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Chapter 32

Chapter 32 Notes


Department
Management
Course Code
MGFC10H3
Professor
Derek Chau
Chapter
32

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Chapter 32 International Corporate Finance Notes
32.1 Terminology
some of the most common terms used in international finance are the following:
1) A European currency unit (euro) was a basket of 10 European currencies devised in 1979 and intended to serve as a
monetary unit for European Monetary System (EMS). Effective January 2002, the euro replaced 10 domestic currencies.
2) The cross rate is the exchange rate between two foreign currencies, generally neither of which is the US dollar. The US
dollar, however, is used as an interim step in determining the cross rate.
3) Eurobonds are bonds denominated in a particular currency and issued simultaneously in the bond markets of several
European countries. For many international companies and governments, they have become an important way to raise
capital. Eurobonds are issued outside the restrictions that apply to domestic offerings and are typically syndicated in
London. Trading can and does take place anywhere there is a buyer and a seller.
4) Eurocurrency is money deposited in a financial centre outside of the country whose currency is involved.
5) Foreign bonds, unlike Eurobonds, are issued in a single country and are usually denominated in that country’s currency.
Often, the country in which these bonds are issued will draw distinctions between them and bonds issued by domestic
issuers, including different tax laws, restrictions on the amounts issued, or tougher disclosure rules.
6) An American Depository Receipt (ADR) is a security issued in the US to represent shares of a foreign stock, allowing that
stock to be traded in the US. Foreign companies use ADRs, which are issued in US dollars, to expand the pool of potential
US investors. ADRs are available in two forms for about 690 foreign companies: company-sponsored, which are listed on
an exchange, and unsponsored, which are usually held by the investment bank that makes a market in the ADR. Both forms
are available to individual investors, but only company-sponsored issues are quoted daily in newspapers.
7) The London Interbank Rate (LIBOR) is the rate that most international banks charge one another for loans of Eurodollars
overnight in the London market. LIBOR is a cornerstone in the pricing of money-market issues and other short-term debt
issues by both government and corporate borrowers. Less creditworthy issuers will often borrow at a rate about LIBOR.
8) There are two basic kinds of swaps: interest rate and currency. An interest rate swap occurs when two parties exchange
debt with a floating-rate payment for debt with a fixed-rate payment, or vice versa. Currency swaps are agreements to
deliver one currency against another currency. Often both types of swaps are used in the same transaction when debt
dominated in different currencies is swapped.
9) Export Development Canada (EDC) is a federal Crown corporation with a mandate to promote Canadian exports. EDC
provides long-term financing for foreign companies that purchase Canadian exports. To qualify for EDC support, exporters
must produce or market goods with a minimum Canadian content of 60%.
Other government programs to support exports include the federal Programme for Export Market Development (PEMD),
which reimburses part of the costs of developing export markets and a variety of provincial programs.
32.2 Foreign Exchange Markets and Exchange Rates
it is the market where one country’s currency is traded for another’s
most of the trading takes place in a few currencies: the US dollar, euro, British pound sterling, Japanese yen, and Swiss franc
the many different types of participants in the foreign exchange market include:
1) importers who convert their domestic currency to foreign currency to pay for goods from foreign countries
2) exporters who receive foreign currency and may want to convert to the domestic currency
3) portfolio managers who buy and sell foreign stocks and bonds
4) foreign exchange brokers who buy and sell orders
5) traders who make the market in foreign exchange
Exchange Rates
an exchange rate is the price of one country’s currency expressed in terms of another country’s currency
in practice, almost all trading of currencies worldwide takes place in terms of the US dollar
there are two reasons for quoting all foreign currencies in terms of the US dollar
1) it reduces the number of possible cross-currency quotes
2) it makes triangular arbitrage more difficult
Types of Transactions
spot trades involve an agreement on the exchange rate today for settlement in two days, which is called the spot exchange rate
forward trades involve an agreement on exchange rates today for settlement in the future, called the forward exchange rate
a swap is the sale (purchase) of a foreign currency with a simultaneous agreement to repurchase (resell) it sometime in the future
the difference between the sale price and the repurchase price is called the swap rate
32.3 The Law of One Price and Purchasing Power Parity
law of one price (LOP) says that a commodity will cost the same regardless of the country in which it is purchased
if LOP did not hold, arbitrage would be possible by moving a product from one country to another
for the LOP to be strictly true, three assumptions are needed:
1) the transaction cost of trading the product—shipping, insurance, wastage, and so on—must be zero
2) no barriers to trading the product, such as tariffs or taxes, can exist
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