1. Course introduction for 723G33 Risk Management and derivatives (former 723g14 International Finance) Yinghong.chen@liu.se PhD in Financial Economics yinghong.chen@liu.se1

2. Contents 1.Couse introduction for 723G33 2.Main Book, Other Reference books, extra reading list. 3.Detailed schedule. 4.Theories of international trade: comparative advantage and competitive advantage 5.Homework: lab 1 6.Assignment: class preparation of Case Porsche changes tack yinghong.chen@liu.se2

3. LiU: Campus Valla Class location Library Exam place yinghong.chen@liu.se3

4. Main book: Multinational Business Finance by Eiteman, Stonehill and Moffett yinghong.chen@liu.se4

5. Main text book, other Reference books 1. Main Textbook: Multinational Business Finance (Global ed. 13th. ed. ISBN: 9780273765530. ) David K. Eiteman, Arthur I. Stonehill and Michael H. Moffett 2. Complemetary book: (optional) International Business: Competing in the Global Market Place. ISBN: 9780077140656 yinghong.chen@liu.se5

6. Extra reading list: 1.The big Mac Index. http://www.economist.com/markets/Bigmac/Index.cfm http://www.economist.com/markets/Bigmac/Index.cfm 2.Irrational Exuberance, 2000, Princeton University Press, Robert J. Shiller 3.John C. Hull, Options, Futures and other Derivatives, 8E. ISBN-10: 0132777428 ISBN-13: 9780132777421©2012 Prentice Hall. (obs: for those who wants to get more on option pricing, this is the source, earlier version will do too) 4.International Business: Environment and Operations, John D. Daniels, Lee H. Radebaugh & Daniel P. Sullivan; 12 th edition, for cultural aspect of International business of MNEs 5.International Economics: Theory and Policy, 8/E, Paul R. Krugman yinghong.chen@liu.se6

7. 5 May, 2014MomentLocationContents Week 19 Monday May 5 13:15- 15:00 L1P26 Course Outline, Important Topics In International Corporate Finance, chapter 1 TuesdayMay 6 13:15- 17:00 L2T27 ESM:chapter 2-3, Prepare Case: Porsche Changes Tack ThursdayMay 8 13:15- 15:00 L3T27 ESM: Chapter 5, 6, 7 Foreign Exchange Market and parity conditions Week 20 monday May 12 10:15- 12:00 L4T27ESM:chapter 8, 9 currency derivatives, Exchange rate TuesdayMay 13 13:15- 15:00 L 5T27ESM: Chapter 10, 11, 12: exposure management Group A (am) Group B (pm) May 14 08:15- 15: 00 Using Reuters 3000 Börssal in C- hus: instructor Lab 1. Exchange Rate Theory Test. Instructions on course website. ThursdayMay 15 10:15- 12:00 SeminarT11Exercise 4-12, Questions session yinghong.chen@liu.se7

8. FridayMay 1610:15-12:00L 6T11 Risk management: an integrated risk approach. Financial risk, operational risk, macroeconomic risk, country risk, etc Prepare for options. Week 21 Wed. May 1910:15-12:00WorkshopT19Workshop: options, derivatives May1913:15-15:00 T23GROUP STUDY: QUESTIONS, DISCUSSIONS Week 22 Tuesday May 2710:15-12:00L7T11 Options, derivatives Wed.May 2813:15-15:00L8T11 Review. Old exam questions, etc May 30 10:15-12:00 13:15:15:00 Final Seminar: presentation A37 Project presentation (by group) Group A, B, C, D Discussant group (E, F, G, H) Project presentation (by group) Group E, F, G, H discussant group (A, B, C, D) exam 5 June 08:00-12:00Terra yinghong.chen@liu.se8

9. Grading principle Grading principle: Presentation and lab 40% Final exam 60% 1.Obligatory lectures and seminars. 2.Obligatory Lab exercise on testing the Equilibrium Theory of Exchange Rate (Exercise to be handed in before 25 of May, according to lab instructions) (10% of the final) 3.Group presentation on 30 th of May is obligatory (30% of the final). Topic choices: Risk management of global firms. Case studies. etc Deadline, 27 th of May. Send to both your discussant group and yinghong.chen@liu.se Instructions on website. yinghong.chen@liu.se 4. The exam is set on the 5 th of June. (60% of the total points) Grade A: 90-100%, Grade B: 80-90%, Grade C: 70-80%, and so on. yinghong.chen@liu.se9

10. Introduction: importance of risk management of MNEs 1.Definition of Globalization. I define globalization as producing where it is most cost-effective, selling where it is most profitable, and sourcing capital where it is cheapest, without worrying about national boundaries. —Narayana Murthy, President and CEO, Infosys yinghong.chen@liu.se10

11. Importance of risk management of MNEs 2.There are unique risks and opportunities involved in running international firms compared to purely domestic firms. They are foreign exchange risk, operating risk, country specific risk, laws and regulations, cultural aspect of multinational firms, etc. 3.Derivative securities such as options and futures are used by corporate financial managers of MNEs for hedging activities. Case in point: Porsche changes tack. yinghong.chen@liu.se11

12. Various aspects of International Business The Cultural Environments Facing Business The Political and Legal Environments Facing Business The Economic Environments Facing Businesses Globalization and Society yinghong.chen@liu.se12

13. Theories of international trade Theory of Comparative advantage (Factor Endowment: land, labor, location, natural resources, population) International Trade and Factor-Mobility Theory Porter´s theory of competitive advantages of nations of International trade (chapter 17) Rationales of Foreign direct investment, FDIs yinghong.chen@liu.se13

14. The theory of comparative advantage The theory of comparative advantage provides a basis for explaining and justifying international trade in a model world assumed to enjoy: – free trade; – perfect competition; – no uncertainty; – costless information; and – no government interference. yinghong.chen@liu.se14

15. The theory of comparative advantage – Absolute advantage and comparative advantage, opportunity costs – Firms in Country A specialize in making products that can be produced relatively efficiently, given Country A’s endowment of factors of production, that is, land, labor, capital, and technology – Firms in Country B do likewise, given the factors of production found in Country B – In this way the total combined output of A and B is maximized yinghong.chen@liu.se15

16. Exhibit 1.3 Global Outsourcing of Comparative Advantage yinghong.chen@liu.se16

17. Comparative advantage vs. Competitive advantage Although international trade might have approached the comparative advantage model during the nineteenth century, it certainly does not today, for the following reasons: – Countries do not appear to specialize only in those products that could be most efficiently produced by that country’s particular factors of production (as a result of government interference and ulterior motivations) – At least two factors of production – capital and technology – now flow directly and easily between countries yinghong.chen@liu.se17

18. The Porter's Diamond model for the competitive advantage of nations (chapter 17) Sources of competitive advantage: Factor Conditions: nation's position in factors of production, such as natural resources, climate, skilled labors, infrastructure, technology, etc Demand Conditions: of home buyers needs - their sophistication Suppliers and Related Industries: clusters of related/supervising industries. Firm Strategy, Structure and Rivalry: attitude, willingness to succeed, domestic rivary. yinghong.chen@liu.se18

19. Four Determinants of National Competitive Advantage yinghong.chen@liu.se19

20. Pricing of foreign exchange International parity conditions: Relationship between Interest Rates and, spot and forward exchange rates, inflation, changes in spot rate Arbitrage principle: The law of one price, normally we use home currency value per dollar, direct quote. Indirect quote: 1 £= 1,5 $ yinghong.chen@liu.se20

21. 7-21 The law of one price and Exchange Rates If the identical product or service can be: – sold in two different markets; and – no restrictions exist on the sale; and – transportation costs of moving the product between markets are equal, then – the products price should be the same in both markets. This is called the law of one price.

22. 7-22 Exhibit 7.11 International Parity Conditions in Equilibrium (Approximate Form)

23. Exhibit 1.1 Global Capital Markets yinghong.chen@liu.se23

24. What is Different About International Financial Management of MNEs? Exhibit 1.4 summarizes the differences. – Culture and history differ among countries – Corporate governance – Greater levels of foreign exchange and political risks – Financial theory and applications are modified in the global versus domestic marketplace – Specialized and complicated financial instruments become tools of the trade yinghong.chen@liu.se24

25. Exhibit 1.4 What Is Different About International Financial Management? ESM: 13 th edition25

26. Market Imperfections: A Rationale for the Existence of the Multinational Firm MNEs strive to take advantage of imperfections in national markets for products, factors of production, and financial assets. Imperfections in the market for products translate into market opportunities for MNEs. Large international firms are better able to exploit such competitive factors as economies of scale, managerial and technological expertise, product differentiation, and financial strength than their local competitors. yinghong.chen@liu.se26

27. Strategic motives drive the decision to invest abroad and become a MNE and can be summarized under the following categories: – Market seekers – Raw material seekers – Production efficiency seekers – Knowledge seekers – Political safety seekers These categories are not mutually exclusive. Market Imperfections: A Rationale for the Existence of the Multinational Firm yinghong.chen@liu.se27

28. The Globalization Process Stage I: early domestic phase growing into the international trade phase (Exhibit 1.5) Stage II: A successful firm will continue to grow from simple international trade to the multinational phase characterized by production and investment both at home and abroad (Exhibit 1.6) Growth may be limited by the twin agency problems of corporate insiders and the rulers of sovereign states (Exhibit 1.7) yinghong.chen@liu.se28

29. Exhibit 1.5 Trident Corp: Initiation of the Globalization Process ESM: 13 th edition29

30. Exhibit 1.6 Trident’s Foreign Direct Investment Sequence ESM 13 th edition30

31. Exhibit 1.7 Potential Limits of Financial Globalization ESM: 13 th edition31

32. Exercise Exercise Chapter 1: To warm up to the later assignment, I strongly suggest you do this. Problems 1 to 5. Recardian theory of Comparative advantages : China and France, Hand in by group or individually no later than 14th of May. yinghong.chen@liu.se32

33. Assignment: Prepare the Porsche case before thursday Form two groups A and B: one will present the Porsche Changes Tack case. The other asks questions, Preparation needed. The Case is to be found on course homepage under course notes. http://www.iei.liu.se/fek/frist/723G33?l=enhttp://www.iei.liu.se/fek/frist/723G33?l=en Discussion of the class follows: 1.Various risk management aspects of Porsche. 2.Ownership, management style, synergies, financial risks, performance, etc. 3.Update of the case. Other info: Porsche Homepage http://www.porsche- se.com/pho/en/ yinghong.chen@liu.se33

34. The holding structure of Porsche SE as of May 3 rd, 2012. ¹ voting rights yinghong.chen@liu.se34

35. Some concepts before the case of Porsche Changes Tack Ownership structure and corporate governance Owner control vs. Management control Family ownership (concentrated ownership: common in Continental Europe Shareholder oriented governance structure, or stakeholder oriented governance structure The conflicts of interests: shareholders verses other constituents (stakeholders: debt holders, labor unions, governments, etc), Performance measures, ROA, ROE 35yinghong.chen@liu.se

36. 36 Mini-Case Questions: Porsche Changes Tack 1.What strategic decisions made by Porsche over the years 1999 to 2004 had given rise to its extremely high return on invested capital? 2.Vesilina D. wondered if she might have to distinguish between the Porsche’s ability to generate results for stockholders versus its willingness to do so. What do you think? 3.Is pursuing the interest of Porsche’s controlling families different from maximizing the returns to its public share owners? yinghong.chen@liu.se

37. 37 Exhibit 1 Porsche’s Growth in Sales, Income, and Operating Margin yinghong.chen@liu.se

38. 38 Exhibit 2 Return on Invested Capital (ROIC) for European Automakers, 2004 yinghong.chen@liu.se

39. 39 Exhibit 3 Porsche’s Velocity (capital turnover), Margin, and ROIC yinghong.chen@liu.se

40. Useful links for today Main Book homepage for Multinational Business Finance, 13 th, 12 th ed. Both are ok. http://wps.pearsoned.co.uk/ema_ge_eiteman_mbf_13/ http://wps.pearsoned.co.uk/ema_ge_eiteman_mbf_12/ Corporate Finance Foundations: Global Edition, by Hirt, Block and Danielsen, 14E, McGraw-Hill. Chapter 19 and 21 http://highered.mcgraw- hill.com/sites/0073530727/student_view0/index.html http://highered.mcgraw- hill.com/sites/0073530727/student_view0/video_clips.html yinghong.chen@liu.se40

41. Practical help How to get around Linköping University? 1.English version of the University: http://www.liu.se/?l=en http://www.liu.se/?l=en 2. Need help? book a Librarian for information searching and database, etc. http://www.bibl.liu.se/?l=en 3. School map: http://www.liu.se/om-liu/till-liu/kartor?l=en Search a location, reserve a room etc. yinghong.chen@liu.se41