The Chinese University of Hong Kong
CUHK Business School
FINA3020 International Finance
First Term 2015 – 2016
A. Staff Information
Instructor:
Office:
Phone:
Email:
Office Hours:
Dr. Anson C. K. AU YEUNG
Room 1245, Department of Finance, CYT
3943 3780 ansonauyeung@baf.cuhk.edu.hk By Appointment
TA:
Office:
Phone:
Email:
Office Hours:
Miss. Karen LEE
Room 1155, Department of Finance, CYT
3943 7840 karenlee@baf.cuhk.edu.hk By Appointment
B. Class Schedule
Session
FINA3020A
FINA3020B
Day
Thursday
Monday
Time
14:30 – 17:15
14:30 – 17:15
Venue
CKB UG04
WMY 406
C. Course Overview
Businesses are operating in an increasingly competitive environment. Managing businesses either directly or indirectly exposed to international competition requires an understanding of currency markets, foreign exchange derivatives, exchange risk, exposure and risk management. This course assumes the viewpoint of the financial manager of a multinational corporation (MNC) with investment or financial operations in more than one country.
Managers encounter new opportunities as they extend their operations into international markets, as well as new costs and risks. The challenge facing the multinational financial manager is to successfully develop and execute business and financial strategies in more than one national business environment.
The aim of this course is to provide you a framework for analyzing financial decisions relating to risk management, financing and investments. These issues cannot be viewed in isolation. For instance, a U.S. corporation may be unwilling to accept a positive-NPV EUR export contract or to borrow JPY unless the exchange risk can be hedged; or a corporate loan can simultaneously serve as a hedge. Hedging is even used to facilitate asset valuation and
NPV-analysis. Because the issues are linked, we prefer to arrange the material in the following way:
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1. The Institutional Framework – Money, banking, international banking and international payments, and exchange rate regimes.
2. International Financial Markets – The exchange market, the international money and capital markets, and their satellite markets (futures, options, swaps). In these topics you become acquainted with the hedging and funding instruments. Our extensive discussion of forward contracts also allows us to address many key issues in corporate finance, like the relevance of hedging, the currency of invoicing issue, financial reporting and valuation problems, and so on. A good understanding of forward contracts also helps to analyze the more recent derivative contracts, like futures, options, and swaps. In this part we take the exchange rate and the interest rates as given, and use arbitrage arguments to analyze the derivative contracts.
3. Exchange Rate Determination – We leave the comparatively firm ground of arbitrage pricing, and use equilibrium theories like purchasing power parity, the balance of payments theory, and mean-variance asset pricing to understand where exchange rates and interest rates come from.
4. Risk Management – Using the insights from the first two parts, we now address the issues of the relevance of hedging and of exposure in a systematic way.
5. International Capital Budgeting – How should we deal with the intricacies of international capital budgeting (including taxation and political risks), and how should we set the cost of capital?
D. Learning Outcomes
After completing this course, students should be able to:
Understand the international environment in which the MNC operates.
Understand the structure and functioning of international financial markets, including the foreign exchange market.
Understand exchange rate quotations, explain how exchange rate movements are measured, explain how exchange rates are determined, and describe the factors that cause exchange rate movements.
Conduct international arbitrage in foreign exchange and international money markets.
Determine the various types of foreign exchange exposure and apply different techniques to hedge exchange rate risk.
Evaluate the benefits of international diversification.
Implement capital budgeting decisions and analyze the factors that affect multinational capital budgeting.
Explain the factors that affect an MNC’s cost of capital and capital structure decisions.
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E. References
1. (BH) Bekaert and Hodrick, International Financial Management, 2nd Edition, Pearson,
2012.
2. (ERS) Eun, Resnick and Sabherwal, International Finance, 6th Global Edition, McGrawHill Irwin, 2012.
F. Academic Integrity
Attention is drawn to University policy and regulations on honesty in academic work, and to the disciplinary guidelines and procedures applicable to breaches of such policy and regulations. Details may be found at http://www.cuhk.edu.hk/policy/academichonesty.
With each assignment, students may be required to submit a statement that they are aware of these policies, regulations, guidelines and procedures.
G. Course Requirements and Assessment
Group Project, 15 December 2015
Individual Assignments
Midterm Exam, 30 October 2015
Final Exam, 7 December 2015
The final grade will be assigned based on a relative frequency distribution (percentile ranking) of the total points accumulated over the entire semester. This means that your final grade will be determined by the relative performance of other students in the class as well as the overall performance of the entire class.
Makeup exams will only be given under extreme circumstances with appropriate third-party documentation. 3
H. Group Project
Task Nature
Group Project
Purpose
To take the role of a foreign exchange client adviser at an investment bank in evaluating two alternatives – a forward contract and a currency option – to hedge exchange rate exposure.
Learning Outcomes
To formulate a basis for discussion about why and when firms should hedge. To create awareness about the factors that contribute to a firm’s exchange rate exposure. To facilitate understanding of how hedging futures other corporate objectives – meeting interest payments and growth objectives for EPS.
To develop understanding of two wellknown hedging instruments, a forward contract and a currency option.
To further understanding of the fundamentals that underlie these instruments, such as the forecasting of forward rates using interest-rate parity and the use of the Black-Scholes model to value currency options.
You are suggested to form a group of 4 to 5 students to work on the case. If your group has more than 5 students, you must split it up. You are also not encouraged to work alone. You must email the list of your group members with each member’s name, student ID and email address to my TA before 2 October 2015.
The deadline of report submission is 15 December 2015. Late submission will receive a penalty of 5 points deduction per day.
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I. Course Schedule
Class
Week 1
Week 2
Week 3
Week 4
Week 5
Week 6
Week 7
Week 8
Week 9
Topic
Topic 2: Spot Exchange Markets
Exchange rate quotation: direct/indirect and bid/ask.
Arbitrage and least-cost dealing across market makers.
Topic 3: Understanding Forward Exchange
Contracts
A diagram of spot, forward and money markets. Arbitrage and least-cost dealing in perfect markets, interest rate parity.
The forward rate as the certainty equivalent future spot rate.
Topic 3: Understanding Forward Exchange
Contracts
The market value of a forward contract.
Implications for the valuation of foreign currency assets and liabilities; for financial reporting; for hedging, invoicing, investment and financing policies.
Forward rate agreement (FRA): valuation and uses.
Public Holiday
Topic 4: Purchasing Power Parity
Purchasing power parity (PPP)
Deviations from PPP and real exchange risk. Topic 5: The Balance of Payments
The BOP approach to exchange rate determination. Topic 6: Asset Approach of Exchange Rate
Determination
An introduction to the portfolio model of exchange rate determination
Topic 7: Risk and Return in Forward
Markets
The unbiased expectation hypothesis
(UEH)
Fisher open relationship
A general evaluation of the idealized relations. Topic 8: Currency Options
Foreign exchange options.
Currency option pricing
Requirements
BH: Chapter 2
ERS: Chapter 4
BH: Chapter 3
ERS: Chapter 4
BH: Chapter 3
ERS: Chapter 4
BH: Chapter 8
ERS: Chapter 5
BH: Chapter 4
ERS: Chapter 3
ERS: Chapter 5
BH: Chapter 7
ERS: Chapter 5
BH: Chapter 20
ERS: Chapter 6
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Class
Week 10
Week 11
Week 12
Week 13
Week 14
Topic
Topic 11: Contractual Exposure to
Exchange Rate
Measuring transaction exposure.
Money market, forward and option hedge.
Topic 12: Operating Exposure to Exchange
Rate
The source of operating exposure and the importance of the economic environment.
Measuring and hedging operating exposure. Topic 13: Accounting Exposure to
Exchange Rate
The current rate method.
The current/non-current method.
The monetary/non-monetary method.
Topic 10: Currency and Interest Rate
Swaps
The fixed-for-fixed currency swap.
Interest rate swap.
Final Exam
Requirements
BH: Chapter 17
ERS: Chapter 13
ERS: Chapter 12
ERS: Chapter 14
BH: Chapter 21
ERS: Chapter 10
I reserve the rights to make appropriate changes concerning the addition and deletion of topics, assigned readings and the order of presentation.
