International Finance

Maurice D. Levi

2005
4e

606pages






Contents
List of illustrations xiii
Preface xviii
1 THE WORLD OF INTERNATIONAL FINANCE 1
Unique dimensions of international finance 1
The benefits of studying international finance 1
The growing importance of international finance 2
Topics covered in this book 13
Summary 17
Review questions 17
Assignment problems 18
Bibliography 18
Parallel material for case courses 19
Appendix A 19
Appendix B 22
PART I
THE MARKETS FOR FOREIGN EXCHANGE 27
2 AN INTRODUCTION TO EXCHANGE RATES 29
The foreign bank note market 29
The spot foreign exchange market 32
Organization of the interbank spot market 32
Direct versus indirect exchange and cross exchange rates 43
Summary 50
Review questions 51
Assignment problems 51
Bibliography 52
3 FORWARD EXCHANGE 53
What is forward foreign exchange? 53
Forward exchange premiums and discounts 54
Forward rates versus expected future spot rates 56
Payoff profiles on forward exchange 56
Outright forward exchange and swaps 58


The flexibility of forward exchange 60
Forward quotations 61
Summary 65
Review questions 66
Assignment problems 66
Bibliography 67
4 CURRENCY FUTURES AND OPTIONS MARKETS 68
Currency futures 68
Currency options 75
Forwards, futures, and options compared: a summary 85
Summary 86
Review questions 87
Assignment problems 88
Bibliography 89
Appendix A 89
PART II
THE DETERMINATION OF EXCHANGE RATES 95
5 THE BALANCE OF PAYMENTS 97
Influences on currency supply and demand 97
Principles of balance-of-payments accounting 98
Balance-of-payments entries and the factors that influence them 99
Implications of the balance-of-payments accounting identity 108
The net international investment position 111
Objectives of economic policy 113
Summary 114
Review questions 116
Assignment problems 116
Bibliography 117
6 SUPPLY-AND-DEMAND VIEW OF EXCHANGE RATES 119
Imports, exports, and exchange rates 120
The factors affecting exchange rates 122
The stability of exchange rates 130
Short-run versus long-run trade elasticities and the J curve 133
Summary 135
Review questions 136
Assignment problems 136
Bibliography 137
Appendix A 137
PART III
THE FUNDAMENTAL INTERNATIONAL PARITY CONDITIONS 141
7 THE PURCHASING-POWER-PARITY PRINCIPLE 143
The law of one price 143
Absolute (or static) form of the PPP condition 144
The relative (or dynamic) form of PPP

Efficient markets (or speculative) form of PPP 147
The empirical evidence on PPP 148
Reasons for departures from PPP 151
Statistical problems of evaluating PPP 152
The practical importance of PPP 154
Summary 155
Review questions 156
Assignment problems 156
Bibliography 157
8 INTEREST PARITY 159
The investment and borrowing criteria 160
The covered interest-parity condition 166
Combining PPP and interest parity 169
Why covered interest differences persist 171
Summary 184
Review questions 185
Assignment problems 186
Bibliography 187
PART IV
MANAGING FOREIGN EXCHANGE RISK AND EXPOSURE 189
9 FOREIGN EXCHANGE EXPOSURE AND RISK 191
The importance of understanding risk and exposure and measuring them 191
The nature of exchange-rate risk and exposure 192
Examples of foreign exchange exposure 193
Exposure as a regression slope 198
Definition of foreign exchange risk 204
Exposure, risk, and the parity relationships 205
Summary 211
Review questions 213
Assignment problems 213
Bibliography 214
10 ACCOUNTING EXPOSURE VERSUS REAL EXPOSURE 216
Accounting principles 216
Real changes in exchange rates 220
Summary 226
Review questions 227
Assignment problems 227
Bibliography 228
11 OPERATING EXPOSURE 230
Operations affected by exchange rates 230
The exporter 231
The importer 240
Summary of effects of exchange rates on exporters and importers 244
Effect of currency of invoicing and forward hedging 244
Measuring exposure: an alternative approach 249
Summary 251


Review questions 252
Assignment problems 253
Bibliography 254
12 HEDGING RISK AND EXPOSURE 256
Whether to hedge: managerial hedging versus shareholder hedging 256
Hedging of receivables and payables 259
The cost of forward hedging 260
The benefit of forward hedging 264
Financial engineering: payoff profiles of different hedging techniques 272
Having a company hedging policy 276
Summary 276
Review questions 277
Assignment problems 278
Bibliography 279
13 EXCHANGE-RATE FORECASTING AND SPECULATION 280
Speculation 280
Market efficiency 283
Exchange-rate forecasting 288
Summary 300
Review questions 302
Assignment problems 302
Bibliography 303
PART V
INTERNATIONAL INVESTMENT AND FINANCING 305
14 CASH MANAGEMENT 307
The objectives of cash management 307
Investment and borrowing choices with transaction costs 308
International dimensions of cash management 310
Summary 319
Review questions 320
Assignment problems 320
Bibliography 321
15 PORTFOLIO INVESTMENT 322
The benefits of international portfolio investment 322
International capital asset pricing 331
Bonds and international portfolio diversification 339
Settlements of international portfolio investments 341
Summary 341
Review questions 343
Assignment problems 343
Bibliography 344
16 CAPITAL BUDGETING FOR FOREIGN INVESTMENTS 346
Selecting projects 346
Difficulties in evaluating foreign projects 348


Cash flows: home versus foreign perspectives 349
Discount rates: corporate versus shareholder perspectives 351
The adjusted-present-value technique 351
Selecting the appropriate discount rates 354
An example 356
Actual practice of capital budgeting 360
Summary 361
Review questions 362
Assignment problems 362
Bibliography 363
Appendix A 364
The different forms of taxes 364
Organizational structures for reducing taxes 367
Appendix B 369
17 THE GROWTH AND CONCERNS ABOUT MULTINATIONALS 373
The growth of MNCs 373
Special issues facing MNCs: transfer pricing 381
Special issues facing MNCs: country risk 384
Problems and benefits from the growth of MNCs 390
Transnational alliances 393
Summary 393
Review questions 395
Assignment problems 395
Bibliography 396
18 INTERNATIONAL DIMENSIONS OF LONG-TERM FINANCING 397
Equity financing 397
Bond financing 402
Bank financing, direct loans, and the like 410
Government and development-bank lending 413
Other factors affecting the financing of subsidiaries 413
Financial structure 414
Summary 417
Review questions 418
Assignment problems 418
Bibliography 419
PART VI
INSTITUTIONAL STRUCTURE OF INTERNATIONAL TRADE AND FINANCE 421
19 MULTINATIONAL BANKING 423
The Eurodollar and offshore currency markets 423
Multinational banking 431
Summary 441
Review questions 442
Assignment problems 442
Bibliography 443
20 INSTRUMENTS AND INSTITUTIONS OF INTERNATIONAL TRADE 445
Extra dimensions of international trade 445
International trade involving letters of credit: an overview of a typical transaction 445




Alternative payment and guaranteeing procedures 450
The financing of international trade 452
Countertrade 456
The institutions regulating international trade 459
Summary 463
Review questions 464
Assignment problems 464
Bibliography 465
PART VII
THE INTERNATIONAL MACROECONOMIC ENVIRONMENT: THEORIES
AND PRACTICES 467
21 ASSET-BASED THEORIES OF EXCHANGE RATES 469
Stock versus flow theories of exchange rates 469
The monetary theory of exchange rates 469
The asset approach to exchange rates 474
The portfolio-balance approach to exchange rates 475
Theories of exchange-rate volatility 479
Summary 483
Review questions 484
Assignment problems 484
Bibliography 485
22 ALTERNATIVE SYSTEMS OF EXCHANGE RATES 487
The classical gold-standard system 488
The Bretton Woods and dollar standards 491
The European monetary system (EMS) 496
Hybrid systems of exchange rates 499
Target zones 502
Summary 504
Review questions 506
Assignment problems 506
Bibliography 507
Appendix A 508
Appendix B 511
23 THE INTERNATIONAL FINANCIAL SYSTEM: PAST, PRESENT, AND FUTURE 514
The past 514
The present 529
The future 529
Degree of exchange-rate flexibility: fixed versus flexible exchange rates 536
Summary 543
Review questions 544
Assignment problems 545
Bibliography 546
Glossary 547
Name index 573
Subject index