INTERNATIONALBUSINESSFINANCEFINS3616

TutorialWeek2

TheGlobalFinancialSystem&ExchangeRateSystems

YourTutor&TutorinCharge:PeterAndersenpeter.andersen@unsw.edu.au

Besuretocheckyourstudentemailaccountlotsthroughoutthesemester,asIllbesendingyoumyslidesandlotsofothermaterials.

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CONTACTDETAILS

FINS3616 PeterKjeldAndersen(2015S1)

ASSESSMENT DATE HOWMUCH

TutorialAttendance&Participation Everyweek 10%

MidsemesterExamination Week7(inLecture) 30%

Group Project Weeks11+12 25%

Final Exam Exam Period 35%

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ASSESSMENTS

FINS3616 PeterKjeldAndersen(2015S1)

Classparticipationmarksaredesignedforyoutodemonstratethatyouhaveprepared theassignedtutorialhomeworkmaterialpriortoclass.

Therewillbenewquestions giventoyouinclass,whichyouwillcompleteinyourassignmentgroups.Doingthesenewquestionsinatimeefficientmannerwillrequireyoutohavecompletedthehomeworkpriortoclass.

Afteranallottedamountofworkingtime,groupswillbechosenatrandomtoteachoneofthequestionstotherestoftheclass.Everybodyinthegroupmustgetuptopresentaportionofthegroupsassignedquestion.

CLASSPARTICIPATIONCLARIFICATION

7FINS3616 PeterKjeldAndersen(2015S1)

LETS BEGIN

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THEGLOBALFINANCIALSYSTEM

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TUTORIALQUESTION1Q. Defineglobalization.Howhasitproceededintradeingoodsandservices

versuscapitalmarkets?

A. Globalizationreferstotheincreasingconnectivityandintegrationofcountriesandcorporationsandthepeoplewithinthemintermsoftheireconomic,political,andsocialactivities.Becauseofglobalization,multinationalcorporationsdominatethecorporatelandscape.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION2Q. Describefourwaysthatacompanycansupplyitsproductstoaforeign

country.Howdotheydiffer?

A. AnMNCcansupplyaforeignmarketthrough: Licensing franchisinglocalfirmsabroadtomanufacturethecompanysproducts Settingupajointventurewithaforeigncompany, orbyforeigndirectinvestment.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION3Q. WhatpercentageownershiptypicallydefinesFDI?

A. Foreigndirectinvestment(FDI)occurswhenacompanyfromonecountrymakesasignificantinvestmentthatleadstoatleasta10%ownershipinterestinafirminanothercountry.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION4Q. Whatistheagencyproblem?Howdocompaniesovercometheconflictof

interestbetweenmanagersandshareholders?

A. Agencyproblemsarisebecausetheownersofthefirmdonottypicallymanagethefirm,anditdeviseswaystoresolvetheseproblems.Thisisoftencalledtheseparationofownershipandcontrol.

Amanagerofafirm,inparticularthechiefexecutiveofficer(CEO),isviewedasanagentwhocontractswithvariousprincipalsmostimportantlythefirmsshareholdersbutalsothefirmscreditors,suppliers,clients,andemployees.

Theprincipalsmustdesigncontractsthatmotivatetheagenttoperformactionsandmakedecisionsthatareinthebestinterestsoftheprincipals.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION5Q. Whyisownershipmoreconcentratedinemergingcountriesthanthatin

developedcountries?

A. Inmanydevelopedcountries,theruleoflawisstrongenoughtodisciplinemanagersthroughlegalmeans,forexamplebytakeoversandproxycontestsorthroughcontractualcompensationplans.

Concentratedownershipisonewayinwhichagencyproblemsaremitigatedindevelopingcountries.Ablockofstockisheldbyeitherawealthyinvestor,afamily,orafinancialintermediary,whichmightbeabank,aholdingcompany,ahedgefundorapensionfund.Thelargeshareholderclearlyhasavestedinterestinmonitoringmanagementandhasthepowertoimplementchangesinmanagement.

Negativeaspectsofthisapproachincludepossiblecollusionbetweenthelargeshareholderandthemanagementtoexpropriatewealthfromsmallershareholdersandthefactthatthestockmaybemoredifficulttotradeonthestockmarketifasubstantialblockofsharesiswithdrawnfromthemarketbutisstillavailabletobesoldshouldthelargeshareholderwanttosell.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION9Q. Whatisaninstitutionalinvestor?Alongwithindividualinvestors,whatdo

theydetermine?

A. InstitutionalInvestorsareorganizationsthatinvestpoolsofmoneyonbehalfofindividualinvestorsorotherorganizations.

Examplesincludebanks,insurancecompanies,pensionfunds,mutualfunds,anduniversityendowments.

Institutionalinvestors,togetherwithindividualinvestors,determinethepricesofbondsandstocksimplicitlydeterminingtheexpectedratesofreturnontheseassetstherebysettingtheMNCscostofcapital.

Thecostofcapital,inturn,affectsprojectvaluations,whichdeterminesacompanysinvestments.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION12Q. Whatdoesitmeanforacountrytoexperienceacapitalinflow?

A. Whenacountryexperiencesacapitalinflow,foreignresidentsareinvestingindomesticassetsanddomesticresidentsaresellingforeignassets.

Thesetransactionsarecreditsonthebalanceofpaymentsbecausethecountryiseffectivelyexportingassets.

FINS3616 PeterKjeldAndersen(2015S1)

TRUEORFALSEQ. MNCshaveinvestmentorfinancialoperationsinmorethanonecountry.A. True

Q. Thetermsstakeholderandshareholderaresynonymous.A. False

Q. TheMNCfacesgreaterconstraintsthanthedomesticcorporationinthetimingandlocationofitsinvestments.

A. False

Q. Politicalriskistheriskthatthebusinessenvironmentinahostcountrywillchangeunexpectedlyduetopoliticalevents.

A. True

FINS3616 PeterKjeldAndersen(2015S1)

TRUEORFALSEQ. Thedomesticfinancialmanagermustbeknowledgeableinseveralareas

withinfinance,whereasthemultinationalfinancialmanagerusuallyspecializesinasinglearea,suchascorporatefinance,investments,orfinancialmarkets.

A. False

Q. Theworldsfinancialmarketsarebecomingincreasinglysegmentedaslargeinternationalcommercialbanksachievemoreandmoreeconomicpower.

A. False

Q. Purchasesandsalesofforeignassetsbydomesticresidentswouldappearintheofficialsettlementsaccountofthebalanceofpayments.

A. False

Q. Theexportandimportofeducation,insurance,consulting,telecommunications,androyaltiesonfilmsshouldbeenteredintheunilateraltransferssubcategoryofthecurrentaccount.

A. FalseFINS3616 PeterKjeldAndersen(2015S1)

MCQEXAMPLE1Q. Corporatestakeholdersincludeeachofa.d.except____.

a) Creditorsb) Customersc) Managersd) Shareholderse) Eachoftheaboveisastakeholderinthefirm

Theanswerise).

FINS3616 PeterKjeldAndersen(2015S1)

MCQEXAMPLE2Q. Whatisthenamefortheshiftingofnonstrategicfunctionstospecialist

firmstoreducecosts?a) outsourcingb) multinationalcompanyc) globalizationd) importe) alloftheabove

Theanswerisa).

FINS3616 PeterKjeldAndersen(2015S1)

MCQEXAMPLE3Q. Whichofthefollowingwascreatedinanefforttopromotefreetrade?

a) WorldTradeOrganizationb) IMFc) Multilateraldevelopmentbanksd) TheOrganizationforEconomicCooperationandDevelopmente) Alloftheabove

Theanswerisa).

FINS3616 PeterKjeldAndersen(2015S1)

MCQEXAMPLE4Q. Whichoneofthefollowingisthemostcommonmethodofovercomingthe

agencyprobleminemergingcountries?a) concentratedownershipb) independentboardsc) hostiletakeoversd) foreigndirectinvestmente) shareholderactivism

Theanswerisa).

FINS3616 PeterKjeldAndersen(2015S1)

MCQEXAMPLE5Q. The____oftheIMFsBalanceofPaymentsStatisticsmeasurescrossborder

transactionsassociatedwithchangesinownershipofassetsandliabilities.a) Currentaccountb) Capitalaccountc) Tradeaccountd) Investmentincomeaccounte) Noneoftheabove

Theanswerisb).

FINS3616 PeterKjeldAndersen(2015S1)

MCQEXAMPLE6Q. Itistherightgiventofirmstoproducespecificproductsinexchangefora

________fee.a) Jointventureb) FDIc) Licensingd) Noneoftheabovee) Alloftheabove.

Theanswerisc).

FINS3616 PeterKjeldAndersen(2015S1)

EXCHANGERATESYSTEMS

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TUTORIALQUESTION1Q. Whatislikelytohappenifacentralbanksuddenlyprintsalargeamountof

newmoney?

A. Whereastherearetheoriesthatpredictthatchangesinthesupplyofmoneyhaverealeffectsontheeconomyintheshortrun,itislikelythatifthecentralbankshowerstheeconomysuddenlywithmoney,theonlyresultwillbehigherinflation.Thisisbecausethedemandformoneyultimatelydependsontheamountofrealtransactionsintheeconomyandhowmuchmoneyisneededtofacilitatethesetransactions.Additionalsupplyofmoneyisunlikelytomakepeopleconsumemoreorworkharder.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION2Q. Howcanyouquantifycurrencyriskinafloatingexchangeratesystem?

A. Tocharacterizetheriskofacurrencyposition,youmusttrytocharacterizetheconditionaldistributionofthefutureexchangeratechanges.Withfloatingexchangerates,historicalinformationprovidesusefulinformationaboutthisdistribution.Forexample,youcanusedatatomeasuretheaveragehistoricaldispersion(standarddeviationorvolatility)ofthedistribution.Thehigherthisvolatility,theriskierarepositionsinthiscurrency.Finally,weshouldpointoutthatvolatilityisanadequateindicatorofriskwhenexchangeratechangesareapproximatelynormallydistributed.Inreality,thedistributionofexchangeratechangesdisplaysfattails,eveninfloatingexchangeratesystems,andthisincreasestheriskofcurrencypositions.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION3Q. WhatwastheBrettonWoodscurrencysystem?

A. IntheBrettonWoodsSystem,inplacebetween1944and1971,theparticipatingcountriesagreedtoanexchangerateregimethatlinkedtheirexchangeratestothedollar.Theycouldfluctuateina1%bandaroundafixedparity.Thedollaritselfhadafixedgoldparity($35perounce).Whenacountryranintoatemporarybalanceofpaymentsproblem(acurrentaccountdeficit)thatthreatenedthecurrencypeg,itcoulddrawonthelendingfacilitiesoftheIMF,alsoestablishedatBrettonWoodsin1944,tohelpitdefendthecurrency.Countrieswerealsoallowedtochangetheirparitieswhentheirbalancesofpaymentswereconsideredtobeinfundamentaldisequilibrium.Thesystembrokedownin1971.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION4Q. Describetwodifferentcurrencysystemsthathavebeenintroducedin

countriessuchasHongKongandEcuadortoimprovethecredibilityofpeggedexchangeratesystems.

A. HongKonghasacurrencyboardsystem.Acurrencyboardisamonetaryinstitutionthatissuesbasemoney(notesandcoins,andrequiredreservesoffinancialinstitutions)thatisfullybackedbyaforeignreservecurrencyandfullyconvertibleintothereservecurrencyatafixedrateandondemand.Hence,thedomesticcurrencymonetarybaseis100%backedbyassetspayableinthereservecurrency.Inpracticalterms,thisrequirementbarsthecurrencyboardfromextendingcredittoeitherthegovernmentorthebankingsector.EcuadorinsteadhasofficiallyadoptedtheU.S.dollarasitscurrency.Thisisanexampleof(Official)dollarization,whichoccurswhenaforeigncurrencyhasexclusiveorpredominantstatusasfulllegaltenderinaparticularcountry.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION5Q. Whatisthedifferencebetweenatargetzoneandacrawlingpeg?

A. Inatargetzone,thecurrencyisallowedtofluctuateinapercentagebandaroundacentralvalue.Onecanviewapeggedsystemasatargetzonesystemwithaverynarrowband.Inacrawlingpegsystem,thefixedrateorbandisadjustedovertime,typicallyinapredeterminedwayasafunctionoftheinflationdifferentialbetweenthecrawlingpegcountryandthecountrytowhosecurrencythepegisset.Suchasystemisoftenusedindevelopingcountries,wherethecrawlofthebandpreventsthecountryfromlosingtoomuchcompetitivenesswhenitsinflationrateishigherthanthatofthebenchmarkcountry.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION6Q. WhatwastheEMS?

A. EMSstandsforEuropeanMonetarySystem,atargetzonesystemthatoperatedinEuropebetween1979and1999.Exchangerateswere,formostofthetime,maintainedbetweenbandsof2.25%aroundcentralrates.ThecountriesparticipatingintheEMSwereagraduallyincreasingnumberofEuropeanUnioncountries.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION7Q. WhatdidtheMaastrichtTreatytrytoaccomplish?

A. The1991MaastrichtTreatymappedouttheroadtoeconomicandmonetaryunionwithintheEuropeanUniontobefinalizedby1999.TheTreatycalledforeliminatingallremainingrestrictionsonthemovementofcapitalandpaymentsbetweenmemberstatesandbetweenmemberstatesandthirdcountries;thecreationofaEuropeancentralbank,andtheintroductionofanewcurrency,theeuro,in1999.Themonetaryunionwasindeedestablished(butnotallEUcountriesparticipate).

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION8Q. DoyoubelieveitsmonetaryunionwillbebeneficialforEurope?

A. ThegainsarealreadybeingrealizedthroughoutEuropeforexample,carpriceshavedecreasedandconvergedacrossEurope.Academicresearchdocumentssizableeconomicbenefitsfollowingtheintroductionoftheeurointermsofpriceconvergence,lowercostsofcapital,andincreasedtrade.Forexample,theEuropeanCommissionhasestimatedthemicroeconomicgainsofmonetaryuniontoamountto0.5%ofGDPoftheentireEUasubstantialsum.Ontheotherhand,thesovereigndebtcrisesinGreece,Ireland,andPortugal,andpotentiallyinSpain,andthepersistenthighunemploymentratesinthesecountrieswhileGermanythrivessuggestthatasymmetricmacroeconomicadjustmentcostsarepresentandarecausingstrainwithinEurope.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION9Q. WhatfactorscontributedtotheMexicanpesocrisisof1995andtotheAsian

crisesof1997

A. Ineachinstance,thegovernmenttriedtomaintainthevalueofthelocalcurrencyatartificiallyhighlevels.Thisdepletedforeigncurrencyreserves.Localbusinessesandgovernmentswerealsoborrowinginnonlocalcurrencies(primarilythedollar),whichheavilyexposedthemtoadropinthevalueofthelocalcurrency.

FINS3616 PeterKjeldAndersen(2015S1)

TUTORIALQUESTION10Q. WhatisthemoralhazardofIMFrescuepackagesforemergingmarkets

whichexperiencedcrises?

A. Moralhazardoccurswhentheexistenceofacontractchangesthebehaviorsofpartiestothecontract.WhentheIMFassistscountriesindefendingtheircurrencies,itchangestheexpectationsandhencethebehaviors oflenders,borrowers,andgovernments.Forexample,lendersmightunderestimatetherisksoflendingtostrugglingeconomiesifthereisanexpectationthattheIMFwillinterveneduringdifficulttimes.

FINS3616 PeterKjeldAndersen(2015S1)

TRUEORFALSEQ. Theexchangeratesysteminwhichacountryallowsthevalueofthe

currencytobedeterminedbythemarketforcesofsupplyanddemandisknownasapeggedexchangeratesystem.

A. False

Q. Inthepeggedexchangeratesystem,thecurrencyhaslimitedflexibilityandtherateiskeptwithinafixedband.

A. False

Q. Decreasesincurrencyvalueswithinafloatingratesystemarecalleddevaluations.

A. False

Q. IMFloanstotroubledeconomiesareunlikelytochangethebehaviors ofinvestors,becauseinvestorscanassesstherisksofmoralhazardforthemselves.

A. False

FINS3616 PeterKjeldAndersen(2015S1)

TRUEORFALSEQ. Currencyincirculationshouldbeincludedintheassetsectionofacentral

bankbalancesheet.A. False

Q. Officialinternationalreservesconsistofthemajorcomponentslikegoldreservesandforeignexchangereserves

A. True

Q. Capitalcontrolmeansthesetofregulationspertainingtoflowsofcapitalintoandoutofacountry

A. True

Q. Ifacentralbanksuddenlyprintsalargeamountofnewmoney,itmayresultinhighinflation

A. True

FINS3616 PeterKjeldAndersen(2015S1)

MCQEXAMPLE1Q. Whichofthefollowingcurrenciesiscurrentlylinkedtothepriceofgold?

a) Britishpoundb) Japaneseyenc) U.S.dollard) Alloftheabovee) Noneoftheabove

Theanswerise)

FINS3616 PeterKjeldAndersen(2015S1)

MCQEXAMPLE2Q. Commonelementsinmanycurrencycrisesincludeeachofthefollowing

except:a) afixedexchangeratesystemthatovervaluedthelocalcurrencyb) alargeamountofforeigncurrencydebtc) asteepdropinthevalueofthelocalcurrencyd) IMFinterventiontoprovideshorttermassistancee) Alloftheabovearecommonduringcurrencycrises

Theanswerise)

FINS3616 PeterKjeldAndersen(2015S1)

MCQEXAMPLE3Q. WhichaccountshouldNOTbeincludedintheassetsectionofacentralbank

balancesheet?a) depositsofprivatefinancialinstitutionsb) officialinternationalreservesc) domesticcreditd) governmentbondse) Alloftheaboveshouldbeincluded

Theanswerisa)

FINS3616 PeterKjeldAndersen(2015S1)

MCQEXAMPLE4Q. Whatisthenegativesideeffectonthemoneysupplyofanonsterilized

foreignexchangeintervention?a) Ahighermoneysupplyeventuallyleadstolowerinflation,andthe

foreignexchangeobjectiveoftheIMF'spolicymayconflictwithitsabroadgoalofpricestability.

b) Ahighermoneysupplyeventuallyleadstohigherinflation,andtheforeignexchangeobjectiveoftheIMF'spolicymayconflictwithitsdomesticgoalofpricestability.

c) Ahighermoneysupplyeventuallyleadstolowerinflation,andtheforeignexchangeobjectiveofthecentralbank'spolicymayconflictwithitsdomesticgoalofpricestability.

d) Ahighermoneysupplyeventuallyleadstohigherinflation,andtheforeignexchangeobjectiveofthecentralbank'spolicymayconflictwithitsdomesticgoalofpricestability.

e) NoneoftheaboveTheanswerisd)

FINS3616 PeterKjeldAndersen(2015S1)

MCQEXAMPLE5Q. Whenacentralbankbuysforeigncurrency,itsinternationalreserves

________.a) decreaseb) increasec) remainunchangedd) aredifficulttodeterminee) Alloftheabovearepossible

Theanswerisb)

FINS3616 PeterKjeldAndersen(2015S1)

MCQEXAMPLE6Q. Whatisthemostlikelyoutcomeifacentralbanksuddenlyprintsalarge

amountofnewmoney?a) nochangeintheinflationrateb) higherinflationc) recessiond) prosperitye) nothingwillbechanged

Theanswerisb)

FINS3616 PeterKjeldAndersen(2015S1)