Imad A. Moosa Department of Accounting and Finance Mortash University Boston Burr Ridge, IL Dubuque, IA Madison, Wl New York San Francisco St. Louis Bangkok Bogota Caracas Kuala Lumpur Lisbon London Madrid Mexico City Milan Montreal New Delhi Santiago Seoul Singapore Sydney Taipei Toronto
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«*«ABOUT THE AUTHOR PREFACE ACKNOWLEDGEMENTS MAJOR CHANGES IN THE THIRD EDITION TEXT AT A GLANCE x xi xii xiii xiv 1. AN OVERVIEW 1 1.1 The Importance of International Finance 2 1.2 International Finance and the Role of the Financial Manager 5 1.3 Indicators of the Intemationalisation of Finance 7 1.4 Post-War Economic, Financial and Institutional Developments 8 1.5 The Global Financial Crisis 23 Summary 29 Key Terms 29 Review Questions 30 2. THE FOREIGN EXCHANGE MARKET 33 2.1 Definition and Characteristics of the Foreign Exchange Market 34 2.2 Market Participants 35 2.3 The Size and Composition of the Foreign Exchange Market 37 2.4 The Mechanics and Technology of Foreign Exchange Trading 43 2.5 The Spot Exchange Rate 44 2.6 Spot Foreign Exchange Position Keeping 57 2.7 The Forward Exchange Rate 59 Summary 63 Key Terms 64 Review Questions 65 Problems 66 Appendix 2.1: More Foreign Exchange Jargon 68 Appendix 2.2: Types of Trading Orders 70 3. THE BALANCE OF PAYMENTS AND EFFECTIVE EXCHANGE RATE 71 3.1 Definition of the Balance of Payments 72 3.2 Australian Balance of Payments Statistics 72 3.3 The Balance of Payments and the Foreign 4. 4.1 4.2 Exchange Market 76 3.4 Factors Affecting the Balance of Payments Position 81 3.5 The Real Effective Exchange Rate 87 Summary 96 Key Terms 96 Review Questions 97 Problems 97 4.3 4.4 4.5 4.6 4.7 EXCHANGE RATE DETERMINATION 101 Some Stylised Facts about Exchange Rates 102 Factors Affecting Supply and Demand in the Foreign Exchange Market 103 Speculation in the Spot Foreign Exchange Market 113 Purchasing Power Parity 115 The Monetary Model of Exchange Rates 122 Determination of the Bid-Offer Spread and the Forward Spread 125 Factors Affecting the Australian Dollar Exchange Rate 127 Summary 132 Key Terms 133 Review Questions 133 Problems 135
THE INTERNATIONAL MONETARY SYSTEM AND EXCHANGE RATE ARRANGEMENTS 5.1 Definition and Criteria of Classification 5.2 Flexibility of Exchange Rates as a Criterion for Classification 5.3 The Classical Gold Standard 5.4 The Inter-War Period 5.5 The Bretton Woods System 5.6 The Present System 5.7 The European Monetary System 5.8 The Australian Dollar Exchange Rate Arrangements 5.9 Fixed versus Flexible Exchange Rates 5.10 The Future of the International Monetary System 137 138 138 144 146 146 148 152 155 156 157 7. INTERNATIONAL BANKING REGULATION AND THE BASEL ACCORDS 179 7.1 7.2 7.3 7.4 7.5 Why Banks are Important The Kinds of Risk Facing Banks Operational Risk The Pros and Cons of Banking Regulation Regulatory Functions and Forms of 180 181 182 186 7.6 7.7 7.8 7.9 7.10 7.11 Regulation 187 Some Capital-Related Concepts 191 The Basel Committee 195 The Basel I Accord 197 The Basel II Accord: Introduction 199 The Pillars of Basel II 200 A Critique of Basel II 206 Summary 210 Key Terms 211 Review Questions 211 Problems 212 Summary 159 Key Terms 160 Review Questions 161 6. THE EUROCURRENCY MARKET AND INTERNATIONAL BANKING 6.1 The Eurocurrency Market 6.2 Eurocurrencies and Eurocurrency Banking Centres 6.3 The Evolution and Growth of the Eurocurrency Market 6.4 Some Features of Eurobanking 6.5 Interest Rate Determination 6.6 International Banking 6.7 The Organisational Set-up of International Banking 163 164 164 166 168 169 171 172 8. 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 8.9 8.10 EXCHANGE RATE FORECASTING, TECHNICAL ANALYSIS AND TRADING RULES 215 What is Forecasting? 216 Why Do We Need Exchange Rate Forecasting? 216 Econometric Forecasting Models Time Series Forecasting Models Market-Based Forecasting Judgmental Forecasting Composite Forecasting Forecasting Performance Evaluation Technical Analysis Trading Rules 219 224 226 229 230 231 239 248 Summary 176 Key Terms 177 Review Questions 178 Summary 252 Key Terms 253 Review Questions 254 Problems 255
9. CURRENCY FUTURES AND SWAPS 257 9.1 Currency Futures: Definition and Origin 258 9.2 Futures and the Problematic Properties of Forward Contracts 258 9.3 A Comparison of Forward and Futures Markets 266 9.4 Specifications of Currency Futures Contracts 269 9.5 Currency and Interest Rate Swaps 270 9.6 Swap Terminology 278 12. FOREIGN EXCHANGE RISK AND EXPOSURE 12.1 Definition of Risk 12.2 Value at Risk 12.3 Definition of Exposure 12.4 Volatility of the Australian Dollar Exchange Rates 12.5 Transaction Exposure 12.6 Economic Exposure Summary 279 Key Terms 280 Review Questions 280 Problems 280 12.7 Translation Exposure 347 348 351 355 360 361 363 364 10. CURRENCY OPTIONS 283 Summary 366 Key Terms 367 Review Questions 367 Problems 368 10.1 Origin and Basic Concepts 284 10.2 Description of Currency Options Contracts 295 10.3 Option Positions 296 10.4 Determinants of Option Premiums 305 10.5 Exotic Options 308 Summary 310 Key Terms 310 Review Questions 311 Problems 311 11. INTERNATIONAL ARBITRAGE 313 11.1 Two-Point Arbitrage 314 11.2 Three-Point and Multi-Point Arbitrage 316 11.3 Commodity Arbitrage 321 11.4 Covered Interest Arbitrage 323 11.5 Uncovered Interest Arbitrage 331 Summary 340 Key Terms 341 Review Questions 341 Problems 342 13. FOREIGN EXCHANGE RISK 13.1 13.2 13.3 13.4 13.5 13.6 13.7 13.8 13.9 Why Worry About Foreign Exchange Risk? Hedging Short-Term Transaction Exposure with Forward and Futures Contracts Money Market Hedging of Short-Term Transaction Exposure Option Hedging of Short-Term Transaction Exposure Hedging a Contingent Exposure Hedging Long-Term Transaction Exposure Other Techniques of Managing Transaction Exposure Managing Economic Exposure Managing Translation Exposure 371 372 374 382 390 394 396 397 404 407 Summary 411 Key Terms 412 Review Questions 412 Problems 413
14. INTERNATIONAL SHORT-TERM FINANCING AND INVESTMENT 14.1 International Short-Term Financing 14.2 International Short-Term Investment 14.3 The Effective Financing Rate and Effective Rate of Return 14.4 Introducing the Bid-Offer Spreads 14.5 Implications of International Parity Conditions 14.6 Introducing Probability Distributions 14.7 Financing and Investment with Currency Portfolios 14.8 Centralised Versus Decentralised Cash Management 417 418 422 422 427 429 432 435 436 Summary 441 Key Terms 441 Review Questions 442 Problems 442 15. 15.1 15.2 15.3 15.4 15.5 15.6 15.7 15.8 INTERNATIONAL LONG-TERM FINANCING AND INVESTMENT International Bank Loan Financing International Bond Financing International Equity Financing Other Sources of Long-Term Financing Bond Investment Equity Investment The Benefits of International Portfolio Diversification International Capital Asset Pricing Model 447 448 449 453 454 456 460 464 471 16. FOREIGN DIRECT INVESTMENT AND INTERNATIONAL CAPITAL BUDGETING 479 16.1 16.2 16.3 16.4 16.5 16.6 16.7 16.8 Background 480 Approaches to International Business 480 Theories of Foreign Direct Investment 482 Evaluating Direct Investment Projects 487 Evaluating Foreign Direct Investment Projects 492 More About Taxation 496 Foreign Direct Investment and Country Risk 499 Transfer Pricing 501 Summary 504 Key Terms 506 Review Questions 506 Problems 507 USEFUL WEBSITES ABBREVIATIONS CURRENCY SYMBOLS LIST OF FORMULAE GLOSSARY INDEX 509 511 513 514 521 547 Summary 474 Key Terms 475 Review Questions 476 Problems 477