In the sections dealing with global investments, we address the questions including:

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1 June 25, 2008 MS&E 247s International Investments Handout # 1 Page 1 of 6 STANFORD UNIVERSITY MWF 3:15-4:30 pm (Live broadcast on SITN channel E2) Yee-Tien (Ted) Fu Gates B01 Summer 2008 (3 units) COURSE OBJECTIVE This course examines important issues in the rapidly evolving area of international financial markets and strategies, and global investments. It focuses on various aspects of international portfolio management in an open-economy macroeconomic setting, and is a natural extension to the theories and practical issues explored in Investments and/or Finance. To be specific, the course addresses to the following needs of a modern investor in a global environment: grappling with such concerns as how to value global companies as well as when and how (1) monetary and fiscal policies affect exchange rates; (2) foreign exchange risk affects companies and investment portfolios; (3) global correlations collapse; (4) foreign exchange risk should be hedged; and (5) multi-period performance attribution distinguishes skill from luck. We will also use real-life examples from market practices to emphasize the engineering dimensions of financial contract design (financial engineering), that market practitioners professionalize by blending theory with practice. Real financial contract examples will be discussed along with the relevant sections of the Levich and Solnik texts during the progress of this course. Recent practices and incidences on international financial innovation and challenges (e.g., sub-prime mortgage loans and collateralized debt obligations) will be studied in depth with financial constructs detailed in Fabozzi s Bond Markets, Strategies, and Analysis. This course is aimed at students wishing to acquire a sound understanding of the main opportunities in international investments. For example, the relevance of hedging in the management of currency risk will be studied in light of theoretical results and empirical evidence. Foreign direct investment (FDI) will also be introduced, since in general, the revenue streams generated from FDI by U.S. firms is about three times as large as the revenue generated from the exporting of U.S. goods by U.S. firms. Due to the ever increasing importance of international corporate governance, there is a corresponding need to decipher and use information in financial reports. At least one class meeting and one case study will touch on some key issues in international financial reporting and analysis, such as financial disclosure/transparency, incentives for off-balance sheet liabilities, hedge accounting, lease accounting, footnote disclosures, and inter-corporate equity investments, and international financial reporting differences. OVERVIEW In this course, we explore the characteristics of international financial markets and strategies, and global investments; and examine some international aspects of corporate financial management. In the sections dealing with international financial markets and strategies, we address a standard set of questions including: What are the essential institutional and organizational features of the market place? What are the fundamental determinants of prices and price relationships in the market? Are market prices set efficiently in relation to a theoretical model, or are there evidences of market inefficiencies or shortcomings in the theoretical models?

2 June 25, 2008 MS&E 247s International Investments Handout # 1 Page 2 of 6 What are the major policy decisions faced by private individuals and institutions, as well as public policymakers and regulatory agencies, in each market? What are collateralized mortgage obligations? What are collateralized debt obligations? What are active bond portfolio management strategies? What are liabilities funding strategies? In the sections dealing with global investments, we address the questions including: When and how monetary and fiscal policies affect exchange rates? When and how foreign exchange risk affects companies and investment portfolios? When and how global correlations collapse and derivative pricing kernels fail? When and how foreign exchange risk should be hedged? In the topics that relate primarily to corporate financial management, our emphasis is on how a financial manager should use his/her knowledge of international financial markets to address questions such as: How can we measure the firm's exposure to financial and operational risks? How can we manage the firm's exposure to financial and operational risks? How can we evaluate international projects and exploit differences in the cost of capital? ASSIGNMENTS AND GRADING Problem Sets 30% (Due on s 7/14, 7/21, 7/28, 8/04 and 8/11) Mid-term 30% (Close Book, Open Formula Sheets) Final 40% (Open Book, Open Notes) HOW TO REACH ME Office : Terman Engineering Center, Room: 367 Office hours : MWF 4:30-5:30 p.m. Office phone : (650) [Fax: (650) ] <ffuy@stanford.edu> Department liaison : Roz Morf <rozm@stanford.edu> Terman Engineering Center, Room 405 Tel: (650) Fax: (650) Course assistants : Supakorn Mudchanatongsuk <supakorn@stanford.edu> Terman Engineering Center, Room 498, Tel: Office Hours: Thursdays 3-5 p.m. Mohammad Mousavi < mousavi@stanford.edu > Terman Engineering Center, Room 397, Tel: TBA Office Hours: Tuesdays 3-5 p.m. Weekly Problem Session (Viewable from Stanford Online): TBA. Course web page : (Summer 2008) ID: 247s PASSWORD: Stanford88 TEXT Required Text (available from Stanford Bookstore):

3 June 25, 2008 MS&E 247s International Investments Handout # 1 Page 3 of 6 1. Richard M. Levich, International Financial Markets: Prices and Policies, 2 nd Ed., McGraw-Hill/Irwin, 2001, ISBN: (a course reader, available from Bookstore). Alternatively, a more complete Adobe Acrobat ebook titled International Investments 2007, which is actually a four-in-one (Levich: International Investments 2E, Jorion: Value at Risk 3E, Penman: Financial Statement Analysis and Security Valuation 3E, and King & King: International Economics and International Economics Policy: A Reader 4E) with an ISBN of It may be ordered from Highly Recommended Texts (Great for Chartered Financial Analyst (CFA) Exams): 2. Bruno Solnik, et. al., Global Investments, 6 th Ed., Pearson, 2009, ISBN: Fabozzi, Frank J., Bond Markets, Analysis, and Strategies, 6 th Ed., Pearson, 2007, ISBN: (work well with Levich and Solnik texts, covers sub-prime loans, etc.) 4. David G. Luenberger, Investment Science, Oxford University Press, 1997, ISBN: (the definitive rigorous introduction to Investments) Recommended Reading: 5. Philippe Jorion, Value at Risk, Irwin/McGraw-Hill, 2007, ISBN: R. Feenstra and A. M. Taylor, International Economics, Worth Publishers, 2008, ISBN: Levich, et. al., International Investments, 1 st Ed., McGraw-Hill, 2006, ISBN: Chacko, et al., Financial Instruments & Markets: A Case book, Wiley, 2006, ISBN: Desai, Mihir A., International Finance: A Case book, Wiley, 2006, ISBN: Neftci, Salih N., Principles of Financial Engineering, Academic Press, 2004, ISBN: Shapiro, Alan C., Multinational Financial Management, 8 th Ed., Wiley, 2006, ISBN: McDonald, Robert L., Derivatives Markets, 2 nd Ed., Addison-Wesley, 2006, ISBN: X. 13. Mankiw, N. Gregory, Macroeconomics, 6 th Ed., Worth Publishers, 2007, ISBN: Marthinsen, John, Risk Takers 2 nd Ed, Addison-Wesley, 2008, ISBN: COURSE OUTLINE AND ASSIGNMENTS HW Due Dates: s 7/14, 21, 28; 8/04, 11. In-class Midterm: 8/03; Final Exam: 8/15 or Saturday 8/16. Lecture 1 6/25/08 Lecture 2 6/27/08 Lecture 3 Introduction Some samples of the topics to be covered in the course, including foreign direct investment (FDI), the law of one price, a macroeconomic theory of the open economy, parity conditions, examples of interest rate parity and covered interest arbitrage, swaps & linkages across international capital markets, CFA exam questions. READING ASSIGNMENT: Wall Street Journal, Financial Times, International Herald Tribune, Business Week and Economist articles ( ID: 247s PASSWORD: Stanford88). ASSIGNMENT: Levich Chapter 2, Exercises 1, 2, 3, 4. (no need to hand in) Market Structure and Institutions TOPICS: Market participants; volume, composition, and growth of trading, foreign exchange products and activities, the relationship between spot and forward contracts, synthetic contracts (the replicating portfolio idea), trends toward automated trading, controls over trading. ASSIGNMENT: Levich Chapter 3, Exercises 1, 2, 6, 7, 10. (Due on 7/14/08) Solnik Chapter 1, Problems 9, 12, 16, 18, 20. (no need to hand in) International Parity Conditions: Purchasing Power Parity

4 June 25, 2008 MS&E 247s International Investments Handout # 1 Page 4 of 6 6/30/08 Lecture 4 7/02/08 TOPICS: International parity conditions in a perfect capital market, why parity conditions are useful, absolute and relative PPP, empirical evidence on PPP, policy decisions and PPP. ASSIGNMENT: Levich Chapter 4, Exercises 5, 6, 7. (Due on 7/14/08) International Parity Conditions: Interest Rate Parity and the Fisher Parities TOPICS: Interest rate parity and covered interest arbitrage, the impact of transaction costs, taxes and uncertainty on parity; uncovered interest rate parity or the Fisher International Effect, financial strategies based on deviations from parity, forward rate unbiased condition. ASSIGNMENT: Levich Chapter 5, Exercises 1, 4, 5, 6. (Due on 7/14/08) Solnik Chapter 2, Problems 3, 14, 16. (no need to hand in) 7/04/08 Fri No Class: July 4 th celebration, Rains BBQ event Lectures 5,6 7/07/08 7/09/08 Lecture 7 7/11/08 Determination of Spot Exchange Rates: Theory and Evidence TOPICS: Exchanges rates and macroeconomic news announcements, asset models of the spot exchange rate, the monetary model, the sticky-price monetary model, the portfolio balance model; Empirical evidence on exchange rate models, empirical evidence on the role of news. ASSIGNMENT: Levich Chapter 6, Questions 3, 7, 10, 14. (Due on 7/21/08) Solnik Chapter 3, Problems 10, 13. (no need to hand in) Foreign Exchange Market Efficiency TOPICS: Theory of exchange market efficiency, interpreting efficient market studies, empirical evidence on spot market efficiency, technical trading models, empirical evidence on forward market efficiency. ASSIGNMENT: Levich Chapter 7, Exercises 1, 2. (Due on 7/21/08) Lectures 8,9 7/14/08 7/16/08 Lecture 10 7/18/08 Lecture 11 7/21/08 Foreign Exchange Rate Forecasting TOPICS: Forecasting under pegged rates versus floating rates, short-run versus long-run forecasts, forecast performance evaluation -- accurate versus useful forecasts; short-run forecast: trends versus random walks, long-run forecasts: is there mean reversion? composite forecasts. ASSIGNMENT: Levich Chapter 8, Exercises 1, 2, 3, 4. (Due on 7/28/08) Solnik Chapter 3, Problems 17, 18, 19. (no need to hand in) The Eurocurrency Market TOPICS: Origins of the market, market dimensions and location, pricing Eurocurrency deposits and loans, risks of Eurocurrency deposits, interest rate risk in Eurocurrency loans, competitive responses to offshore markets, approaches to regulating offshore markets. ASSIGNMENT: Levich Chapter 9, Exercises 3, 4, 5. (Due on 7/28/08) The Eurobond Market TOPICS: Origins of the market, market dimensions and currency composition, regulatory and institutional features, primary market practices, the gray market, onshore-offshore arbitrage, pricing determinants of Eurobonds, competitive responses - the Rule 144a market. ASSIGNMENT: Levich Chapter 10, Exercises 1, 2. (Due on 7/28/08) Alternative Investments (Solnik: Chapter 8)

5 June 25, 2008 MS&E 247s International Investments Handout # 1 Page 5 of 6 TOPICS: Investment Companies, Real Estate, Private Equity, Hedge Funds and Absolute Return Strategies, Closely Held Companies and Inactively Traded Securities, Distressed Securities/Bankruptcies, Commodity Markets and Commodity Derivatives ASSIGNMENT: Solnik Chap 8, Prob. 4, 6, 8, 10, 14, 16, 18. (no need to hand in) Lecture 12 7/23/08 Lecture 13 7/25/08 International Bond Portfolios TOPICS: Dimensions of national bond markets, calculating the hedged and unhedged returns on international bonds, the "free-lunch" notion in international bond funds, active versus passive currency risk management, empirical evidence on international bonds, Brady bonds, global asset allocation. ASSIGNMENT: Levich Chapter 14, Exercises 1, 2. (Due on 8/04/08) Collateralized Mortgage Obligations (Fabozzi: Chapter 12) ASSIGNMENT: Fabozzi Chapter 12, Exercises 1, 2. (no need to hand in) Collateralized Debt Obligations (Fabozzi: Chapter 12) ASSIGNMENT: Fabozzi Chapter 15, Question 20. (no need to hand in) Currency and Interest Rate Futures TOPICS: Institutional differences between futures and forwards, the marking-tomarket convention, payoff profiles of futures contracts, futures and hedging, the term structure of forward prices, currency risk premium in forwards, success and failure of new futures contracts, do futures markets effect cash market volatility? ASSIGNMENT: Levich Chapter 11, Exercises 1, 2, 3, 4. (Due on 8/04/08) Fabozzi Chapter 26, Question 11, 15. (no need to hand in) Lecture 14 7/28/08 Currency and Interest Rate Options TOPICS: Option terminology, contract specifications, payoff profiles of options, options and hedging, pricing spot currency options, the discrete time binomial option pricing approach (another replicating portfolio), the continuous time lognormal approach, empirical evidence on option pricing models, estimating volatility, historical versus implied volatility, managing the risks in option positions. Lecture 15 7/30/08 Continue with Currency and Interest Rate Options ASSIGNMENT: Levich Chapter 12, Exercises 5, 6, 7, 8. (Due on 8/11/08) Derivatives: Risk Management with Speculation, Hedging, and Risk Transfer (Solnik: Chapter 10) ASSIGNMENT: Solnik Chap 10, Prob. 1, 2, 7, 8, 9, 11, 12. (no need to hand in) 8/01/08 Fri Mid-term Examination (In-Class, Closed Book, Open Formula Sheet) Lectures 16, 17 8/04/08 8/06/08 Currency and Interest Rate Swaps TOPICS: Origins of the swap market, measuring the size of the market, gross versus net measures of the market, basic cash flow requirements of currency and interest rate swaps, the swap as a collection of forward contracts (another replicating portfolio), risks of swaps, Measuring the risks of swaps, amortization and diffusion effects, price quoting conventions in swaps, pricing interest rate and currency swaps, sources of gains to the users of swaps, risk exposure and capital requirements for swaps dealers and counterparties, netting agreements, BIS capital requirements.

6 June 25, 2008 MS&E 247s International Investments Handout # 1 Page 6 of 6 ASSIGNMENT: Levich Chapter 13, Exercises 1, 2. (Due on 8/11/08) Lecture 18 8/08/08 Lecture 19 8/11/08 Lecture 20 8/13/08 Interest-Rate Swaps and Agreements (Fabozzi: Chapter 28) ASSIGNMENT: Fabozzi: Chap 28, Exercises 14, 16, 17. (no need to hand in) Credit Derivatives (Fabozzi: Chapter 29) ASSIGNMENT: Fabozzi: Chap 29, Exercises 10, 13, 25. (no need to hand in) Measuring Exposure to International Financial Risks TOPICS: Macroeconomic risks and the value of the firm, direct and indirect economic exposures, accounting measures of exposure (translation and transaction exposure), economic measures of exposure (regression and scenario analysis), empirical evidence. ASSIGNMENT: Levich Chapter 16, Exercise 3. (no need to hand in) Managing Exposure to International Financial Risks TOPICS: Why should the firm hedge? Financial strategies toward risk management, selecting a suitable hedging instrument, picking the right hedge ratio, the Value at Risk (VAR) approach, BIS regulations and the use of inhouse VAR measures. ASSIGNMENT: Levich Chapter 16, Questions 4, 5. (no need to hand in) Topics in International Financial Reporting and Analysis TOPICS: Financial disclosure/transparency, incentives for off-balance sheet liabilities, hedge accounting, lease accounting, footnote disclosures, intercorporate equity investments, international financial reporting differences and inflation. International Equity Portfolios TOPICS: International portfolio diversification, size and institutional features of global equity markets, international investment vehicles (ADRs, closed-end funds, CBs, WEBS), risk and return in international equity markets, factors leading to over- and under-weighting of home country shares, barriers to international investment, harmonization of issuing and listing standards. ASSIGNMENT: Levich Chapter 15, Exercises 3, 4, 5. (no need to hand in) International Asset Pricing (Solnik Chapter 4) TOPICS: Asset Pricing Theory, The Domestic Capital Asset Pricing Model, Asset Returns and Exchange Rate Movements, The Domestic CAPM Extended to the International Contexts, International CAPM, Market Imperfections and Segmentation, Practical Implications, A Global Approach to Equilibrium Pricing, Estimating Currency Exposures, Tests of the ICAPM. ASSIGNMENT: Solnik Chap 4, Problems 4, 7, 13, 17, 18. (no need to hand in) Equity Analysis (in Solnik Chapter 6 Equity: Concepts and Techniques, pages ) ASSIGNMENT: Solnik Chap 6, Problems 8, 10, 12, 14, 16. (no need to hand in) The Case of International Diversification (Solnik Chapter 9) TOPICS: The Traditional Case for International Diversification, The Case Against International Diversification, The Case of International Diversification Revisited, The Case for Emerging Markets. ASSIGNMENT: Solnik Chapter 9, Problems 3, 4, 6. (no need to hand in)

7 June 25, 2008 MS&E 247s International Investments Handout # 1 Page 7 of 6 8/15/08 Final Examination (12:15-3:15 p.m.) or- 8/16/08 Sat Choose one convenient time to take the Final Exam. Current update: This Version: