MULTINATIONAL FINANCE. Barry Topf April 2014

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1 MULTINATIONAL FINANCE Barry Topf April

2 INTRODUCTION Course Goals Methodology Organization Background Course Outline 2

3 COURSE GOALS Acquire analytical tools Obtain necessary knowledge and perspective Familiarity with basic concepts and their uses - and their limitations Basic quantitative and computational skills 3

4 Multinational Finance Multinational financial management is financial management conducted in more than one cultural, social, economic, or political environment However, in today s world important to everyone regardless of nature of operations Especially clear in Israel 4

5 Methodology 3 six hour sessions trial by ordeal + 3 six hour sessions With Kobi Textbook Multinational Finance, Kirt C. Butler, 5 th edition Additional Readings Some audiovisual enrichment Open format, questions, comments and discussions- and feedback- welcomed. Relevance from an Israeli viewpoint 5

6 Organization Schedule: Today; May 8 th, May 15 th Quizes: May 8 th and May 15 th at 7:30 pm; Final Quiz May 22 Grades: Simple average of best two out of three quiz grades Bonus possibility for participation 6

7 Organization Session Schedule (tentative): 4:00-5:20 5:20-5:40 Break 5:40-7:00 7:00-7:30 Break 7:30-8:40 8:40-8:50 Break 8:50-9:45 7

8 My Background מנהל חדר עסקות בבנק ישראל מנהל מחלקת מט"ח בב"י מנהל חטיבת השווקים בב"י חבר בועדה המוניטארית בבנק ישראל היום: חבר ועדת השקעות של משקיעה מוסדי יועץ לקרן המטבע הבינלאומי IMF( ) 8

9 Course Outline The International Financial Environment The Multinational Enterprise The International Capital Market and Investment Management Along the way: Efficient Markets Agency theory Behavioral Finance Regulation and macro risk Monetary Policy and Operations The Crisis 9

10 The International Financial Environment Chapters 1-4 Integration of the world s markets for goods, services, and financial instruments Balance-of-payments statistics Exchange rate systems Fixed versus floating, and everything in between Recent history of international exchange rates Recent currency crises The evolving role of the IMF Regulatory environment 10

11 Integration of global markets for goods and services Global trend toward free-market economies; particularly the industrialization of the Pacific Rim 1991 breakup of the Soviet Union; the reunification of Germany; and the migration of central and eastern European countries toward the European Union 1995 creation of the World Trade Organization (WTO) China s emergence in international markets, Hong Kong s 1997 return to China, and China s 2001 entry into the WTO 1999 creation of the euro and its adoption by an expanding set of European countries 11

12 Integration of the world s markets Balance-of-payments statistics Exchange rate systems Recent history of international exchange rates U.S. Merchandise Trade ($ billions) Imports Exports Trade deficit

13 The Impossible Trinity MONETARY INDEPENDENCE FIXED EXCHANGE RATE OPEN CAPITAL ACCOUNT 13

14 Capital Flows Open Trade Account no restrictions on imports and exports Open Current Account no restrictions on services Open Capital Account - no restrictions on financial flows Convertible Currency Reserve Currency 14

15 Capital Flows Foreign Exchange Controls Outward/Inward FDI /Portfolio Residents/nonresidents Taxes Reserve Requirements Minimum Holding Periods Repatriation Limitations Administrative Measures 15

16 Integration of the world s markets Balance-of-payments statistics Exchange rate systems Recent history of international exchange rates Integration of financial markets An increase in cross-border financing Increasingly interdependent national financial markets, including cooperative linkages among securities exchanges An increasing number of cross-border mergers, acquisitions, and joint ventures Increased international regulation

17 The Bretton Woods Agreement World Bank - which now includes International Bank for Reconstruction and Development International Development Association International Finance Corporation Multilateral Investment Guarantee Agency Int l Centre for Settlement of Investment Disputes International Monetary Fund (IMF) Responsible for ensuring the stability of the international financial system Compiles balance-of-payments statistics GATT/WTO

18 Integration of World Markets GATT/WTO Multilateral Mercosur Caricom Asean Efta Nafta Bilateral US-Israel Australia-New Zealand 18

19 Integration of the world s markets Balance-of-payments statistics Exchange rate systems Recent history of international exchange rates The U.S. Balance of Payments Goods: Exports Goods: Imports Trade Balance Services: Credit Services: Debit Balance on Goods & Services Income: Credit Income: Debit Balance on Goods, Servs, & Income Current transfers: Net Current Account Source: IMF (

20 The U.S. balance of payments Capital account: Net Direct Investment Abroad Direct Invest from Abroad Portfolio Investment Assets Portfolio Invest Liabilities Other Investment Assets Other Investment Liabilities Financial Account Net Errors and Omissions 20

21 BOP: International Comparisons GDP in GDP per Trade surplus per billions capita GDP capita Germany $3,085 $37, % $2,506 Australia $918 $40, % $1,320 Korea $1,554 $31, % $685 China $11,300 $8, % $173 Brazil $2,284 $11, % $158 Japan $4,389 $34, % $48 India $4,463 $3, % -$127 Canada $1,389 $40, % -$261 U.K. $2,250 $35, % -$2,545 U.S. $15,040 $48, % -$2,568 Greece $306 $27, % -$3,536 21

22 % 6 ISRAEL CURRENT ACCOUNT BALANCE % OF GDP ) מקור: הלשכה המרכזית לסטטיסטיקה ועיבודי בנק ישראל

23 Integration of the world s markets Balance-of-payments statistics Exchange rate systems Exchange rate systems Recent history of international exchange rates Pegged or fixed exchange rate systems Forges a direct link between inflation differentials and employment levels Can result in large adjustments Floating exchange rate systems Allows exchange rates to adjust for inflation differences Allows employment levels and wages to equalize through the exchange rate mechanism

24 AFRICA ASIA MIDDLE EAST AMERICAS Djibouti Hard peg Hong Kong - Ecuador Soft Peg Burundi, WAEMU Nepal Saudi Arabia Argentina Floating Nigeria, S. Africa India, Australia, Malaysia Israel, Turkey Chile EUROPE Bulgaria Russia,Denmark Sweden, UK, Eurozone Hard pegs: Exchange arrangements with no separate legal tender, and currency board arrangements Soft pegs: Conventional peg arrangements, stabilized arrangements, crawling pegs, crawl-like arrangements, and pegs within horizontal bands Floating arrangements: 'Floating' (largely market determined and without exchange rate targets) 'Free floating' (market determined with very infrequent intervention) 24

25 Major events in the history of FX rates Bretton Woods Conference 1946 IMF and World Bank created Exchange rate turmoil begins the modern era of floating 1971 exchange rates Jamaica Agreement (1976) European Exchange Rate Mechanism (1979) Treaty of Maastricht1991 Introduction of the euro (1999) Euro begins public circulation (2002) Integration of the world s markets Balance-of-payments statistics Exchange rate systems Recent history of international exchange rates

26 Major events in the history of FX rates Integration of the world s markets Balance-of-payments statistics Exchange rate systems Recent history of international exchange rates 1946 Bretton Woods Conference Dollar is convertible into gold at $35/ounce Other currencies are pegged to the dollar The IMF and the World Bank also were created

27 Balance-of-payments statistics Exchange rate systems Recent history of international exchange rates Major events in the history of FX rates 1971 Exchange rate turmoil U.S. dollar falls off the gold standard Most currencies float on world markets 1976 Jamaica Agreement Floating rates are declared acceptable 1979 European Monetary System (EMS) European Exchange Rate Mechanism (ERM) established to maintain EEC currencies within a 2.25% band around central rates European currency unit (ECU) created

28 Major events in the history of FX rates 1991 Treaty of Maastricht EC members agree to a broad agenda of economic, financial and monetary reforms A single European currency is proposed as the ultimate goal of monetary union 1999 Introduction of the euro Emu-zone currencies pegged to the euro European bonds convert to the euro 2002 Euro begins public circulation The euro is now a major international currency Integration of the world s markets Balance-of-payments statistics Exchange rate systems Recent history of international exchange rates

29 Israel s ER Regimes 1985 Peg to dollar 1986 Peg to basket Horizontal Bands Adjustments of central rate Adjustments of width 1991-present Crawling Bands Adjustments of central rate Adjustments of width Adjustments of slope Asymmetric slopes internal Bands 29

30 Chronology of the Transition After a few years the Band became irrelevant Formally eliminated in 2005 Ten years of non-intervention During crisis of 2008, resumed intervention 2010 Discretionary policy introduced 30

31 Israel s Transition The FX Regime and the FX Market Exchange-Rate Regime : Fixed Exchange Rates : Horizontal Exchange-Rate Band : Crawling Exchange-Rate Band 2005: Band eliminated 2008: Resume Intervention Trading System : Fixing : Multilateral Trade : Continuous Bilateral Trade 31

32 Ingredients of Transition 4-The Foreign Exchange Market: Interbank Trading Environment: Regime, Supervision, Authorities Surplus Units Bank Deficit Units Bank Broker Bank Surplus Units Bank Infrastructure: Communications, Computer 32 Systems, Clearing Systems

33 Israel s Transition The FX Regime NIS shekels (July 85 - May 89) Peg to USD 10% Peg to Basket basket 8% 3% 5% 3% USdollar III IV I II III IV I II III IV I II III IV I II

34 Israel s Transition The FX Regime NIS shekels /Basket 2.90 (Jan 89-Mar 92) % 3% 6% Multilateral Trade 3% 3% 6% adjustm ent 5% 5% 10% 5% 5% I II III IV I II III IV I II III IV I II % 6% Hurt the specs 5% artificial

35 Israel s Transition The FX Regime (Oct91 - May01) Bilateral Trade Broker 6% slope 6% slope 14% % slope % slope 9% slope 5% 5% 5% 5% 6% slope 5% 5% Internal band 7% 14% 7% 4% slope 6% slope Differential slopes 07/08/98 2% slope End of Intervention / /92 09/92 03/93 09/93 03/94 09/94 03/95 09/95 03/96 09/96 03/97 08/97 02/98 08/98 02/99 08/99 02/00 08/00 02/01 08/01

36 Israel s Transition The FX Regime % slope % slope % % slope % slope 9% slope 5% 5% 5% 5% 6% slope 5% 5% 7% 7% 6% slope 07/08/98 14% 4% slope 2% slope /91 03/92 09/92 03/93 09/93 03/94 09/94 03/95 09/95 03/96 09/96 03/97 08/97 02/98 08/98 02/99 08/99 02/00 08/00 02/01 08/01

37 Integration of the world s markets Balance-of-payments statistics Exchange rate systems Recent history of international exchange rates Recent currency crises Causes and consequences Countries in crisis Currency crises and the IMF Recent currency crises Mexican peso crisis of 1995 Asian contagion of 1997 Korea, Indonesia, and Thailand Russian ruble crisis in 1998 Brazilian real crisis in 1998 Argentinian peso crisis of 2002

38 Balance-of-payments statistics Exchange rate systems Recent history of international exchange rates Currency crises Contributing factors in each crisis A fixed or pegged exchange rate system that overvalued the local currency A large amount of foreign currency debt Consequences of currency crises Currency crises have a pronounced negative short-term impact on the local economy A market-based exchange rate can have an invigorating long-term impact on the local economy and on the local stock market

39 Integration of the world s markets Balance-of-payments statistics Exchange rate systems Recent history of international exchange rates Indonesia s 1997 currency crisis Stock market (Dec 1995 = 1.00; in rupiah) Indonesian rupiah ($/rupiah)

40 International Regulatory Regime Bank Supervision :Basel I, II, III ECB Supervision Anti-Money Laundering (AML), anti-terrorist, sanctions IOSCO Insurance 40