Chapter 1

Chapter 1 An OverviewCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-2Objectives To identify factors that have led to the prominence of international financeTo explain the role of the financial managerTo verify the internationalisation of financeTo identify the developments leading to the formation of the present financial environmentTo examine the causes and consequences of the global financial crisis

Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-3IntroductionInternational finance as studied here deals with the financial operations of business firms in an environment of open and integrated financial marketsThe world of finance has changed as a result of the global financial crisisCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-4The importance of international finance International finance has assumed increasing importance at an accelerating rateThings started to change with the collapse of the Bretton Woods system(cont.)Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-5The importance of international finance (cont.) The shift to floating exchange rates was accompanied by a trend towards the abolition of capital controls and the implementation of financial deregulation(cont.)Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-6The importance of international finance (cont.) The pace of deregulation has been slowed down by the onset of financial crises, particularly the global financial crisisCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-7International , multinational and transnational firms Traditionally, the term international business firm refers to firms involved in importing and exportingA multinational firm carries out some of its production activity abroad(cont.)Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-8International , multinational and transnational firms (cont.) As the distinction between home and abroad becomes blurred, transnational firms emergeHere, international firms indulge in international operations in the modern senseCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-9Examples of international interdependenceA decision to change US interest rates affects Australian home ownersThe Asian crisis affected the operations of Australian companiesThe US accounting scandals (e.g. Enron) affected stock markets worldwideThe US subprime crisis that surfaced in 2007 became a global financial crisis in 2008-09 (and perhaps beyond)Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-10The micro and macro aspects of international financeThe micro aspects pertain to the financial operations of business firms, including financing, investment, hedging, arbitrage and speculation(cont.)Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-11The micro and macro aspects of international finance (cont.)The macro aspects pertain to the international monetary system and the determination of interest and exchange ratesCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-12International finance and the role of the financial managerThe financial manager needs to be concerned about:Fluctuations in exchange and interest ratesBalance-of-payments difficultiesFinancial contagionCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-13The effect of exchange rate fluctuationsExchange rate fluctuations can demolish businesses. Examples include:The Beecham GroupLaker AirlinesCaterpillar and Eastman KodakCanonCoca-Cola AmatilNABCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-14Knowledge needed by the financial managerMajor economic indicatorsGovernment policiesThe channels and effects of contagionForeign exchange risk managementFactors affecting the demand for the firms productsCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-15Indicators of the internationalisation of financeInternational bank lendingSecurities transactions with foreignersFlows of portfolio investment and FDITrading volume in the FX marketThe percentage of FX trading conducted with cross-border counterpartiesCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-16Post-war developmentsThe economic and financial environment within which business firms operate is the product of some developments that followed World War IICopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-171. The emergencee of the Eurodollar marketThe Eurodollar market emerged in London in the late 1950sCurrently known as the Eurocurrency market, it encompasses non-dollar currenciesCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-182. Currency convertibility European currencies became convertible in the late 1950sThe yen became convertible in the early 1960sCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-193. The EEC and EMU The EEC was established in 1957 by the Treaty of RomeRelated developments include the EMS and the EMUFrom an original membership of 6 countries, membership stood at 27 countries in early 2009Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-204. Changes in relative economic size There has been a trend towards greater symmetry in economic sizeThe relative size of the United States has declined significantly. Those of the EU, Japan and China have risenCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-215. Deterioration of the US external position The United States has become a deficit and net debtor countryThe twin deficit problem refers to deficits in the budget and the current accountJapan has been a surplus country, but a deficit was registered in early 2009 because of the global financial crisisChina has replaced Japan as the financier of the US deficit

Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-22Current account balance (US)Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-23Current account balance (Japan)Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-24Current account balance (UK)Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-25Current account balance (Australia)Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-266. Fluctuations in oil prices The price of oil rose in 1973-1974 and again in 1979-1980The price collapsed in 1986, and declined significantly in 1998In 2003, the price rose and then fell as developments in Iraq unfoldedHaving reached a record of USD147 a barrel in 2008, the price of oil collapsed during the global financial crisisCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-27Average real and nominal price of oil (1971=100)Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-28Monthly average oil price in 2008 Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-297. The international use of non-dollar currencies The US dollars use has declined with respect to trading volume in the FX market, the invoicing of trade, the holding of reserves, and the denomination of Eurocurrency deposits, international loans and international bondsCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-308. Increased capital mobility Since the 1980s, the volume of net and gross capital flows has increased significantly

Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-319. Integration, deregulation and globalisation There has been a trend towards deregulation and integration of financial marketsGlobalisation has emerged due to increasing market integrationIn the aftermath of the global financial crisis, more thought is given to the costs and benefits of globalisation and deregulation

Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-3210. Regional cooperation Examples of regional cooperation are the following:European Economic Community (EEC)North American Free Trade Agreement (NAFTA)Asia-Pacific Economic Cooperation Council (APEC)Closer Economic Relations (CER) AgreementCentral Europe Free Trade Area (CEFTA)Baltic Free Trade Area (BFTA)

Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-3311. Increased volatility of financial markets Increased volatility of exchange rates can be traced back to the collapse of the BW systemIncreased volatility of interest rates can be traced back to the 1979 shift by the Federal Reserve to money supply targeting

Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-34JPY/USD exchange rateCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-35GBP/USD exchange rateCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-36Percentage change in JPY/USD exchange rateCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-37Percentage change in GBP/USD exchange rateCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-3812. Securitisation and financial innovation Securitisation is the tendency for raising funds by issuing marketable securitiesInnovation refers to the creation of new financial instruments or the recreation of old instruments in a new formThe global financial crisis has changed attitude towards securitisation and financial engineering. A financial innovation (CDOs) played a big role in the crisisCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-3913. Financial crises and contagion Financial crises have become widespread in the post-war period, particularly since the 1980sContagion is the process whereby a financial crisis moves from one country to anotherMajor examples are the EMS crisis, Asian crisis, Mexican crisis, Argentine crisis and the global financial crisisCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-40The global financial crisis The global financial crisis has resulted from the US subprime crisis, leading to the Great Recession of 2009This crisis is far more complex than earlier crises because financial innovation and securitisation have created complex securities whose risk profile is difficult to assess

Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-41Origin of the crisisMortgage originators provide loans to low-quality borrowersLoans are converted into complex securities, which are sold to investorsWhen house prices start to fall, payment to the holders of these securities ceasesAll financial markets are adversely affected

Copyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-42The DJIA during the crisisCopyright 2010 McGraw-Hill Australia Pty Ltd PPTs t/a International Finance: An Analytical Approach 3e by Imad A. MoosaSlides prepared by Afaf Moosa1-43The players and causesMortgage originatorsRating agenciesPolicy makers and regulatorsThe role of securitisationThe role of globalisation