unit of another foreign currency
2. Example
Value of peso = $0.07
Value of Canadian dollar = $0.70
Value of peso in C$ = Value of peso in $

Value of C$ in $
= $0.07 = C$ 0.10
$0.70
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Assume 1 USD = 106.29 JPY and 1 USD =

23400 VND. If Honda Vietnam have an
imported machinery value 1 billion yen, how
much VND must this company pay?
What is BID cross –exchange rate for Swiss

Francs priced in euro?
Bid Ask
CHF 0.8648 0.8653
Euro 1.5000 1.5200
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Answer:
CHF/EUR = CHF/USD: EUR/USD

 BID = MIN = BID (CHF/USD): ASK
(EUR/USD) = 0.8648/1.5200=0.5689
What is ASK cross –exchange rate for Swiss

Francs priced in euro?
Bid Ask
CHF 0.8648 0.8653
Euro 1.5000 1.5200
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Answer:
ASK =ASK (CHF/USD): BID (CHF/USD) =

0.8653/1.5000 = 0.5769
Calculate the bid-ask cross exchange rate:
• USD/VND = 19470 - 19500

Question 1: • USD/JPY = 83.460 - 83.464
• PY/VND = bid - ask
• USD/HKD = 1.7769 – 1.7771

Question 2: • GBP/USD = 2.9185 – 2.9188
• GBP/HKD) = bid - ask
• EUR/USD = 1.4769 – 1.4771

Question 3: • GBP/USD = 2.1185 – 2.1188
• GBP/EUR) = bid - ask
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Question 1: When does the foreign exchange market close?
a/ Never.
b/ 4:00 p.m. EST (New York time).
c/ 4:00 p.m. GMT (London time).
d/ 4:00 p.m. (Tokyo time).
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Question 2: The spot foreign exchange market is
a/open 24/7 somewhere in the world

b/the largest and most active financial market in the
world
c/an over-the-counter market.
d/ /All of the above answers are correct.
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Question 3: The Bid price
a/ is the price that a dealer stands ready to pay.

b/ refers only to auctions like eBay, not over the
counter transactions with dealers.
c/ is the price that a dealer stands ready to sell at.
d/ none of above answers are correct.
Question 4: Which of the following is not a possible

bid/ask quotation for AUD?
a/ $.52/$.51
b/ $.49/$.50
c/ $.50/$.51
d/ $.51/$.52
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Question 5: Which of the following factor does not

affects the bid/ask spread/
a/ Personal relationship
b/ Inventory expenses
c/ Volume
d/ Order expenses
ER Quotations
Question 6: If one U.S. dollar is worth 1.3 Australian

dollars, how much is one Australian dollar in U.S.
dollars?
a/1.3 U.S. dollars

b/0.700 U.S. dollars
c/1.67 U.S. dollars
d/0.77 U.S. dollars
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ER Quotations
Question 7: If the $/€ bid and ask prices are $1.50/€

and $1.51/€, respectively, the corresponding €/$ bid and
ask prices are:
a/ €0.6623 and €0.6667.
b/ $1.51 and $1.50.
c/ €0.6667 and €0.6623.
d/ None of above
Question 8:
Find the no-arbitrage cross exchange rate.

The dollar-euro exchange rate is quoted as
$1.60 = €1.00 and the dollar-pound
exchange rate is quoted at $2.00 = £1.00.
a/ $1.25/£1.00
b/ £1.25/€1.00
c/ €0.80/£1.00
d/ €1.25/£1.00
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Question 9:
Suppose a bank customer with €1,000,000 wishes

buy Japanese yen. The dollar-euro exchange rate is
quoted as $1.60 = €1.00 and the dollar-yen
exchange rate is quoted at $1.00 = ¥120. How many
yen will the customer get?
a/ ¥192,000,000
b/ ¥5,208,333
c/ ¥75,000,000
d/ ¥5,208.33
Question 10:
What is the BID cross-exchange rate for
Canadian dollars priced in euro?
a/ €0.6094/CAD
b/ €0.6104/CAD
c/ €0.6181/CAD
d/ €0.6191/CAD
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Currency Derivatives
1. Forward Contracts: agreements between a

foreign exchange dealer and an MNC that
specifies the currencies to be exchanged, the
exchange rate, and the date at which the
transaction will occur.
 The forward rate is the exchange rate
specified by the forward contract.
 The forward market is the over-the-
counter market where forward contracts are
traded.
2. Futures Contracts: similar to forward

contracts but sold on an exchange
 Specifies a standard volume of a particular
currency to be exchanged on a specific settlement
date.
 The futures rate is the exchange rate at which one

can purchase or sell a specified currency on the
specified settlement date.
 The future spot rate is the spot rate that will exist
at a future point in time and is uncertain as of
today.
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3. Currency Options Contracts

a. Currency Call Option: provides the right to buy
currency at a specified strike price within a
specified period of time.
b. Currency Put Option: provides the right to sell

currency at specified strike price within a specified
period of time.
International Money Market
1. Corporations or governments need short-term

funds denominated in a currency different from
their home currency.
2. The international money market has grown because
firms:
a. May need to borrow funds to pay for imports
denominated in a foreign currency.
b. May choose to borrow in a currency in which the
interest rate is lower.
c. May choose to borrow in a currency that is expected to
depreciate against their home currency
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Origins and Development
1. European Money Market: Dollar deposits in banks in

Europe and other continents are called Eurodollars or
Eurocurrency. Origins of the European money market can
be traced to the Eurocurrency market that developed
during the 1960s and 1970s.
2. Asian Money Market: Centered in Hong Kong and

Singapore. Originated as a market involving mostly
dollar-denominated deposits, and was originally known as
the Asian dollar market.
Money Market Interest Rates Among Currencies
1. The money market interest rates in any particular

country are dependent on the demand for short-
term funds by borrowers, relative to the supply of
available short-term funds that are provided by
savers.
2. Money market rates vary due to differences in the

interaction of the total supply of short-term funds
available (bank deposits) in a specific country
versus the total demand for short-term funds by
borrowers in that country.
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Exhibit 3.4 Comparison of Money Market Interest Rates
Global Integration of Money Market Interest Rates
1. Money market interest rates among countries tend

to be highly correlated over time.
2. When economic conditions weaken, the

corporate need for liquidity declines, and
corporations reduce the amount of short term
funds they wish to borrow.
3. When economic conditions strengthen, there is

an increase in corporate expansion, and
corporations need additional liquidity to support
their expansion.
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Risk of International Money Market Securities
1. International Money Market Securities are

debt securities issued by MNCs and government
agencies with a short-term maturity (1 year or
less)
2. Normally, these securities are perceived to be
very safe from the risk of default.
3. Even if the international money market securities
are not exposed to credit risk, they are exposed
to exchange rate risk when the currency
denominating the securities differs from the home
currency of the investors.
International Credit Market
1. MNCs sometimes obtain medium-term funds

through term loans from local financial
institutions or through the issuance of notes
(medium-term debt obligations) in their local
markets.
2. Loans of 1 year or longer extended by banks to
MNCs or government agencies in Europe are
commonly called Eurocredits or Eurocredit
loans.
3. To avoid interest rate risk, banks commonly use
floating rate loans with rates tied to the London
Interbank Offer Rate (LIBOR).
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Regulations in the Credit Market
1. Single European Act:

 Capital can flow freely throughout Europe.
 Banks can offer a wide variety of lending, leasing, and
securities activities in the EU.
 Regulations regarding competition, mergers, and taxes are
similar throughout the EU.
 A bank established in any one of the EU countries has the
right to expand into any or all of the other EU countries.
2. Basel Accord - Banks must maintain capital equal to at

least 4 percent of their assets. For this purpose, banks’ assets
are weighted by risk.
Regulations in the Credit Market (Cont.)
3. Basel II Accord - Attempts to account for differences in

collateral among banks. In addition, this accord encourages
banks to improve their techniques for controlling
operational risk, which could reduce failures in the banking
system. Also plans to require banks to provide more
information to existing and prospective shareholders about
their exposure to different types of risk.
4. Basel III Accord - Called for new methods of estimating

risk-weighted assets that would increase the level of risk-
weighted assets, and therefore require banks to maintain
higher levels of capital.
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Syndicated Loans in the Credit Market
1. Sometimes a single bank is unwilling or unable to

lend the amount needed by an MNC or
government agency.
2. A syndicate of banks can be formed to

underwrite the loans and the lead bank is
responsible for negotiating the terms with the
borrower.
Impact of the Credit Crisis on the Credit Market
1. The credit crisis of 2008 triggered by defaults in

subprime loans led to a halt in housing
development, which reduced income, spending,
and jobs.
2. Financial institutions became cautious with their

funds and were less willing to lend funds to
MNCs
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International Bond Market
1. Foreign bonds are issued by borrower

foreign to the country where the bond is
placed.
2. Eurobonds are bonds sold in countries other
than the country of the currency denominating
the bond
 Partially a result of the Interest Equalization Tax
(EIT) imposed by the U.S. government in 1963 to
discourage U.S. investors from investing in
foreign securities.
Eurobonds
1. Features:
 Bearer bonds
 Annual coupon payments
 Convertible or callable
2. Denominations
 commonly denominated in a number of currencies
3. Underwriting Process
 multinational syndicate; simultaneously placed in many
countries
4. Secondary Market
 market makers are in many cases the same underwriters
who sell the primary issues
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Development of Other Bond Markets
1. Bond markets have developed in Asia and

South America
2. Bond market yields among countries tend to be
highly correlated over time.
3. When economic conditions weaken, aggregate
demand for funds declines with the decline in
corporate expansion.
4. When economic conditions strengthen,
aggregate demand for funds increases with the
increase in corporate expansion.
Risk of International Bonds
1. Credit Risk - represents the potential for default.

2. Interest Rate Risk - potential for the value of
bonds to decline in response to rising long-term
interest rates.
3. Exchange Rate Risk - represents the potential for
the value of bonds to decline (from the investor’s
perspective) because the currency denominating the
bond depreciates against the home currency.
4. Liquidity Risk - represents the potential for the
value of bonds to decline because there is not a
consistently active market for the bonds.
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Impact of the Greek Crisis on Bonds
1. Spring 2010: Greece experienced weak

economic conditions and large increase in the
government budget deficit.
2. Concern spread to other European countries

such as Spain, Portugal, and Ireland that had
large budget deficits.
3. May 2010: many European countries and the

IMF agreed to provide Greece with new loans.
International Stock Markets
1. Issuance of Stock in Foreign Markets - Some

U.S. firms issue stock in foreign markets to enhance
their global image.
2. Issuance of Foreign Stock in the U.S.
a. Yankee stock offerings - Non-U.S. corporations
that need large amounts of funds sometimes issue
stock in the United States
b. American Depository Receipts (ADR) -
Certificates representing bundles of stock. ADR
shares can be traded just like shares of a stock.
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Non-U.S. Firms Listing on U.S.

Exchanges
1. Non-U.S. firms have their shares listed on the

New York Stock Exchange or the Nasdaq
market so that the shares can easily be traded
in the secondary market.
2. Effect of Sarbanes-Oxley Act on Foreign

Stock Listings - Many non-U.S. firms decided to
place new issues of their stock in the United Kingdom
instead of in the United States so that they would not
have to comply with the law.
Investing in Foreign Stock Markets
1. Many investors purchase stocks outside of the

home country.
2. Recently, firms outside the U.S. have been
issuing stock more frequently.
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Exhibit 3.5 Comparison of Stock Exchanges (as of 2008)
Source: World Federation of Exchanges

How Market Characteristics Vary among Countries
1. Stock market participation and trading activity are

higher in countries where managers are encouraged to
make decisions that serve shareholder interests, and
where there is greater transparency.
2. Factors that influence trading activity:
 Voting power
 Legal protection of shareholders
 Government enforcement of securities laws
 Corporate corruption
 Level of financial disclosure
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Exhibit 3.6 Impact of Governance on Stock Market

Participation and Trading Activity
How Financial Markets Serve MNCs
1. Corporate functions that require foreign exchange

markets.
 Foreign trade with business clients.
 Direct foreign investment, or the acquisition of foreign
real assets.
 Short-term investment or financing in foreign securities.
 Longer-term financing in the international bond or stock
markets.
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Exhibit 3.7 Foreign Cash Flow Chart of an MNC
Summary
 The foreign exchange market allows currencies to be

exchanged in order to facilitate international trade or
financial transactions. Commercial banks serve as financial
intermediaries in this market.
 The international money markets are composed of several
large banks that accept deposits and provide short-term
loans in various currencies. This market is used primarily by
governments and large corporations.
 The international credit markets are composed of the same
commercial banks that serve the international money
market. These banks convert some of the deposits received
into loans (for medium-term periods) to governments and
large corporations.
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Summary (Cont.)
 The international bond markets facilitate international

transfers of long-term credit, thereby enabling governments
and large corporations to borrow funds from various
countries. The international bond market is facilitated by
multinational syndicates of investment banks that help to
place the bonds.
 International stock markets enable firms to obtain equity
financing in foreign countries. Thus, these markets help
MNCs finance their international expansion.
33

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12/09/2020

International Corporate Finance

3 International Financial Markets

Describe the background and corporate use of the

 International money market

 International credit market

 International bond market

 International stock markets

Technical terms in this chapter

1. Hedge (v) = cover (v)

International financial market

Foreign Exchange Market

1. Allows for the exchange of one currency for

History of Foreign Exchange

Who join FX market?

History of Foreign Exchange

Foreign exchange transactions

 Over-the-counter market with telecommunications

Foreign exchange markets

1. A foreign exchange transaction for immediate exchange is

Foreign Exchange Quotations

1. At any given point in time, a bank’s bid (buy) quote

Ask rate  Bid rate

Factors That Affect the Spread

VIETCOMBANK EXCHANGE RATE 25 June 2020

Mã NT Tên ngoại tệ Bid Ask Spread(%)

GBP POUND STERLING 28356,25 29245,09

Exhibit 3.1 Computation of the Bid Ask Spread

Factors That Affect the Spread

S Order costs (+)

Foreign exchange quotations

Foreign exchange quotations

Foreign exchange quotations

Cross Exchange Rates

1. Cross exchange rate is the amount of one foreign currency

Value of peso in C$ = Value of peso in $

Assume 1 USD = 106.29 JPY and 1 USD =

What is BID cross –exchange rate for Swiss

CHF/EUR = CHF/USD: EUR/USD

What is ASK cross –exchange rate for Swiss

ASK =ASK (CHF/USD): BID (CHF/USD) =

Calculate the bid-ask cross exchange rate:

• USD/VND = 19470 - 19500

• USD/HKD = 1.7769 – 1.7771

• EUR/USD = 1.4769 – 1.4771

Foreign exchange transactions

Question 1: When does the foreign exchange market close?

Foreign exchange transactions

Question 2: The spot foreign exchange market is

a/open 24/7 somewhere in the world

Foreign Exchange Quotations

Question 3: The Bid price

a/ is the price that a dealer stands ready to pay.

Foreign Exchange Quotations

Question 4: Which of the following is not a possible

Factors That Affect the Spread

Question 5: Which of the following factor does not

Question 6: If one U.S. dollar is worth 1.3 Australian

a/1.3 U.S. dollars