international finance lecture notes

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INTERNATIONAL INTERNATIONAL FINANCEFINANCE

LECTURE NOTESLECTURE NOTES

MM IPMI

Prof. Roy Sembel, Ph.DOctober 2009 – February 2010

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January 9 AGENDA

Review of course outline, assignments, and last-week materials

Exchange rate forecasting

Fundamental & Technical Analysis

Efficient Market Theory

Simulation: 5 minute presentation on temporary results

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December 19 AGENDA

Review of course outline and assignments

International arbitrage: Locational, triangular, interest arbitrage

Interest rate parity

Purchasing power parity

International Fisher Effect

Case: Whaler Publishing Company (p. 657)


Guest Lecturer: GCG

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‘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

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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

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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 625-minute presentation of the crises

Project 1: Crises of the world

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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: SimulationInternational Portfolio Investment

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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

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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

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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

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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.

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Assignment agenda January 9:

Readings:

Fundamental vs Emotion in Stock Market

Project/Case:

Investment Simulation: weekly performance report

Book Review: Submit report (10 pages, A4, times roman 12, line spacing 1,5)

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Readings: Book review summaries

Project/Case:

Book Review: 30 minute presentation per group


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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

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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

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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

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January 9 AGENDA






Corporate Motives for Forecasting Exchange Rates

Forecasting exchange rates

1QA\Value of the firm

1QA\Dollar cash flows

Cost of capital

Decide whether to obtain financing in foreign currencies

Decide whether to hedge foreign currency cash flows

Decide whether to invest in foreign projects

Decide whetherforeign subsidiaries should remit earnings

Forecasting Techniques

• Methods for forecasting exchange rates can be categorized into four general groups:

1. Fundamental

2. Technical,

3. Market-based, and

4. Mixed.

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Exchange rate: BIG PICTURE

Inflation Differential

Income Differential

Gov’t Trade Restriction

Interest ratedifferential

Capital flowrestriction

Domestic DEMAND for foreign goods

Foreign DEMANDfor domestic goods

Domestic DEMAND for foreign currency

SUPPLY of foreignCurrency for sale

Domestic DEMAND for foreign securities

Foreign DEMANDfor

domestic securities

EXCHANGERATE

betweenthe foreign &

domesticcurrency

Domestic DEMAND for foreign currency

SUPPLY of foreignCurrency for sale

• Based on fundamental relationships between economic variables and exchange rates. ¤ E.g. subjective assessments, quantitative

measurements based on regression models and sensitivity analyses.

• Limitation of PPP to forecast future exchange rates: PPP may not hold and future inflation rates are also uncertain

Fundamental Forecasting

• In general, fundamental forecasting is limited by:¤ uncertain timing of the impact of the factors,¤ need to forecast factors that have an

immediate impact on exchange rates,¤ omission of factors that are not easily

quantifiable, and¤ changes in the sensitivity of currency

movements to each factor over time.

Fundamental Forecasting

• Use historical data to predict future values ¤ E.g. time series models.

• Speculators may find the models useful for predicting day-to-day movements

• Typically focus on the near future and rarely provide point or range estimates limited use to MNCs

Technical Forecasting

Video: Technical Analysis

• Trend

• Support vs Resistance; Channel

• Double bottom, Double top

• Head and Shoulder, Inverted H & S

• Triangle (Symmetric, Ascending, Descending)

• Gap (Common, Breakaway, Measuring, Exhaustion)

• Uses market indicators to develop forecasts.

• Current spot/forward rates are often used, since speculators will ensure that the current rates reflect the market expectation of the future exchange rate.

• For long-term forecasting, the interest rates on risk-free instruments can be used under conditions of IRP.

Market-Based Forecasting

Mixed Forecasting

• Mixed forecasting refers to the use of a combination of forecasting techniques.

• The actual forecast is a weighted average of the various forecasts developed.

Comparison of Forecasting Methods

• The different forecasting methods can be evaluated

¤ graphically – by visually comparing the deviations from the perfect forecast line, or

¤ statistically – by computing the forecast errors for all periods.

Forecasting Rp/US$

Group Dates

11 12 13 14 15 comments

1 9250 9250 9250 9250 9250 TA

2 9260 9280 9315 9290 9280 TA

3 9276 9224 9241 9163 9206 TA

4 9279 9275 9274 9276 9275 TA (MA-3)

5 Random walk == Exch Rate on 10

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January 9 AGENDA






Forecasting Under Market Efficiency

• If the foreign exchange market is weak-form efficient, then the current exchange rates already reflect historical information. So, technical analysis would not be useful.

• If the market is semistrong-form efficient, then all the relevant public information is already reflected in the current exchange rates.

• If the market is strong-form efficient, then all the relevant public and private information is already reflected in the current exchange rates.

• Foreign exchange markets are generally found to be at least semistrong-form efficient.


• Nevertheless, MNCs may still find forecasting worthwhile, since their goal is not to earn speculative profits but to use exchange rate forecasts to implement policies.

• In particular, MNCs may need to determine the range of possible exchange rates in order to assess the degree to which their operating performance could be affected.


Exchange Rate Volatility

• A more volatile currency has a larger expected forecast error.

• MNCs measure and forecast exchange rate volatility so that they can specify a range (confidence interval) around their point estimate forecasts [REMEMBER LAST WEEK CASE: WHALER]

Exchange Rate Volatility

• Exchange rate volatility can be forecasted using: recent (historical) volatility, a historical time series of volatilities

(there may be a pattern in how the exchange rate volatility changes over time), and

the implied standard deviation derived from currency option prices.

CONFIRMATION OF EMH

• Performance of Mutual Funds < Market Index

• No persistence of Good Performance

• The Rise of Index Funds¤ Above-average Performance¤ Low costs

• VIDEO: Who Needs Experts ?

Market Efficient?

• Games:

¤ US$ Forecast

¤ Speed of the response of the market

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EFFICIENT MARKET EXPERIMENT

GROUP X

1. Recently, US$ has been fluctuating around Rp 9.250/US$ to

2. Give your prediction of Rp/US$ at the end of this year (2010) !

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GROUP Y


2. Do you believe that US$ will rise to above Rp 10.500/US$ at the end of this year ?


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GROUP Z


2. Do you believe that US$ will rise to above Rp 8.000/US$ at the end of this year ?


IS THE MARKET EFFICIENT ?

• According to Eugene Fama

• According to Grossman-Stiglitz

• According to Fischer Black

• According to You ?

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January 9 AGENDA






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Investment Simulation Results

Group Portfolio value Main contributor

19/12 9/1

1 105,4 106,3 Mexico, Indonesia

2 100,8 102,1 South Kor, Hong Kong

3 97,9 100,4 China, Indonesia

4 101,2 103,1 Indonesia, DJIA

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Readings: Book review summaries

Project/Case:

Book Review: 30 minute presentation per group


LEARNING LOGLEARNING LOG

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