1. Chapter 27 Principles PrinciplesofCorporateFinance Tenth Edition Managing International Risks Slides by Matthew Will Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved McGraw Hill/Irwin

2. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 2 McGraw Hill/Irwin Topics Covered  Foreign Exchange Markets  Some Basic Relationships  Hedging Currency Risk  Exchange Risk and International Investment Decisions  Political Risk

3. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 3 McGraw Hill/Irwin Foreign Exchange Markets Exchange Rate - Amount of one currency needed to purchase one unit of another. Spot Rate of Exchange - Exchange rate for an immediate transaction. Forward Exchange Rate - Exchange rate for a forward transaction.

4. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 4 McGraw Hill/Irwin Exchange Rates Example What is the franc premium (annualized)? franc Premium = 2 x ( 1.4457 - 1.4282) = 2.45% 1.4282 Dollar Discount = 2.45% Example What is the Yen discount (annualized)? Yen Discount = 2 x ( 103.52 - 101.18) = 4.26% 103.52 Dollar Premium = 4.26%

5. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 5 McGraw Hill/Irwin International Prices The Big Mac Index – The price of a Big Mac in different countries (Feb 1, 2007)

6. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 6 McGraw Hill/Irwin Purchasing Power & Exchange Rates

7. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 7 McGraw Hill/Irwin Exchange Rates Nominal versus Real Exchange Rates U.S. Dollar / UK (in log scale)

8. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 8 McGraw Hill/Irwin Exchange Rates Nominal versus Real Exchange Rates U.S. Dollar / France (in log scale)

9. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 9 McGraw Hill/Irwin Exchange Rates Nominal versus Real Exchange Rates U.S. Dollar / Italy (in log scale)

10. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 10 McGraw Hill/Irwin Interest Rates and Inflation Countries with the highest interest rates generally have the highest inflation rates. In this diagram each of the 55 points represents a different country.

11. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 11 McGraw Hill/Irwin Auto Industry Data 2003

12. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 12 McGraw Hill/Irwin Exchange Rate Risk Example - Honda builds a new car in Japan for a cost + profit of 1,715,000 yen. At an exchange rate of 120.700Y:$1 the car sells for $14,209 in Indianapolis. If the dollar rises in value, against the yen, to an exchange rate of 134Y:$1, what will be the price of the car? 1,715,000 = $12,799 134 Conversely, if the yen is trading at a forward discount, Japan will experience a decrease in purchasing power.

13. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 13 McGraw Hill/Irwin Exchange Rate Risk Example - Harley Davidson builds a motorcycle for a cost plus profit of $12,000. At an exchange rate of 120.700Y:$1, the motorcycle sells for 1,448,400 yen in Japan. If the dollar rises in value and the exchange rate is 134Y:$1, what will the motorcycle cost in Japan? $12,000 x 134 = 1,608,000 yen

14. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 14 McGraw Hill/Irwin Capital Budgeting 1) Exchange to $ and analyze 2) Discount using foreign cash flows and interest rates, then exchange to $. 3) Choose a currency standard ($) and hedge all non dollar CF. Techniques

15. Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved 28- 15 McGraw Hill/Irwin Political Risk