International Corporate Finance Summary
Master business engineering: business & technology
1st semester 2020-2021
Prof. dr. James Thewissen
Textbook (only selected chapters):
- Bekaert and Hodrick, International Financial Management, 2018,
Cambridge University Press
- Sercu, P., International Finance: Theory into Practice, 2009, Princeton
University Press
Exam:
- Written exam, closed book, combination of theory and exercises
Table of contents:
Part 1: Architecture of international markets………………………………………
Foreign exchange markets
The Impossible Trinity and the predictability of exchange rates
New trends in international finance (cryptocurrencies and ICOs)
Part 2: International parity conditions and exchange rate determination……
PPP, real-exchange rates and the interest rate parity
iCAPM
Part 3: International corporate finance……………………………………………..
International capital budgeting
Management of transactional exposure
Management of economic exposure
Part 4: International capital markets………………………………………………..
International equity financing and share cross-listing
M&As – new evidence and cross-country analysis
Tax avoidance
,Table of Contents
PART 0 – Introduction ........................................................................................................... 5
1. Globalization .................................................................................................................. 5
2. International finance or the existence of borders ............................................................ 5
3. Borders complicate the job of the CFO ........................................................................... 7
3.1. Exchange rate risk................................................................................................... 7
3.2. Segmentation of consumer-goods markets – the Big Mac standard ........................ 7
3.3. Credit risk .............................................................................................................. 10
3.4. Political risk ........................................................................................................... 10
3.5. International tax issues.......................................................................................... 11
4. Why is international finance useful? ............................................................................. 11
PART 0 – History of international markets ........................................................................... 12
1. Four take-aways ........................................................................................................... 12
2.1. At the beginning… ................................................................................................. 12
2.2. The Gold Standard, 1876-1913 ............................................................................. 13
2.3. The Inter-War years and WWII, 194-1944 ............................................................. 14
2.4. Bretton Woods and the IMF, 1944 ......................................................................... 14
2.5. Today .................................................................................................................... 15
3.1. A trinity .................................................................................................................. 17
4.1. Continuum from most rigid to least interventionist ................................................. 18
4.2. Fixed band exchange rate ..................................................................................... 18
4.3. Crawling peg ......................................................................................................... 18
4.4. Details on various regimes .................................................................................... 18
4.5. How to fix the exchange rate? ............................................................................... 19
4.6. To fix or not to fix? ................................................................................................. 19
4.7. Currency boards.................................................................................................... 19
4.8. Dollarization .......................................................................................................... 19
4.9. The currency regime Choices for Emerging Markets ............................................. 20
4.10. Regime evolution ............................................................................................... 20
PART 1 – Architecture of International Markets ................................................................... 23
1. Introduction .................................................................................................................. 23
A) Foreign exchange market - spot markets for foreign currency ...................................... 25
2. MAJOR MARKETS ...................................................................................................... 25
2.1. Market segments ................................................................................................... 25
2.2. Wholesale: 2 kind of professionals: market makers and currency brokers ............. 26
2.3. Volume over time and by currency: geography and market size ............................ 26
2.4. Transaction types .................................................................................................. 27
3. Exchange rates ............................................................................................................ 28
1
, 3.1. Our Convention: HC units per unit of FC .................................................................. 28
3.2. Bid & ask spread ....................................................................................................... 29
3.3. Primary and cross rates ............................................................................................ 29
3.4. Determinants of bid and ask spreads ........................................................................ 31
4. The Law of one price for the stock market .................................................................... 33
4.1. Two way arbitrage ................................................................................................. 33
4.2. Triangular arbitrage and the LOP .......................................................................... 35
4. Forward contracts......................................................................................................... 38
4.1 Definition ............................................................................................................... 38
4.2 Relevance ............................................................................................................. 40
5. Exchange rate regimes................................................................................................. 41
5.1 Continuum from most rigid to least interventionist ................................................. 41
5.2 € ............................................................................................................................ 44
5.3 The Venezuelan case............................................................................................ 45
Exercises on spot markets for foreign currency ................................................................... 47
B) Impossible trinity & the predictability of exchange rates ................................................ 51
➔Asian Currency Crisis ...................................................................................................... 51
➔Contemporary Issues in Finance / International finance / Do we know what makes forex
markets tick? (CH10 HB) ..................................................................................................... 56
1. Statistics ....................................................................................................................... 59
2. Behavior of spot exchange rates .................................................................................. 60
2.1 Changes in log rates: findings ............................................................................... 62
3. Exchange rates and economic policy fundamentals ..................................................... 69
3.1 The monetary model (understand logic behind it – read it) .................................... 69
3.2 Results .................................................................................................................. 72
3.3 Discussion ............................................................................................................. 74
PART 2: INTERNATIONAL PARITY CONDITIONS AND EXCHANGE RATE
DETERMINATION............................................................................................................... 78
A) Purchasing Power and Interest rate parties ..................................................................... 78
1. The purchasing power parity ........................................................................................ 78
1.1. Absolute PPP ........................................................................................................ 78
1.2. Relative PPP ......................................................................................................... 84
2. The covered interest rate parity .................................................................................... 88
1.1. Perfect market assumption .................................................................................... 89
1.2. General formula .................................................................................................... 94
1.3. In practice – The carry trade .................................................................................. 96
Exercises on parity conditions ............................................................................................. 98
PART 3 – Managing Contractual Exchange Rate Exposure .............................................. 100
Transaction Exposure & Hedging: Managing Contractual Exchange Rate Exposure ......... 100
2
, 1. Why you need to understand FX exposure? ............................................................... 100
2. Introduction to Transaction Exposure ......................................................................... 100
2.1. Forward contract ..................................................................................................... 103
2.2. Hedging with options............................................................................................... 107
2.3. Example – Comparing the three hedges ................................................................. 108
Exercises on hedging – transaction exposure.................................................................... 111
Key Exercises for International Corporate Finance ............................................................ 115
PART 4: INTERNATIONAL CORPORATE FINANCE/ INTERNATIONAL CAPITAL
MARKETS ......................................................................................................................... 116
A) Share cross-listing: why and when should we cross-list our shares?............................. 116
1. Introduction ................................................................................................................ 116
2. Segmentation and integration in the world’s stock exchanges (how are exchange
markets organized?) .......................................................................................................... 117
2.1. Federation International de Bourses de Valerus (FIBV) .......................................... 117
2.2. Why do not exchanges places simply merge? ........................................................ 118
3. Why might companies want to list shares abroad? ..................................................... 119
3.1. How it works? ......................................................................................................... 119
3.2. Possible gains from foreign or cross listings? ......................................................... 121
3.3. Possible costs from foreign or cross listings? .......................................................... 121
4. Shareholders likely reaction to diversification opportunities ........................................ 122
4.1. Why would new investors be interested in international diversification? ...................... 122
4.2. Why would companies prefer global investors? A partial equilibrium exploration ........ 123
4.3. Conventional wisdom .................................................................................................. 124
5. Impact of cross-listing on firm value............................................................................ 125
6. Conclusion ................................................................................................................. 127
B) Mergers and Acquisitions .............................................................................................. 129
1. Mergers and acquisitions............................................................................................ 129
2. M&A’s in waves – Neo-classical vs. market-timing explanations ................................ 134
1.1. The Neo-classical explanation for M&A activity ................................................... 135
1.2. Is there any evidence as to the behavioural theory of M&As? ............................. 139
1.3. Horse race between the neo-classical and the behavioural views ....................... 142
3. Managers’ overconfidence – M&A valuation effects and hubris .................................. 145
3.1 Long-term performance .......................................................................................... 145
3.2 Short-term stock returns – A predictor of future performance .................................. 150
3.3 Anticipation hypothesis – focus on acquires............................................................ 154
3.4 Predictive ability of short-term returns ..................................................................... 158
4. Behavioral biases ....................................................................................................... 159
4.1 Manager overconfidence ........................................................................................ 159
4.2 Hubris ..................................................................................................................... 162
3
Master business engineering: business & technology
1st semester 2020-2021
Prof. dr. James Thewissen
Textbook (only selected chapters):
- Bekaert and Hodrick, International Financial Management, 2018,
Cambridge University Press
- Sercu, P., International Finance: Theory into Practice, 2009, Princeton
University Press
Exam:
- Written exam, closed book, combination of theory and exercises
Table of contents:
Part 1: Architecture of international markets………………………………………
Foreign exchange markets
The Impossible Trinity and the predictability of exchange rates
New trends in international finance (cryptocurrencies and ICOs)
Part 2: International parity conditions and exchange rate determination……
PPP, real-exchange rates and the interest rate parity
iCAPM
Part 3: International corporate finance……………………………………………..
International capital budgeting
Management of transactional exposure
Management of economic exposure
Part 4: International capital markets………………………………………………..
International equity financing and share cross-listing
M&As – new evidence and cross-country analysis
Tax avoidance
,Table of Contents
PART 0 – Introduction ........................................................................................................... 5
1. Globalization .................................................................................................................. 5
2. International finance or the existence of borders ............................................................ 5
3. Borders complicate the job of the CFO ........................................................................... 7
3.1. Exchange rate risk................................................................................................... 7
3.2. Segmentation of consumer-goods markets – the Big Mac standard ........................ 7
3.3. Credit risk .............................................................................................................. 10
3.4. Political risk ........................................................................................................... 10
3.5. International tax issues.......................................................................................... 11
4. Why is international finance useful? ............................................................................. 11
PART 0 – History of international markets ........................................................................... 12
1. Four take-aways ........................................................................................................... 12
2.1. At the beginning… ................................................................................................. 12
2.2. The Gold Standard, 1876-1913 ............................................................................. 13
2.3. The Inter-War years and WWII, 194-1944 ............................................................. 14
2.4. Bretton Woods and the IMF, 1944 ......................................................................... 14
2.5. Today .................................................................................................................... 15
3.1. A trinity .................................................................................................................. 17
4.1. Continuum from most rigid to least interventionist ................................................. 18
4.2. Fixed band exchange rate ..................................................................................... 18
4.3. Crawling peg ......................................................................................................... 18
4.4. Details on various regimes .................................................................................... 18
4.5. How to fix the exchange rate? ............................................................................... 19
4.6. To fix or not to fix? ................................................................................................. 19
4.7. Currency boards.................................................................................................... 19
4.8. Dollarization .......................................................................................................... 19
4.9. The currency regime Choices for Emerging Markets ............................................. 20
4.10. Regime evolution ............................................................................................... 20
PART 1 – Architecture of International Markets ................................................................... 23
1. Introduction .................................................................................................................. 23
A) Foreign exchange market - spot markets for foreign currency ...................................... 25
2. MAJOR MARKETS ...................................................................................................... 25
2.1. Market segments ................................................................................................... 25
2.2. Wholesale: 2 kind of professionals: market makers and currency brokers ............. 26
2.3. Volume over time and by currency: geography and market size ............................ 26
2.4. Transaction types .................................................................................................. 27
3. Exchange rates ............................................................................................................ 28
1
, 3.1. Our Convention: HC units per unit of FC .................................................................. 28
3.2. Bid & ask spread ....................................................................................................... 29
3.3. Primary and cross rates ............................................................................................ 29
3.4. Determinants of bid and ask spreads ........................................................................ 31
4. The Law of one price for the stock market .................................................................... 33
4.1. Two way arbitrage ................................................................................................. 33
4.2. Triangular arbitrage and the LOP .......................................................................... 35
4. Forward contracts......................................................................................................... 38
4.1 Definition ............................................................................................................... 38
4.2 Relevance ............................................................................................................. 40
5. Exchange rate regimes................................................................................................. 41
5.1 Continuum from most rigid to least interventionist ................................................. 41
5.2 € ............................................................................................................................ 44
5.3 The Venezuelan case............................................................................................ 45
Exercises on spot markets for foreign currency ................................................................... 47
B) Impossible trinity & the predictability of exchange rates ................................................ 51
➔Asian Currency Crisis ...................................................................................................... 51
➔Contemporary Issues in Finance / International finance / Do we know what makes forex
markets tick? (CH10 HB) ..................................................................................................... 56
1. Statistics ....................................................................................................................... 59
2. Behavior of spot exchange rates .................................................................................. 60
2.1 Changes in log rates: findings ............................................................................... 62
3. Exchange rates and economic policy fundamentals ..................................................... 69
3.1 The monetary model (understand logic behind it – read it) .................................... 69
3.2 Results .................................................................................................................. 72
3.3 Discussion ............................................................................................................. 74
PART 2: INTERNATIONAL PARITY CONDITIONS AND EXCHANGE RATE
DETERMINATION............................................................................................................... 78
A) Purchasing Power and Interest rate parties ..................................................................... 78
1. The purchasing power parity ........................................................................................ 78
1.1. Absolute PPP ........................................................................................................ 78
1.2. Relative PPP ......................................................................................................... 84
2. The covered interest rate parity .................................................................................... 88
1.1. Perfect market assumption .................................................................................... 89
1.2. General formula .................................................................................................... 94
1.3. In practice – The carry trade .................................................................................. 96
Exercises on parity conditions ............................................................................................. 98
PART 3 – Managing Contractual Exchange Rate Exposure .............................................. 100
Transaction Exposure & Hedging: Managing Contractual Exchange Rate Exposure ......... 100
2
, 1. Why you need to understand FX exposure? ............................................................... 100
2. Introduction to Transaction Exposure ......................................................................... 100
2.1. Forward contract ..................................................................................................... 103
2.2. Hedging with options............................................................................................... 107
2.3. Example – Comparing the three hedges ................................................................. 108
Exercises on hedging – transaction exposure.................................................................... 111
Key Exercises for International Corporate Finance ............................................................ 115
PART 4: INTERNATIONAL CORPORATE FINANCE/ INTERNATIONAL CAPITAL
MARKETS ......................................................................................................................... 116
A) Share cross-listing: why and when should we cross-list our shares?............................. 116
1. Introduction ................................................................................................................ 116
2. Segmentation and integration in the world’s stock exchanges (how are exchange
markets organized?) .......................................................................................................... 117
2.1. Federation International de Bourses de Valerus (FIBV) .......................................... 117
2.2. Why do not exchanges places simply merge? ........................................................ 118
3. Why might companies want to list shares abroad? ..................................................... 119
3.1. How it works? ......................................................................................................... 119
3.2. Possible gains from foreign or cross listings? ......................................................... 121
3.3. Possible costs from foreign or cross listings? .......................................................... 121
4. Shareholders likely reaction to diversification opportunities ........................................ 122
4.1. Why would new investors be interested in international diversification? ...................... 122
4.2. Why would companies prefer global investors? A partial equilibrium exploration ........ 123
4.3. Conventional wisdom .................................................................................................. 124
5. Impact of cross-listing on firm value............................................................................ 125
6. Conclusion ................................................................................................................. 127
B) Mergers and Acquisitions .............................................................................................. 129
1. Mergers and acquisitions............................................................................................ 129
2. M&A’s in waves – Neo-classical vs. market-timing explanations ................................ 134
1.1. The Neo-classical explanation for M&A activity ................................................... 135
1.2. Is there any evidence as to the behavioural theory of M&As? ............................. 139
1.3. Horse race between the neo-classical and the behavioural views ....................... 142
3. Managers’ overconfidence – M&A valuation effects and hubris .................................. 145
3.1 Long-term performance .......................................................................................... 145
3.2 Short-term stock returns – A predictor of future performance .................................. 150
3.3 Anticipation hypothesis – focus on acquires............................................................ 154
3.4 Predictive ability of short-term returns ..................................................................... 158
4. Behavioral biases ....................................................................................................... 159
4.1 Manager overconfidence ........................................................................................ 159
4.2 Hubris ..................................................................................................................... 162
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