Shapiro clisam.tex V2-06/14/2014 8:05P.M. Page2 Shapiro clisam.tex V2-06/14/2014 8:05P.M. Page1 I F M NTERNATIONAL INANCIAL ANAGEMENT Shapiro clisam.tex V2-06/14/2014 8:05P.M. Page2 Shapiro clisam.tex V2-06/14/2014 8:05P.M. Page3 I F NTERNATIONAL INANCIAL M ANAGEMENT Alan C. Shapiro and Peter Moles Shapiro clisam.tex V2-06/30/2014 2:30P.M. Page4 Copyright©2014JohnWiley&SonsLtd Alleffortshavebeenmadetotraceandacknowledgeownershipofcopyright.ThePublisherwouldbegladtohearfromany copyrightholderswhomithasnotbeenpossibletocontact. Registeredoffice JohnWiley&SonsLtd,TheAtrium,SouthernGate,Chichester,WestSussex,PO198SQ,UnitedKingdom Fordetailsofourglobaleditorialoffices,forcustomerservicesandforinformationabouthowtoapplyforpermissionto reusethecopyrightmaterialinthisbookpleaseseeourwebsiteatwww.wiley.com. TherightsofAlanC.ShapiroandPeterMolestobeidentifiedastheauthorsofthisworkhavebeenassertedinaccordance withtheCopyright,DesignsandPatentsAct1988. 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FormoreinformationaboutWileyproducts,visitwww.wiley.com. Designationsusedbycompaniestodistinguishtheirproductsareoftenclaimedastrademarks.Allbrandnamesandproduct namesusedinthisbookaretradenames,servicemarks,trademarksorregisteredtrademarksoftheirrespectiveowners.The publisherisnotassociatedwithanyproductorvendormentionedinthisbook.Thispublicationisdesignedtoprovide accurateandauthoritativeinformationinregardtothesubjectmattercovered.Itissoldontheunderstandingthatthe publisherisnotengagedinrenderingprofessionalservices.Ifprofessionaladviceorotherexpertassistanceisrequired,the servicesofacompetentprofessionalshouldbesought. LibraryofCongressCataloging-in-PublicationData Shapiro,AlanC. Internationalfinancialmanagement/AlanC.Shapiro,PeterMoles. pagescm Includesbibliographicalreferencesandindex. ISBN978-1-118-92932-2(pbk.:alk.paper)1.Internationalbusinessenterprises–Finance. 2.Internationalfinance.I.Moles,Peter.II.Title. HG4027.5.S4652014 658.15’9–dc23 2014017816 ISBN:9781118929322(pbk) ISBN:9781118935866(ebk) ISBN:9781118953556(ebk) AcataloguerecordforthisbookisavailablefromtheBritishLibrary. Typesetin10/12ptTimesbyLaserwordsPrivateLimited,Chennai,India PrintedinGreatBritainbyBellandBainLtd,Glasgow. Shapiro ftoc.tex V2-06/18/2014 6:39P.M. Pagev C ONTENTS PREFACE xvii SELECTEDCURRENCIESANDSYMBOLS xix SYMBOLSANDACRONYMS xxi PART1 THEGLOBALFINANCIALMANAGEMENTENVIRONMENT 1 INTRODUCTIONTOINTERNATIONALFINANCIALMANAGEMENT 3 1.1 TheRiseoftheInternationalCompany 5 EvolutionoftheMultinationalCorporation 9 TheProcessofOverseasExpansionbyMultinationals 18 ABehavioralDefinitionoftheMultinationalCorporation 21 TheGlobalManager 24 1.2 TheInternationalizationofBusinessandFinance 24 PoliticalandLaborUnionConcernsaboutGlobalCompetition 25 ConsequencesofGlobalCompetition 32 1.3 InternationalFinancialManagement:TheoryandPractice 36 CriticismsoftheInternationalCorporation 37 FunctionsofFinancialManagement 37 ThemeofThisText 38 RelationshiptoDomesticFinancialManagement 38 TheImportanceofTotalRisk 40 TheGlobalFinancialMarketplace 41 TheRoleoftheFinancialExecutiveinanEfficientMarket 41 1.4 OutlineoftheText 42 TheGlobalFinancialManagementEnvironment 42 CurrencyandDerivativesMarkets 42 ManagingCurrencyRisks 42 FinancingInternationalOperations 43 InternationalCapitalBudgeting 43 InternationalManagementofWorkingCapital 43 APPENDIX1A TheOriginsandConsequencesofInternationalTrade 45 TheGainsfromTrade 46 SpecializedFactorsofProduction 47 MonetaryPricesandExchangeRates 48 Tariffs 49 v Shapiro ftoc.tex V2-06/18/2014 6:39P.M. Pagevi vi CONTENTS 2 EXCHANGERATEDETERMINATION 51 2.1 SettingtheEquilibriumSpotExchangeRate 52 DemandforaCurrency 52 SupplyofaCurrency 52 FactorsthatAffecttheEquilibriumExchangeRate 53 CalculatingExchangeRateChanges 54 2.2 ExpectationsandtheAssetMarketModelofExchangeRates 58 TheNatureofMoneyandCurrencyValues 61 CentralBankReputationsandCurrencyValues 63 2.3 TheFundamentalsofCentralBankIntervention 73 HowRealExchangeRatesAffectRelativeCompetitiveness 73 ForeignExchangeMarketIntervention 74 TheEffectsofForeignExchangeMarketIntervention 78 2.4 TheEquilibriumApproachtoExchangeRates 80 DisequilibriumTheoryandExchangeRateOvershooting 80 TheEquilibriumTheoryofExchangeRatesandItsImplications 82 2.5 SummaryandConclusions 83 3 THEINTERNATIONALMONETARYSYSTEM 87 3.1 AlternativeExchangeRateSystems 88 TheTrilemmaandExchangeRateRegimeChoice 89 FreeFloat 91 ManagedFloat 93 Target-ZoneArrangement 94 Fixed-RateSystem 94 3.2 ABriefHistoryoftheInternationalMonetarySystem 97 TheClassicalGoldStandard 99 HowtheClassicalGoldStandardWorkedinPractice:1821–1914 100 TheGoldExchangeStandardandItsAftermath:1925–1944 100 TheBrettonWoodsSystem:1946–1971 103 ThePost-BrettonWoodsSystem:1971tothePresent 105 AssessmentoftheFloating-RateSystem 108 3.3 TheEuropeanMonetarySystemandMonetaryUnion 109 TheExchange-RateMechanism 109 LessonsfromtheEuropeanMonetarySystem 109 TheCurrencyCrisisofSeptember1992 110 TheExchangeRateMechanismisAbandonedinAugust1993 111 EuropeanMonetaryUnion 112 OptimumCurrencyArea 118 LessonsfromEMUandtheEuro 128 ExchangeRateRegimesToday 129 3.4 EmergingMarketCurrencyCrises 129 TransmissionMechanisms 129 Shapiro ftoc.tex V2-06/18/2014 6:39P.M. Pagevii CONTENTS vii OriginsofEmergingMarketCrises 130 PolicyProposalsforDealingwithEmergingMarketCrises 131 3.5 SummaryandConclusions 132 4 CURRENCIES:EXPECTATIONS,PARITIES,ANDFORECASTING 135 4.1 ArbitrageandtheLawofOnePrice 135 4.2 PurchasingPowerParity 138 TheLessonofPurchasingPowerParity 142 ExpectedInflationandExchangeRateChanges 144 TheMonetaryApproach 145 EmpiricalEvidence 145 4.3 TheFisherEffect 147 EmpiricalEvidence 149 4.4 TheInternationalFisherEffect 153 EmpiricalEvidence 155 4.5 InterestRateParityTheory 157 EmpiricalEvidence 161 4.6 TheRelationshipBetweentheForwardRateandtheFutureSpotRate 162 EmpiricalEvidence 164 4.7 CurrencyForecasting 165 RequirementsforSuccessfulCurrencyForecasting 166 Market-BasedForecasts 166 Model-BasedForecasts 168 ModelEvaluation 169 ForecastingControlledExchangeRates 171 4.8 SummaryandConclusions 171 5 THEINTERNATIONALMONETARYSYSTEMANDTHEBALANCEOFPAYMENTS 178 5.1 Balance-of-PaymentsCategories 179 CurrentAccount 181 CapitalAccount 182 FinancialAccount 182 Balance-of-PaymentsMeasures 183 TheMissingNumbers 184 5.2 TheInternationalFlowofGoods,Services,andCapital 184 DomesticSavingandInvestmentandtheFinancialAccount 185 TheLinkbetweentheCurrentandFinancialAccounts 186 GovernmentBudgetDeficitsandCurrent-AccountDeficits 189 TheCurrentSituation 190 5.3 CopingwiththeCurrent-AccountDeficit 193 CurrencyDepreciation 193 Protectionism 198 Shapiro ftoc.tex V2-06/18/2014 6:39P.M. Pageviii viii CONTENTS EndingForeignOwnershipofDomesticAssets 199 BoostingtheSavingRate 199 AdjustingGlobalEconomicPolicies 201 Current-AccountDeficitsandUnemployment 202 TheBottomLineonCurrent-AccountDeficitsandSurpluses 202 5.4 SummaryandConclusions 203 6 COUNTRYRISK 208 6.1 MeasuringPoliticalRisk 209 PoliticalStability 210 EconomicFactors 210 SubjectiveFactors 210 6.2 EconomicandPoliticalFactorsUnderlyingCountryRisk 218 FiscalIrresponsibility 219 MonetaryInstability 222 ControlledExchangeRateSystem 223 WastefulGovernmentSpending 223 ResourceBase 223 CountryRiskandAdjustmenttoExternalShocks 224 Market-OrientedVersusStatistPolicies 225 KeyIndicatorsofCountryRiskandEconomicHealth 229 6.3 CountryRiskAnalysisinInternationalLending 236 TheMathematicsofSovereignDebtAnalysis 236 CountryRiskandtheTermsofTrade 238 TheGovernment’sCost/BenefitCalculus 239 LessonsfromtheInternationalDebtCrisis 242 6.4 SummaryandConclusions 243 PART2 CURRENCYANDDERIVATIVESMARKETS 7 CURRENCYMARKETS 249 7.1 OrganizationoftheForeignExchangeMarket 250 TheParticipants 251 Size 255 7.2 TheSpotMarket 257 SpotQuotations 257 TheMechanicsofSpotTransactions 264 7.3 TheForwardMarket 265 ForwardQuotations 266 ForwardContractMaturities 269 7.4 SummaryandConclusions 269