2. 1 - 1 INTERNATIONAL FINANCE LECTURE NOTES MM IPMI Prof. Roy Sembel, Ph.D October 2009 – February 2010

3. 1 - 2 Last week’s (January 16) AGENDA Review of course outline, assignments, and last- week materials Book Review presentation, 25-30 minutes per group USD forecast results Simulation: temporary results

4. 1 - 3 Forecasting Rp/US$ GroupDates 1112131415comments 1 92509250925092509250TA 292609280931592909280TA 392769224924191639206TA 4 92799275927492769275TA (MA-3) Average92669257927092459253 Random walk== Exch Rate on 10/1 Actual92339157917491659165

5. 1 - 4 Error of Forecast GroupDates 11 12 13 14 15 Total 1 2 3 4 Average Rd Wk 17937685 27123141125 4367 2 46118100111 33,25100,259680,75

6. 1 - 5 January 23 AGENDA Course Review Simulation: temporary results Currency Risk Exposure: Transaction, Translation, Economic Exposure Managing Currency Risk with Derivatives Discussion: Barings, SocGen Case: Vogl

7. 1 - 6 ‘Students’  Active learners: Read reading materials Discuss within group (articles, hot issues, investment simulation, solution for cases, book review, preparing presentation) Participate actively in class discussion ‘Lecturer’  Facilitator: Structure syllabus Prepare reading materials, cases, simulation rules & template Invite guest lecturers Facilitate discussion, presentation 3-stage learning: Individual learning Group discussion Class discussion Grading policy: Individual efforts (class participation & quiz) 35% Group efforts (case summary & group presentation) 40% Final examination 25% STUDENT CENTERED APPROACH

8. 1 - 7 COURSE OUTLINE Projects / Cases: 1. Event analysis: (Financial) Crises of the world 2. International Portfolio Investment Simulation 3. Book Review 4. Analysis of one Multi National Company (MNC) 5. Exchange rate forecasting Final Examination

9. 1 - 8 1. Oct 10  Choose one of the crises: Indonesia 1966, Indonesia 1997, Sub-prime mortgage 2007, Jerome Kerviel (Societe Generale 2007), DotCom Bubble 2000, The Great Depression 1929 2. Nov 14  1-page description of the crises 3. Nov 28  Analysis of the causes of the crises 4. Dec 19  What happened after the crises 5. Jan 23  Lessons learned from the crises 6. Jan 30  Submit complete report 7. February 6  25-minute presentation of the crises Project 1: Crises of the world

10. 1 - 9 1. Nov 14  5-minute presentation of criteria, reasons, and fund allocation 2. Nov 28 – Jan 30  weekly performance report 3. February 6  5-minute presentation of final results and lessons learned Project 2: Simulation International Portfolio Investment

11. 1 - 10 Project 3: Book Review 1. Nov 14  Choose one book 2. Jan 9  Submit Report (10 pages, A4, times roman 12, line spacing1.5) 3. Jan 16  Book review presentation

12. 1 - 11 Project 4: Analysis of one Multi National Company (MNC) 1. Oct 10  Choose one MNC 2. Nov 14  Describe briefly the MNC 3. Nov 28  Analyze historical (weekly: last 52 weeks, yearly: last 5 years) performance of MNC’s stock 4. Dec 19  Analyze MNC’s funding and investment strategy 5. Jan 30  Analyze MNC’s financial risk management strategy 6. Feb 6  Submit complete report on MNC

13. 1 - 12 Project 5: Exchange Rate Forecasting 1. Nov 14, 2009 to January 9, 2010  Visit www.oanda.com, play around with Rp/$ data (average daily return, volatility, etc), download monthly data January 2007 – January 2010 2. January 9, 2010  Forecast the Rp/$ (closing) exchange rates for 11/1, 12/1, 13/1, 14/1, 15/1. 3. January 16  Record your forecast error

14. 1 - 13 Final Examination 1. Group take-home examination [40% of total final examination score]: Complete report on Investment simulation, EVENT, MNC 2. Individual in-class examination [60% of total final examination score]: Questions on projects, hot issues, guest lecture, articles, etc.

15. 1 - 14 Assignment agenda January 23: Readings: ICF Ch 5, 10, 11, 12 Managing Derivatives Risks: Barings Several articles on Risk Management Project/Case: ¤ Case: Vogl Co ¤ EVENT: Lessons learned ¤ Investment Simulation: weekly performance report

16. 1 - 15 Assignment agenda January 30: Readings: ICF Ch 16, 19, Appendix 3 p 87-97 Articles: Emerging Market Risk; Measuring Long Term Performance Project/Case: ¤ EVENT: Submit complete report on the crises ¤ MNC: Financial Risk Management in MNC ¤ Investment Simulation: weekly performance report

17. 1 - 16 Assignment agenda February 6: Project/Case: ¤ EVENT: Complete 25-minute presentation of the crises ¤ Simulation: 5 minute presentation of International Portfolio Investment Simulation Results and Lessons learned ¤ MNC: Complete report on MNC

18. 1 - 17 January 23 AGENDA Course Review Simulation: temporary results Currency Risk Exposure: Transaction, Translation, Economic Exposure Managing Currency Risk with Derivatives Discussion: Barings, SocGen Case: Vogl

19. 1 - 18 Investment Simulation Results GroupPortfolio value Main contributor 19/12 9/116/123/1 1105,4106,3 106,6105.1Mexico, Indonesia 2100,8102,1101,2100.1South Kor, Hong Kong 3 97,9100,4 99,8 98.7China, Indonesia 4101,2103,1 98,8100.6Indonesia, DJIA

20. 1 - 19 January 23 AGENDA Course Review Simulation: temporary results Currency Risk Exposure: Transaction, Translation, Economic Exposure Managing Currency Risk with Derivatives Discussion: Barings, SocGen Case: Vogl

21. 1 - 20 Currency risk exposure Exchange rate exposure may affect financing costs ¤ volatile cash flow from exchange rate changes increases risk Transaction exposure ¤ reflects the exposure of an MNC’s future cash transactions to exchange rate movements

22. 1 - 21 Currency risk exposure Economic exposure ¤ measures the direct and indirect risks to cash flows from exchange rate movements Translation exposure ¤ focuses on consolidated financial statements

23. 1 - 22 January 23 AGENDA Course Review Simulation: temporary results Currency Risk Exposure: Transaction, Translation, Economic Exposure Managing Currency Risk with Derivatives Discussion: Barings, SocGen Case: Vogl

24. 1 - 23 DERIVATIVE SECURITIES SECURITIES WHOSE VALUES DEPEND ON OTHER MORE ELEMENTARY ASSET. USES OF DERIVATIVE: SPECULATION ARBITRAGE HEDGING

25. 1 - 24 DERIVATIVES:

26. 1 - 25 FORWARDS CONTRACT BETWEEN TWO PARTIES TO BUY/SELL AN UNDERLYING ASSET WITH PRESPECIFIED AMOUNT, PRICE, AND DELIVERY TIME IN THE FUTURE. LONG VS SHORT

27. 1 - 26 FORWARDS EXAMPLES OF FORWARDS: PRE-HARVEST SALE (IJON) PRE-ARRANGED MARRIAGE (KAWIN SITI NURBAYA)

28. 1 - 27 FORWARDS LONG VS SHORT Long position Spot Price at maturity Short position Payoff Delivery price

29. 1 - 28 HEDGING A shoe manufacturer in Indonesia has just received an order to export several containers of shoes to Japan as soon as possible and will receive payment of 100 million yen six months from now. She estimates that the total cost (including insurance and transportation costs) of the exported shoes is Rp 8 billion rupiah. Yen may appreciate or depreciate against rupiah. Now, the spot price is Rp 100 / yen and six-month forward price is Rp 102 / yen What should she do ?

30. 1 - 29 HEDGING SITUATION : Long yen position (will receive yen) RISK : Yen depreciate against rupiah SOLUTION : Concentrate on shoe business Hedge the currency risk: take short yen position (sell yen forward) to cover the long yen position

31. 1 - 30 FORWARDS HEDGING YEN RECEIVABLES Long yen position in shoe business Rp / yen in six months Short yen position in derivative market Payoff Rp 102 /yen Net result : Currency fluctuation will not affect profit The Rp 2.2 billion profit is locked in from the shoe business, i.e., Rp 10.2 billion (or yen 100 million x Rp 102/yen) - Rp 8 billion

32. 1 - 31 FORWARDS VS FUTURES FORWARDS: TAILOR MADE BETWEEN TWO PARTIES FUTURES: STANDARDIZED, TRADED ON ORGANIZED EXCHANGE

33. 1 - 32 OPTIONS CONTRACT THAT GIVES ITS HOLDER A RIGHT RIGHT TO BUY (CALL) (CALL) OR SELL (PUT) A CERTAIN AMOUNT OF A CERTAIN UNDERLYING ASSET ASSET WITH A CERTAIN PREDETERMINED PRICE (STRIKE/EXERCISE PRICE) AT A CERTAIN TIME IN THE FUTURE AMERICAN VS EUROPEAN OPTIONS PRICE (PREMIUM) OF OPTIONS VS PRICE OF UNDERLYING ASSET

34. 1 - 33 CALL VS PUT CALL OPTIONS Right to BUY S At a price X At time T PUT OPTIONS Right to SELL S At a price X At time T

35. 1 - 34 How does it work? CALL NOWMATURITY Seller Short SELL S Writer Rp Premium S Rp X Buyer BUY S Long Taker Expired CALL OPTIONS Right to BUY S At a price X At time T Right to BUY S At price X At time T Hak digunakan Hak tidak digunakan

36. 1 - 35 How does it work? PUT NOWMATURITY Seller Short BUY S Writer Rp Premium S Rp X Buyer SELL S Long Taker PUT OPTIONS Right to SELL S At a price X At time T Right to SELL S At price X At time T Hak digunakan Hak tidak digunakan Expired

37. 1 - 36 INTRINSIC VS TIME VALUE INTRINSIC VALUE: ¤ MAX (0, | S – X | ) TIME VALUE: ¤ PREMIUM ABOVE INTRINSIC VALUE

38. 1 - 37 OPTIONS PAY-OFF X=30 Price of asset at maturity of options Strike price Pay-off Long Call Options Pay-off Short Call Options -C Profit Long Call Options C Profit Short Call Options BEP = X + C

39. 1 - 38 OPTIONSPAY-OFFX=30 Strike Price Pay-off Long Put Options Pay-off Short Put Options -P Profit Long Put Options P Profit Short Put Options BEP Price of asset at maturity of options

40. 1 - 39 CASE STUDY PT Bank Bangkrut plans to expand its operation to the US and offer to buy a US bank at US$ 10 million. The US bank needs 3 months to consider the offer. Bank Bangkrut gives the US Bank 3 months to decide. 1. WHAT FINANCIAL RISKS ARE FACED BY BB ? 2. WHAT SHOULD IT DO TO HEDGE THE RISK ?

41. 1 - 40 CASE STUDY RISK EXPOSURE: Payoff Rp/$ 10,000 HEDGING

42. 1 - 41 January 23 AGENDA Course Review Simulation: temporary results Currency Risk Exposure: Transaction, Translation, Economic Exposure Managing Currency Risk with Derivatives Discussion: Barings, SocGen, Local Disputes Case: Vogl

43. 1 - 42 CASE: BARINGS What caused Barings’ debacle? Explain the risks of Leeson’s transactions! What lessons we learned from Barings?

44. 1 - 43 January 23 AGENDA Course Review Simulation: temporary results Currency Risk Exposure: Transaction, Translation, Economic Exposure Managing Currency Risk with Derivatives Discussion: Barings Case: Vogl

45. 1 - 44 VOGL Currency exposure? Tools: Forwards? Options? Why?

46. 1 - 45 THANK YOU VERY MUCH FOR YOUR ATTENTION

47. 1 - 46 Assignment agenda January 30: Readings: ICF Ch 16, 19, Appendix 3 p 87-97 Articles: Emerging Market Risk; Measuring Long Term Performance Project/Case: ¤ EVENT: Submit complete report on the crises ¤ MNC: Financial Risk Management in MNC ¤ Investment Simulation: weekly performance report

48. 1 - 47 LEARNING LOG

49. 1 - 48 PREMIUM OPTIONS FACTOREFFECT ON CALL PUT S + - ++ X-+ T ++ D-+ r +-

50. 1 - 49 OPTION VALUATION BINOMIAL MODEL BLACK-SCHOLES C = N(d1) S - N(d2) X e (-Rf * T) SIMULATION d1 = [ log(S/X) + Rf * T +  2 * T/2] / [  * T 0.5 ] d2 = d1 -  * T 0.5