International Finance

Piet Sercu is professor of international finance at the Catholic University of Leuven. He is the coauthor, with Raman Uppal, of "International Financial Markets and the Firm".

• Preface xi Acknowledgments xiv Part I: Introduction and Motivation for International Finance 1 Chapter 1: Why Does the Existence of Borders Matter for Finance? 3 1.1 Key Issues in International Business Finance 4 1.2 What Is on the International CFO's Desk? 11 1.3 Overview of this Book 13 Chapter 2: International Finance: Institutional Background 16 2.1 Money and Banking: A Brief Review 16 2.2 The International Payment Mechanism 28 2.3 International ("Euro") Money and Bond Markets 33 2.4 What Is the Balance of Payments? 35 2.5 Exchange-Rate Regimes 45 Test Your Understanding 58 Part II: Currency Markets 63 About This Part 65 Chapter 3: Spot Markets for Foreign Currency 69 3.1 Exchange Rates 69 3.2 Major Markets for Foreign Exchange 78 3.3 The Law of One Price for Spot Exchange Quotes 87 3.4 Translating FC Figures: Nominal Rates, PPP Rates, and Deviations from PPP 97 3.5 CFO's Summary 108 3.6 Technical Notes 110 Test Your Understanding 110 Chapter 4: Understanding Forward Exchange Rates for Currency 115 4.1 Introduction to Forward Contracts 115 4.2 The Relation between Exchange and Money Markets 119 4.3 The Law of One Price and Covered Interest Parity 123 4.4 The Market Value of an Outstanding Forward Contract 130 4.5 CFO's Summary 140 4.6 Appendix: Interest Rates, Returns, and Bond Yields 141 4.7 Appendix: The Forward Forward and the Forward Rate Agreement 145 Test Your Understanding 154 Chapter 5: Using Forwards for International Financial Management 157 5.1 Practical Aspects of Forwards in Real-World Markets 157 5.2 Using Forward Contracts (1): Arbitrage 161 5.3 Using Forward Contracts (2): Hedging Contractual Exposure 164 5.4 Using Forward Contracts (3): Speculation 172 5.5 Using Forward Contracts (4): Minimizing the Impact of Market Part Imperfections 177 5.6 Using the Forward Rate in Commercial, Financial, and Accounting Decisions 190 5.7 CFO's Summary 194 Test Your Understanding 198 Chapter 6: The Market for Currency Futures 202 6.1 Handling Default Risk in Forward Markets: Old and New Tricks 202 6.2 How Futures Contracts Differ from Forward Markets 207 6.3 Effect of Marking to Market on Futures Prices 215 6.4 Hedging with Futures Contracts 218 6.5 The CFO's Conclusion: Pros and Cons of Futures Contracts Relative to Forward Contracts 226 6.6 Appendix: Eurocurrency Futures Contracts 227 6.7 Technical Notes 232 Test Your Understanding 234 Chapter 7: Markets for Currency Swaps 239 7.1 How the Modern Swap Came About 240 7.2 The Fixed-for-Fixed Currency Swaps 244 7.3 Interest-Rate Swaps 252 7.4 Cross-Currency Swaps 256 7.5 CFO's Summary 258 7.6 Technical Notes 259 Test Your Understanding 259 Chapter 8: Currency Options (1): Concepts and Uses 262 8.1 An Introduction to Currency Options 262 8.2 Institutional Aspects of Options Markets 269 8.3 An Aside: Futures-Style Options on Futures 272 8.4 Using Options (1): Arbitrage 275 8.5 Using Options (2): Hedging 281 8.6 Using Options (3): Speculation 288 8.7 CFO's Summary 291 Test Your Understanding 294 Chapter 9: Currency Options (2): Hedging and Valuation 299 9.1 The Logic of Binomial Option Pricing: One-Period Problems 300 9.2 Notation and Assumptions for the Multiperiod Binomial Model 306 9.3 Stepwise Multiperiod Binomial Option Pricing 312 9.4 Toward Black-Merton-Scholes (European Options) 319 9.5 CFO's Summary 323 9.6 Technical Notes 325 Test Your Understanding 331 Part III: Exchange Risk, Exposure, and Risk Management 337 About This Part 339 Chapter 10: Do We Know What Makes Forex Markets Tick? 342 10.1 The Behavior of Spot Exchange Rates 344 10.2 The PPP Theory and the Behavior of the Real Exchange Rate 358 10.3 Exchange Rates and Economic Policy Fundamentals 373 10.4 Conclusion 384 10.5 Technical Notes 385 Chapter 11: Do Forex Markets Themselves See What Is Coming? 398 11.1 The Forward Rate as a Black-Box Predictor 398 11.2 Forecasts by Specialists 418 11.3 CFO's Summary 423 Test Your Understanding 428 Chapter 12: (When) Should a Firm Hedge Its Exchange Risk? 434 12.1 The Effect of Corporate Hedging May Not Just Be "Additive" 435 12.2 FAQs about Hedging 443 12.3 CFO's Summary 448 Test Your Understanding 449 Chapter 13: Measuring Exposure to Exchange Rates 454 13.1 The Concepts of Risk and Exposure: A Brief Survey 455 13.2 Contractual-Exposure Hedging and Its Limits 457 13.3 Measuring and Hedging of Operating Exposure 461 13.4 Accounting Exposure 474 Test Your Understanding 487 Chapter 14: Value-at-Risk: Quantifying Overall Net Market Risks 493 14.1 Risk Budgeting: A Factor-Based, Linear Approach 494 14.2 The Linear/Normal VaR Model: Potential Flaws and Corrections 502 14.3 Historical Backtesting, Bootstrapping, Monte Carlo, and Stress Testing 515 14.4 CFO's Summary 520 14.5 Epilogue: The Credit Crunch Blues 524 Test Your Understanding 528 Chapter 15: Managing Credit Risk in International Trade 530 15.1 Payment Modes without Bank Participation 531 15.2 Documentary Payment Modes with Bank Participation 536 15.3 Other Standard Ways of Coping with Default Risk 542 15.4 CFO's Summary 545 Test Your Understanding 546 Part IV: Long-Term International Funding and Direct Investment 551 About This Part 553 Chapter 16: International Fixed-Income Markets 558 16.1 "Euro" Deposits and Loans 559 16.2 International Bond and Commercial-Paper Markets 572 16.3 How to Weigh Your Borrowing Alternatives 581 16.4 CFO's Summary 590 Test Your Understanding 592 Chapter 17: Segmentation and Integration in the World's Stock Exchanges 595 17.1 Background Information on International Stock Markets 599 17.2 Why Don't Exchanges Simply Merge? 618 17.3 Can Unification Be Achieved by a Winner Taking All? 625 17.4 CFO's Summary 638 Test Your Understanding 639 Chapter 18: Why--or When--Should We Cross List Our Shares? 641 18.1 Why Might Companies Want to List Shares Abroad? 642 18.2 Shareholders' Likely Reaction to Diversification Opportunities 646 18.3 Sifting through the Empirics on Cross-Listing Effects 651 18.4 CFO's Summary 660 Test Your Understanding 662 Chapter 19: Setting the Cost of International Capital 663 19.1 The Link between Capital-Market Segmentation and the Sequencing of Discounting and Translation 666 19.2 The Single-Country CAPM 669 19.3 The International CAPM 680 19.4 The CFO's Summary re Capital Budgeting 690 19.5 Technical Notes 693 Test Your Understanding 696 Chapter 20: International Taxation of Foreign Investments 703 20.1 Forms of Foreign Activity 703 20.2 Multiple Taxation versus Tax Neutrality 709 20.3 International Taxation of a Branch (1): The Credit System 712 20.4 International Taxation of a Branch (2): The Exclusion System 718 20.5 Remittances from a Subsidiary: An Overview 721 20.6 International Taxation of a Subsidiary (1): The Credit System 724 20.7 International Taxation of a Subsidiary (2): The Exclusion System 730 20.8 CFO's Summary 732 Test Your Understanding 733 Chapter 21: Putting It All Together: International Capital Budgeting 739 21.1 Domestic Capital Budgeting: A Quick Review 739 21.2 InNPV Issue #1: How to Deal with the Implications of Nonequity Financing 751 21.3 InNPV Issue #2: How to Deal with Exchange Rates 758 21.4 InNPV Issue #3: How to Deal with Political Risks 760 21.5 Issue #4: Make Sure to Include All Incremental Cash Flows 765 21.6 Other Things to Do in Spreadsheets While You're There 766 21.7 CFO's Summary 768 21.8 Technical Notes 770 Test Your Understanding 773 Chapter 22: Negotiating a Joint-Venture Contract: The NPV Perspective 777 22.1 The Three-Step Approach to Joint-Venture Capital Budgeting 779 22.2 A Framework for Profit Sharing 781 22.3 Case I: A Simple Pro-Rata Joint Branch with Neutral Taxes and Part Integrated Capital Markets 782 22.4 Case II: Valuing a Pro-Rata Joint Branch when Taxes Differ 784 22.5 Case III: An Unbundled Joint Venture with a License Contract or a Management Contract 786 22.6 CFO's Summary and Extensions 793 Test Your Understanding 797 Further Reading 801 References 803 Part Index 813

"[This] is the most comprehensive textbook on the financing, transactional, and risk management side of international trade and investment currently available... Compared to many other textbooks, this one excels at focusing on the topic at hand and not merely providing a corporate or derivative textbook with some international flavor added. The book provides more than ample material for courses on financial markets and business finance."--Evert Wipplinger, Financial Markets and Portfolio Management