International corporate finance.
Inhoudsopgave
Introduction and Brief History......................................................................................................................... 2
I. Architecture of international markets. ................................................................................................... 2
Spot markets for foreign currency ...................................................................................................................... 2
The exchange market: (not organized market ??)........................................................................... 2
Interbank market: .......................................................................................................................................... 2
Sport rates ..................................................................................................................................................... 3
Forward rates ................................................................................................................................................ 3
Options and futures ....................................................................................................................................... 3
Exchange rates ............................................................................................................................................... 3
Bid and ask rates ............................................................................................................................................ 3
Primary and cross rates ................................................................................................................................. 5
The law of one price ...................................................................................................................................... 7
Triangular arbitrage and the LOP................................................................................................................... 7
Forward contracts.......................................................................................................................................... 9
Predictability..................................................................................................................................................... 11
Stock market: ............................................................................................................................................... 11
Exchange rates ............................................................................................................................................. 11
The behaviour of spot exchange rates: ....................................................................................................... 13
Exchange rates and Economic Policy (fundamentals) ................................................................................. 16
II. International parity conditions and exchange rate determination ........................................................ 19
Purchasing power and interest rate parities. ................................................................................................... 19
Why is the PPP important? .......................................................................................................................... 19
The Big Mac Index (The Economist 1986).................................................................................................... 21
Relative Purchasing Power Parity ................................................................................................................ 22
Real Exchange Rate ...................................................................................................................................... 24
(this is less important for the exam; it is just additional information) ........................................................ 24
The covered interest rate parity .................................................................................................................. 24
The general picture ...................................................................................................................................... 26
The market value of a forward contract ...................................................................................................... 28
III. The International Capital Market. ........................................................................................................ 30
Cross-listing ...................................................................................................................................................... 30
Home Bias .................................................................................................................................................... 30
American Depositary Receipts ..................................................................................................................... 31
Standard portfolio theory ............................................................................................................................ 32
Karolyi-Stulz Litmus Test on the Risk Premium ........................................................................................... 32
Value of Dual Listing .................................................................................................................................... 34
Mergers and Acquisitions ................................................................................................................................. 36
The waves of M&A....................................................................................................................................... 37
Neo-classical Theory .................................................................................................................................... 38
Behavioural Theory ...................................................................................................................................... 40
What drives these waves? ........................................................................................................................... 42
Overconfidence and valuation effects ......................................................................................................... 44
Behavioural biases ....................................................................................................................................... 44
1
,IV. Earnings management as a pervasive strategic tool. ............................................................................ 49
The importance of increase earnings .......................................................................................................... 50
EM practices ................................................................................................................................................ 52
A balance between risk and return.............................................................................................................. 53
Accrual informativeness .............................................................................................................................. 57
The first evidence of the accrual anomaly ................................................................................................... 58
Introduction and brief history
…
I. Architecture of international markets.
Spot markets for foreign currency
The exchange market:
A two-tier market where tradable securities, commodities, foreign exchange, … are being
bought and sold (traded).
→ Wholesale tier: informal network of banks, big corporations, and other financial
institutions, that trade large quantities at lower prices (often to businesses)
ð It is done electronically.
ð 2 players (professionals):
o Market makers: give 2-way quotes binding up to an agreed limit,
credit agreement (bilateral).
à profit = ask price -bid price = spread
o Brokers: connect investors to offers (of someone else). They just do
the special deals (large or structured).
→ Retail tier: traded directly at “customers” (multinational corporations, institutional
investors, money managers, retail investors) at retail price.
It’s a worldwide market: active 24/7 with different time zones.
ð The big 3 (zones): London, NY and Tokyo.
ð Substantial growth in the volume of exchange markets.
Note: this is why Brexit was such a big deal, in the financial world (mostly in the EU).
Because this meant the loss of the biggest trading platform.
Note:
The exchange market is not an organized market.
In the sense that there is not 1 institution or rule book overseeing the market (centralized).
ð The stock market is organized, as the trade happens with companies that
are listed and follow specific rules.
ð Exch market is becoming more centralized/multilateral. (with the interbank
market)
Interbank market:
= a global network utilized by financial institutions to trade currencies and other derivatives
directly between themselves.
Actors:
- reporting dealers: foreign exchange dealers
- other financial institutions: banks, funds, central banks, …
2
, - non-financial institutions: multinational (big) corporations
Sport rates
= A spot transaction in the interbank market is the purchase of foreign exchange, with
delivery and payment to take place normally, on the second following business day
ð immediate payment (t) = 2nd working day (t+2)
ð this is when the deal actually starts.
Forward rates
Required for delivery/payments at future value date of a (predetermined) specified amount of
one currency for a specified amount of another currency.
Rate = Ft,T
ð most used forwards are 30 and 90 days, but it can go up to 10 years.
ð This is used for protection of investment against adverse changes (example a
devaluation of currency)
Note: basically means, setting/negotiating a rate (and agreeing on) for future use.
Options and futures
Option = an option is a financial derivative contract that gives the holder the right, but not the
obligation, to buy or sell an underlying asset at a predetermined price (the strike price) within
a specified period.
→ call and put options.
Futures are like forwards but standardized.
Exchange rates
Quoting convention = the price, in units of home currency, per unit of foreign currency
HC/FC
→ Currencies are quoted in relation to another.
The first currency in quotes (in this case HC) is the base currency, and the second
(FC) is the term of quote currency.
When trading, the (trading) action is applied on the base currency.
It indicates how much of the quote currency is needed to purchase one unit of the base
currency. Example:
ð 1.125 EUR/USD = receive 1 euro in exchange for 1.125 dollars.
Notes: American and European terms:
European terms are not limited to European currencies but refers to the quotation of USD in
relation to any other currency. (USD/…)
American terms refer to any currency (as base currency) in relation to the USD (…/USD)
Dimensions and symbols of quotes:
The dimension is the used Exchange rate (e.g. CAD/USD)
→ professionals use the inverse of the dimension as symbol (e.g. USD/CAD)
Bid and ask rates.
You buy at (bank’s) Ask and sell at a (bank’s) Bid. (own perspective)
ó Ask rate: at which the bank will sell a currency.
ó Bid rate: at which a bank will buy a currency.
3
, ð Banks perspective.
Spread = Ask – Bid ≥ 0
Example: USD/EUR 1.2345-1.2347
Buying at 47
Selling at 45
In retail market: spread will fall with order size.
In wholesale market: spread will fall when risk of posting a quote is lower.
ASK > BID:
Because otherwise there are arbitrage opportunities
Bid rate > ask rate = huge risk-free profit
ð If you would buy at ask and immediately resell at bid (which is higher)
ð Profit with no risk.
BUT banks want to make some money from foreign-currency transactions, so
they prevent this.
If you hold a currency, you might incur depreciation or appreciation.
This is the risk of holding. And you want to be compensated for it.
When selling it acts as a commission (for the taken risk) that you will pay the person
who will exchange the money (bid-ask rate)
Site notes:
From what do you need protection when holding bitcoins? Loss
What is the extra risk taken? The fact that there are no underlying assets. It is a “fake” coin
with no regulations, so risk of fraud is high.
Regulations give a framework (like in FXM)
ICO = initial coin offer
= is a new way for companies to raise capital through crypto currency
→ companies create a digital coin and sell it to investors in exchange for cash or crypto.
There are no ownership powers, like there would be with stock. But it is important that the
company is credible, otherwise no one will want to invest.
ð ICO have gained a lot of popularity lately.
ð But here too there are no regulations, which mean no control. As a result,
almost 80% of the ICOs are scams.
ð But as everyone knows high returns = high risk.
Irony of holding ICO:
The Squid Game Crypto.
Promised a 3000% return, which is obviously too good to be true.
A coin related to the game, and it followed a 6 round game w/o the deadly
consequences. It promised an additional price for the participants arriving in the last round.
ð Red flags: no resale possible, no comments/replies, and set up by unknown
creator.
ð Probably a rug pull: type of crypto scam that occurs when a team pumps their
project’s token before disappearing with the funds.
S&P 500
= stock market Index tracking the stock performance of 500 of the largest US companies
listed. The Standard and Poor’s 500.
→ Most used equity Indices.
4
Inhoudsopgave
Introduction and Brief History......................................................................................................................... 2
I. Architecture of international markets. ................................................................................................... 2
Spot markets for foreign currency ...................................................................................................................... 2
The exchange market: (not organized market ??)........................................................................... 2
Interbank market: .......................................................................................................................................... 2
Sport rates ..................................................................................................................................................... 3
Forward rates ................................................................................................................................................ 3
Options and futures ....................................................................................................................................... 3
Exchange rates ............................................................................................................................................... 3
Bid and ask rates ............................................................................................................................................ 3
Primary and cross rates ................................................................................................................................. 5
The law of one price ...................................................................................................................................... 7
Triangular arbitrage and the LOP................................................................................................................... 7
Forward contracts.......................................................................................................................................... 9
Predictability..................................................................................................................................................... 11
Stock market: ............................................................................................................................................... 11
Exchange rates ............................................................................................................................................. 11
The behaviour of spot exchange rates: ....................................................................................................... 13
Exchange rates and Economic Policy (fundamentals) ................................................................................. 16
II. International parity conditions and exchange rate determination ........................................................ 19
Purchasing power and interest rate parities. ................................................................................................... 19
Why is the PPP important? .......................................................................................................................... 19
The Big Mac Index (The Economist 1986).................................................................................................... 21
Relative Purchasing Power Parity ................................................................................................................ 22
Real Exchange Rate ...................................................................................................................................... 24
(this is less important for the exam; it is just additional information) ........................................................ 24
The covered interest rate parity .................................................................................................................. 24
The general picture ...................................................................................................................................... 26
The market value of a forward contract ...................................................................................................... 28
III. The International Capital Market. ........................................................................................................ 30
Cross-listing ...................................................................................................................................................... 30
Home Bias .................................................................................................................................................... 30
American Depositary Receipts ..................................................................................................................... 31
Standard portfolio theory ............................................................................................................................ 32
Karolyi-Stulz Litmus Test on the Risk Premium ........................................................................................... 32
Value of Dual Listing .................................................................................................................................... 34
Mergers and Acquisitions ................................................................................................................................. 36
The waves of M&A....................................................................................................................................... 37
Neo-classical Theory .................................................................................................................................... 38
Behavioural Theory ...................................................................................................................................... 40
What drives these waves? ........................................................................................................................... 42
Overconfidence and valuation effects ......................................................................................................... 44
Behavioural biases ....................................................................................................................................... 44
1
,IV. Earnings management as a pervasive strategic tool. ............................................................................ 49
The importance of increase earnings .......................................................................................................... 50
EM practices ................................................................................................................................................ 52
A balance between risk and return.............................................................................................................. 53
Accrual informativeness .............................................................................................................................. 57
The first evidence of the accrual anomaly ................................................................................................... 58
Introduction and brief history
…
I. Architecture of international markets.
Spot markets for foreign currency
The exchange market:
A two-tier market where tradable securities, commodities, foreign exchange, … are being
bought and sold (traded).
→ Wholesale tier: informal network of banks, big corporations, and other financial
institutions, that trade large quantities at lower prices (often to businesses)
ð It is done electronically.
ð 2 players (professionals):
o Market makers: give 2-way quotes binding up to an agreed limit,
credit agreement (bilateral).
à profit = ask price -bid price = spread
o Brokers: connect investors to offers (of someone else). They just do
the special deals (large or structured).
→ Retail tier: traded directly at “customers” (multinational corporations, institutional
investors, money managers, retail investors) at retail price.
It’s a worldwide market: active 24/7 with different time zones.
ð The big 3 (zones): London, NY and Tokyo.
ð Substantial growth in the volume of exchange markets.
Note: this is why Brexit was such a big deal, in the financial world (mostly in the EU).
Because this meant the loss of the biggest trading platform.
Note:
The exchange market is not an organized market.
In the sense that there is not 1 institution or rule book overseeing the market (centralized).
ð The stock market is organized, as the trade happens with companies that
are listed and follow specific rules.
ð Exch market is becoming more centralized/multilateral. (with the interbank
market)
Interbank market:
= a global network utilized by financial institutions to trade currencies and other derivatives
directly between themselves.
Actors:
- reporting dealers: foreign exchange dealers
- other financial institutions: banks, funds, central banks, …
2
, - non-financial institutions: multinational (big) corporations
Sport rates
= A spot transaction in the interbank market is the purchase of foreign exchange, with
delivery and payment to take place normally, on the second following business day
ð immediate payment (t) = 2nd working day (t+2)
ð this is when the deal actually starts.
Forward rates
Required for delivery/payments at future value date of a (predetermined) specified amount of
one currency for a specified amount of another currency.
Rate = Ft,T
ð most used forwards are 30 and 90 days, but it can go up to 10 years.
ð This is used for protection of investment against adverse changes (example a
devaluation of currency)
Note: basically means, setting/negotiating a rate (and agreeing on) for future use.
Options and futures
Option = an option is a financial derivative contract that gives the holder the right, but not the
obligation, to buy or sell an underlying asset at a predetermined price (the strike price) within
a specified period.
→ call and put options.
Futures are like forwards but standardized.
Exchange rates
Quoting convention = the price, in units of home currency, per unit of foreign currency
HC/FC
→ Currencies are quoted in relation to another.
The first currency in quotes (in this case HC) is the base currency, and the second
(FC) is the term of quote currency.
When trading, the (trading) action is applied on the base currency.
It indicates how much of the quote currency is needed to purchase one unit of the base
currency. Example:
ð 1.125 EUR/USD = receive 1 euro in exchange for 1.125 dollars.
Notes: American and European terms:
European terms are not limited to European currencies but refers to the quotation of USD in
relation to any other currency. (USD/…)
American terms refer to any currency (as base currency) in relation to the USD (…/USD)
Dimensions and symbols of quotes:
The dimension is the used Exchange rate (e.g. CAD/USD)
→ professionals use the inverse of the dimension as symbol (e.g. USD/CAD)
Bid and ask rates.
You buy at (bank’s) Ask and sell at a (bank’s) Bid. (own perspective)
ó Ask rate: at which the bank will sell a currency.
ó Bid rate: at which a bank will buy a currency.
3
, ð Banks perspective.
Spread = Ask – Bid ≥ 0
Example: USD/EUR 1.2345-1.2347
Buying at 47
Selling at 45
In retail market: spread will fall with order size.
In wholesale market: spread will fall when risk of posting a quote is lower.
ASK > BID:
Because otherwise there are arbitrage opportunities
Bid rate > ask rate = huge risk-free profit
ð If you would buy at ask and immediately resell at bid (which is higher)
ð Profit with no risk.
BUT banks want to make some money from foreign-currency transactions, so
they prevent this.
If you hold a currency, you might incur depreciation or appreciation.
This is the risk of holding. And you want to be compensated for it.
When selling it acts as a commission (for the taken risk) that you will pay the person
who will exchange the money (bid-ask rate)
Site notes:
From what do you need protection when holding bitcoins? Loss
What is the extra risk taken? The fact that there are no underlying assets. It is a “fake” coin
with no regulations, so risk of fraud is high.
Regulations give a framework (like in FXM)
ICO = initial coin offer
= is a new way for companies to raise capital through crypto currency
→ companies create a digital coin and sell it to investors in exchange for cash or crypto.
There are no ownership powers, like there would be with stock. But it is important that the
company is credible, otherwise no one will want to invest.
ð ICO have gained a lot of popularity lately.
ð But here too there are no regulations, which mean no control. As a result,
almost 80% of the ICOs are scams.
ð But as everyone knows high returns = high risk.
Irony of holding ICO:
The Squid Game Crypto.
Promised a 3000% return, which is obviously too good to be true.
A coin related to the game, and it followed a 6 round game w/o the deadly
consequences. It promised an additional price for the participants arriving in the last round.
ð Red flags: no resale possible, no comments/replies, and set up by unknown
creator.
ð Probably a rug pull: type of crypto scam that occurs when a team pumps their
project’s token before disappearing with the funds.
S&P 500
= stock market Index tracking the stock performance of 500 of the largest US companies
listed. The Standard and Poor’s 500.
→ Most used equity Indices.
4
