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Copyright © 2014 by Laurent Jacque. All rights reserved.
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Library of Congress Cataloging-in-Publication Data
Jacque, Laurent L.
International corporate finance + website : foreign exchange, currency derivatives, and risk management in the global capital markets / Laurent L. Jacque.
pages cm.—(Wiley finance series)
Includes index.
ISBN 978-1-118-78186-9 (paperback)—ISBN 978-1-118-78369-6 (ePDF)—
ISBN 978-1-118-78362-7 (ePub) 1. International business enterprises—Finance.
2. Risk management. 3. Foreign exchange. 4. Foreign exchange futures. I. Title.
II. Title: International corporate finance plus website. III. Title: International corporate finance and website.
HG4027.5.J3193 2014
332'.042—dc23
2013042741
For Bebe, Nathalie, and Olivier—my pride and my joy
As globalization is redefining the field of corporate finance, international finance is increasingly permeating most financial transactions, which in yesteryears were deemed to be strictly domestic transactions. In fact, it is very difficult to understand what is happening in capital markets without a firm grasp of currency markets, the investment strategies of sovereign wealth funds, carry trades, foreign exchange derivative products, and so forth. Similarly, project finance cannot be understood without a firm grasp of valuation concepts in a cross-border context. Indeed, international finance is now part and parcel of the basic literacy of any financial executive whether she or he is an investment banker, a treasurer, a CFO, a portfolio manager, or a loan officer. There is no hiding from international finance.
And yet the field of international finance textbooks is not terribly crowded, with the three or four leading titles showing signs of multiple editions fatigue. What is needed is a book offering a fresh perspective on international finance that transcends the boundaries of ethnocentric thinking and an overly U.S.-centric approach—a book that brings the fascinating and rapidly unfolding story of emerging capital markets and their daring multinationals in the mainstream of international finance. International Corporate Finance is purporting to be such a book.
There are several features that will set International Corporate Finance apart from rival books:
International Corporate Finance targets not only the business school market—primarily MBAs, undergraduate seniors, and executive MBAs—but also schools of international affairs and public administration. In draft form it has also been widely used in executive training programs at banks, multinationals, and increasingly government and regulatory agencies.
The book is intended for students taking an elective in international corporate finance that may be part of a finance major (but not necessarily). Although prior exposure to economics and corporate finance would be helpful, the book is self-contained and has no prerequisites.
International Corporate Finance should also appeal to a growing international/export market beyond the domestic university/college market. More generally, there is an explosion in the number of MBA programs offered in emerging market countries such as China, India, Brazil, Russia, and Mexico, where international finance is at the center in the curriculum simply because of the global orientation of these economies. For this rapidly growing market, it is imperative to approach international financial management from an emerging market perspective as well as a U.S. or European perspective. Specific chapters on Asian and Islamic finance and banking as well as BRIC countries, along with illustrations and problems/exercises, should be strong elements of differentiation vis-à-vis existing texts.
International finance is one of the most topical and lively business topics making the front page of any business daily, but, perhaps because of the unique role played by financial derivatives, it is also a highly complex, arcane, technical, and mystifying subject for the average business student. Herein lies the challenge for the instructor and the student: how to capitalize on the star power and captivating nature of international finance without sacrificing the rigor of the explanation. Textbooks all too often err on the side of academic correctness and read like treatises written for other knowledgeable academics rather than fresh-faced students. My approach is to start (most) chapters with real-life decisions—situations to hook the reader who presumably wants to know what possible answers struggling managers could implement—and then derive theory, rather than starting from a theoretical construct at the risk of losing the reader before turning to applications. For example, the chapter on trade financing starts with:
Tata Motors of India’s export manager, Raju Aneja, has just signed an export order for 1, 000 Nanos—its new revolutionary minicar—with Atlas Distributors, a Vespa scooter dealership based in Casablanca (Morocco). The export sale is denominated in euros (€) and calls for payment of €20 million on delivery—scheduled for approximately three months from time of shipment. Tata Motors has never had any commercial dealings with Atlas but was envisioning a long-term relationship with the Moroccan firm. However, it was concerned about the importer’s solvency. The Moroccan dirham was pegged to the euro and partially convertible. How should Tata Motors finance its export trade? Raju knew that this would be the first of many similar deals that Tata Motors was hoping to forge with other emerging market countries where the Nano was expected to meet with much commercial success.
Similarly, the chapter on debt financing starts with:
JetBlue Airlines was seeking to raise $250 million in a seven-year note to upgrade its aging fleet. Ms. Rousse—JetBlue’s newly appointed CFO—was reviewing the different funding options offered by its investment bankers, which included a domestic dollar-denominated zero-coupon bond priced at 61 percent, a dollar-denominated Eurobond with a 7.25 percent annual coupon, and a samurai bond denominated in yen with a semiannual coupon of 4.00 percent. Last, a floating-rate note denominated in euros paying euro-LIBOR + 165 basis points was also being considered. Ms. Rousse was perplexed by the array of currency denominations and the significant differences in nominal interest rates, both of which complicated direct comparisons among the different funding options.
Both chapters progressively build a more rigorous framework as they progress. In the same vein, a rich array of exercises and problems accompany each chapter; they are more than mechanical numerical applications of what is discussed in the chapter itself. Last but not least, most chapters offer a separate short case study (found on the book’s website) for fruitful discussion.
This book is divided into six parts:
Part One: The International Monetary Environment
Part Two: The Foreign Exchange Market and Currency Derivatives
Part Three: International Financing
Part Four: Managing Foreign Exchange Risk
Part Five: Cross-Border Valuation and Foreign Investment Analysis
Part Six: Managing the Multinational Financial System
Part One: The International Monetary Environment. Part One examines the monetary environment within which international financing decisions are made. How exchange rates are determined and the unique role played by central banks’ intervention in setting currency values is the focus of Chapter 2, whereas Chapter 3 presents a brief history of the international monetary system. The architecture of the world economy is outlined in Chapter 4 through the lens of national balance of payments accounting, which records the key flows linking national economies.
Part Two: The Foreign Exchange Market and Currency Derivatives. After introducing the foreign exchange market and its inner workings (Chapter 5), Part Two discusses the valuation of the mother of all currency derivatives—the forward contract—in the context of the theory of interest rate parity (Chapter 6). Currency futures, options, and swaps are detailed in Chapter 7, which shows how they can be harnessed for the purpose of risk management.
Part Three: International Financing. If globalization of financial markets has gone a long way toward eradicating differences in national cost of capital, they have not been entirely erased. This is why global financial markets are often characterized as mildly segmented rather than fully integrated (Chapter 8). Part Three outlines funding as a global procurement decision from both equity markets (Chapter 9) and debt markets (Chapter 10). The uniqueness of financing strategies and capital markets in two regions of the world that loom especially large on the global economy—namely East Asia and the Middle East—is addressed in separate chapters. Chapter 12 profiles the idiosyncrasies of Asian finance and banking in the context of Japan, South Korea, and China, whereas Chapter 13 explores the mysteries of Islamic finance.
Part Four: Managing Foreign Exchange Risk. The exchange rate variable permeates all key financial management decisions and injects a considerable degree of variability in a firm’s overall risk profile. Part Four starts by asking whether hedging part or all of a firm’s exposure to currency risk is indeed value creating for the firm’s owners and therefore warranted (Chapter 14). To the extent that exchange rate forecasting (Chapter 15) is a treacherous activity in the context of clean floating exchange rates, we take a “total risk” view of risk management. Exporters and importers as well as multinational corporations and globally reaching financial institutions generally hedge both transaction and translation exposures by using forwards, futures, options, or swaps. Measuring and managing transaction, translation, and economic exposures are discussed in Chapters 16, 17, and 18, respectively.
Part Five: Cross-Border Valuation and Foreign Investment Analysis. Part Five develops a valuation framework for cross-border investments that uniquely incorporates the different variables such as foreign exchange risk, country risk, asymmetric tax treatment, and different inflation rates. Chapter 20 contrasts different metrics such as net present value of asset-based cash flows or equity-based cash flows versus adjusted present value metrics, and reviews the necessary adjustments to be made to the cost of capital used as the discount rate in international valuation. The framework is applied to cross-border mergers and acquisitions in Chapter 21 and large-scale infrastructural project finance in Chapter 22. Taking the perspective of asset managers manning the desks of mutual funds, pension funds, hedge funds, or sovereign wealth funds, global investing in stocks and bonds is addressed in Chapter 23, which gauges the limit of geographical diversification in the context of ever-increasingly integrated capital markets.
Part Six: Managing the Multinational Financial System. Central to the successful implementation of a global strategy, multinational corporations need financial planning, budgeting, and control systems that incorporate the unique operating circumstances of each and every foreign subsidiary while ensuring that strategic goals are duly achieved (Chapter 24). Finally, Chapter 25 shows how financial decisions should be optimized to exploit fully the multinational enterprise system.
This book comes with a companion website, www.wiley.com/intlcorpfinance (see back of book for details).
Readers have access to all case studies, briefly introduced at the end of each corresponding chapter. These case studies help the reader apply the lessons from this book to real life situations. Each case comes with questions for discussion. Readers also have access to a detailed glossary of key terms used in this book.
Professors can readily download the following materials:
In addition, there are resources specifically for professors’ use, and those are available at John Wiley & Sons’ Higher Education website.
I would be grateful for readers’ and instructors’ constructive comments and suggestions for improvements and revisions. Please write directly to me at laurent.jacque@tufts.edu.
Over the years, research projects, consulting assignments, and discussions with many savvy executives and academics have helped me challenge received wisdom in the area of corporate finance, financial engineering, risk management, and derivatives; for their insight this book is a better one. Most notably I wish to thank Daniel Ades (Kawa Fund), Y. D. Ahn (Daewoo), Bruce Benson (Barings), Joel Bessis (HEC), Amar Bhide (Tufts University), Alex Bongrain (Bongrain S.A.), Charles N. Bralver (Oliver Wyman), James Breech (Cougar Investments), Eric Briys (Cyberlibris), Gaylen Byker (InterOil), Brian Casabianca (International Finance Corporation), Asavin Chintakananda (Stock Exchange of Thailand), Georg Ehrensperger (Garantia), Myron Glucksman (Citicorp), Anthony Gribe (J.P. Hottinguer & Cie), Gabriel Hawawini (INSEAD), Charamporn Jotishkatira (Stock Exchange of Thailand), Robert E. Kiernan (Advanced Portfolio Management), Oliver Kratz (Global Thematic Partners), Margaret Loebl (ADM), Rodney McLauchlan (Bankers Trust), Jacques Olivier (HEC), Craig Owens (Campbell Soup), Avinash Persaud (State Street), Guadalupe Philips (Televisa), Roland Portait (ESSEC), Jorge Ramirez (Aon Risk Solutions), Patrick J. Schena (Tufts University), Christoph Schmid (Bio-Oil), John Schwarz (Citicorp), Manoj Shahi (Shinsei Bank, Japan), Sung Cheng Chih (GIC, Singapore), Charles Tapiero (Polytechnic Institute at NYU), Adrian Tschoegl (Wharton), Seck Wai Kwong (State Street), and Lawrence Weiss (Tufts University).
I am indebted to several individuals who selflessly read and edited different versions of the manuscript, and I wish to express my appreciation to:
I owe a debt of gratitude to Patrick Schena and Ibrahim Warde, who contributed original chapters on Asian finance and Islamic finance, and to Martin Rietzel for writing the appendix on real options. Special thanks are owed to Olivier Jacque for building financial models used throughout the book and to Shuvan Dutta for developing several original case studies. Research assistance from Ravi Chaturvedi, Jaya Movva, and Christina Valverde, as well as timely help from Lupita Ervin for graphics and word processing is gratefully acknowledged. Last but not least, I wish to thank my “editor in chief”—Rishad Sadikot—who painstakingly reviewed the entire manuscript and asked all the hard questions.
Special thanks are owed to the John Wiley & Sons editorial team—most notably Tula Batanchiev (editorial program coordinator), Evan Burton (editor), Meg Freeborn (senior development editor), and Stacey Fischkelta (senior production editor)—for their professional guidance and enthusiasm for the project, which made the final stage of writing this book feel almost easy.
Yet with so much help from so many, I am still searching for the ultimate derivative that would hedge me from all remaining errors: But there is no escape—they are all mine.
LLJ
Winchester and Paris
September 1, 2013
Laurent L. Jacque is the Walter B. Wriston Professor of International Finance and Banking at the Fletcher School of Law and Diplomacy (Tufts University) and Academic Director of its International Business Studies Program. He previously served as Fletcher’s Academic Dean and as such was responsible for the design and the establishment of the new Master of International Business degree and the Center for Emerging Market Enterprises. Since 1990 he has also held a secondary appointment at the HEC School of Management (France). Earlier, he served on the faculty of the Wharton School for 11 years with a joint appointment in the finance and management departments, and taught at the Carlson School of Management (University of Minnesota). He also held visiting appointments at Instituto de Empresa (Spain), Kiel Institute of World Economics (Germany), Pacific Asian Management Institute (University of Hawai), Institut Supérieur de Gestion (Tunisia), and Chulalongkorn University (Thailand) as the Sophonpanich Research Professor.
He is the author of three books, Global Derivative Debacles: From Theory to Malpractice (World Scientific, 2010), translated into French, Russian, Chinese, and Korean; Management and Control of Foreign Exchange Risk (Kluwer Academic Publishers, 1996); Management of Foreign Exchange Risk: Theory and Praxis (Lexington Books, 1978); as well as more than 25 articles on risk management and international corporate finance that have appeared in leading academic and professional journals such as Management Science, Journal of Risk and Insurance, Journal of Applied Corporate Finance, Journal of International Business Studies, Insurance: Mathematics and Economics, Journal of Operations Research Society, Columbia Journal of World Business, and other publications. He served as an advisor and consultant to Wharton Econometrics Forecasting Associates, and as a member of Water Technologies Inc.’s board of directors.
A recipient of several teaching awards, Laurent Jacque also recently won the James L. Paddock award for teaching excellence at the Fletcher School and the Europe-wide HEC-CEMS award in 2008. He is a consultant to a number of firms and active in executive education around the world. Laurent Jacque is a graduate of HEC (Paris) and received his MA, MBA, and PhD from the Wharton School (University of Pennsylvania).