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International Corporate Finance (Globalisation (Foreign Exchange Markets…
International Corporate Finance
Globalisation
Companies operate in multiple countries
Currency risk
Foreign Exchange Markets
Exchange rate
Spot rate
Cross rate
Bid (buying) price
Offer (selling) price
Spread
Cross Rates
Exchange rate of two lesser currencies using a large currency as a common denominator
Triangular Arbitrage
Make profit using inconsistencies between cross rates and larger rates
Riskless profit
Unlikely to be successful in modern day
Types of Transactions
Spot Trade
Use spot rate for trade within two days
Forward Trade
Agree exchange rate in advance
Less currency risk
Interest Rate Parity
Relationship between spot rates, forward rates and interest rates
Difference between interest rates offset by difference in spot rate and forward rate
Covered Interest Arbitrage
Borrow at lower risk-free rate and invest at higher risk-free rate
International Capital Budgeting
Home Currency Approach
Find future exchange rates and convert foreign cash flows
Foreign Currency Approach
Find foreign discount rate, find NPV, then convert to home currency
Exchange Rate Risk
Short-term Exposure
Day-to-day fluctuations
Use forward contracts to eliminate risk
Long-term Exposure
Unanticipated change in relative economic conditions
Match foreign currency inflows and outflows
Translation Exposure
Translation gains and losses (IAS 21)