Introduction to International

Finance
FINA6222 Selected Topics in Finance: International Finance
CUHK Business School

Week 1
Welcome
• Instructor: Alvin Ang, PhD, CFA
• Office: Room 854, Cheng Yu Tung Building
• Email: [email protected]
• Consultation: By appointment
• Education:
• PhD in Finance, Master in Financial Economics, Master of Finance from UNSW Business
School, University of New South Wales
• BBA major in Finance from Goizueta Business School, Emory University
• CFA
• Industry experience: Investment banking (CDO), Portfolio management
(structured credit)
1
Course Content
1. Introduction 3. Risk Management
• Globalization and MNCs • FX exposures
• FX markets • FX derivatives
• Exchange rate systems • Currency hedging

2. International Capital Markets 4. International Corporate Finance

• Debt financing • Capital budgeting
• Equity financing • Cash management
• Portfolio management

2
Lecture Schedule
Week Date Topic Readings
1 3/9 Introduction ERC: Ch. 1
2 10/9 International Monetary System ERC: Ch. 2
3 17/9 Foreign Exchange Market ERC: Ch. 5
4 24/9 International Debt and Equity ERC: Ch. 11, 12, 13
Financing

CASE DUE: MAS

5 8/10 International Portfolio Investment ERC: Ch. 15
6 15/10 MIDTERM TEST

CASE DUE: ALIBABA

7 22/10 Foreign Currency Derivatives ERC: Ch. 7 and 14
8 29/10 Foreign Exchange Exposures ERC: Ch. 8, 9, and 10
9 5/11 Risk Management and Foreign ERC: Ch. 8, 9, and 10
Currency Hedging
10 12/11 International Capital Budgeting ERC: Ch. 17 and 18

CASE DUE: GM
11 19/11 Multinational Cash Management ERC: Ch. 19

CASE DUE: GROUPE ARIEL Article: “Repatriation Taxes and

Foreign Cash Holdings: The Impact
of Anticipated Tax Reform”
12 26/11 FINAL EXAM
3
Course Materials
Textbook
International Financial Management, 9th edition
Cheol S. Eun, Bruce G. Resnick, and Tuugi Chuluun
McGraw Hill (2021)

Case studies
Harvard case studies will be distributed to you.

4
Course Assessment

Component Weight Due Date

Class Participation 10% Ongoing
Group Project 20% Weeks 4, 6, 10, or 11
Individual Assignments 10% Assignment 1: Week 5
Assignment 2: Week 10
Midterm Test 20% Week 6 (in-class)
Final Examination 40% Week 12 (in-class)

5
Assignments
• No late submissions will be accepted.
• Submit assignments on Blackboard.
• Only one submission is allowed per assignment.
• Approach the TA if you have questions.

6
Midterm Test and Final Exam
• The test and exam are compulsory.
• Students who miss the test or exam without prior approval will receive a zero
mark.
• Only verified emergency situations may be considered as valid reasons to miss the
test or exam.
• No supplementary midterm test will be offered. Instructor will reallocate the
weight to other assessments.
• A supplementary final exam may be offered only under extenuating
circumstances.

7
Class Participation
• You are expected to attend all lectures.
• Attendance will be recorded.
• Your attendance record may serve as a point of reference for matters such as
requests for recommendation letters, grade appeals, and priority in email
responses.
• Your score for participation is based on attendance and contribution to lecture
discussions.

8
Email Etiquette
• Use your CUHK email account.
• Include the course code in the subject line (e.g., “FINA3020A Request for
Meeting”).
• Address your instructor as Professor or Dr. [Surname].
• Address your TA as Ms. or Mr. [Surname].
• Always use a polite and positive tone (e.g., “Would it be possible to schedule an
appointment with you….” instead of “I want to make an appointment with
you…”).
• Be patient and wait for a response. Don’t expect responses after office hours or
during the weekends.

9
Why study International Finance?
• MNCs are even more ubiquitous today with globalization.
• Importance of foreign operations to firms has increased significantly.
• Besides the growing magnitude of foreign operations, processes are
increasingly integrated including sourcing, production, and financing.
• Therefore, financing and investment decisions must be made in an
international setting.

10
What’s Special About International Finance
• Three major dimensions set international finance apart from domestic finance
1.Foreign exchange risk and political risks.
2.Market imperfections.
3.Expanded opportunity set.
• Largely stem from the fact that sovereign nations have the right to issue
currencies, formulate their own economic policies, impose taxes, and regulate
movements of people, goods, and capital across their borders.

11
Foreign Exchange Risk
• Foreign exchange risk is the risk of facing uncertain future exchange rates
• In addition to businesses, individuals and households may also be seriously
exposed to uncertain exchange rates.
• Exchange rates among major currencies (for example, U.S. dollar, Japanese
yen, British pound, and euro) fluctuate continuously in an unpredictable
manner.
• Exchange rate uncertainty influences all major economic functions, including
consumption, production, and investment.

12
Monthly Percentage Change in JPY/USD

Source: Bank for International Settlements, U S dollar exchange

rates.
13
Foreign Country Risk
• Political risk arises from potential losses to the parent firm resulting from adverse
political developments in the host country
• Ranges from unexpected changes in tax rules to outright expropriation of
assets held by foreigners.
• Arises from the fact that a sovereign country can change the “rules of the
game” and the affected parties may not have effective recourse.
• Especially relevant in those countries without a traditional rule of law.

14
Market Imperfections
• Market imperfections may be described as various frictions, such as transaction
costs and legal restrictions, that prevent the markets from functioning perfectly
• World markets are highly imperfect.
• Numerous barriers hamper the free movement of people, goods, services, and capital
across national boundaries (for example, legal restrictions, excessive transaction and
transportation costs, information asymmetry, and discriminatory taxation).
• Restrict the extent to which investors can diversify their portfolios.

15
Expanded Opportunity Set
• Firms may benefit from an expanded opportunity set when they venture into the
arena of global markets
• Firms can gain from greater economies of scale when their tangible and
intangible assets are deployed on a global basis.
• True for corporations, as well as individual investors.
• “It just doesn’t make sense to play in only one corner of the sandbox.”

16
From Traditional to Multinational Finance
• Traditional finance setting

Firm 1
Questions
• How should firms obtain
financing?
• How should firms analyze
Firm 2 Capital Markets investment opportunities?
• How should firms manage risks?

Firm 3

17
From Traditional to Multinational Finance
• Multinational finance setting Questions
Sub 1A
• How should firms
obtain financing in
Firm 1
global capital
Sub 1B
markets?
• How should firms
Sub 2A
Firm 2
Capital Markets analyze investment
opportunities in
Sub 2B different countries?
• How should firms
Sub 3A Firm 3 manage additional
risks?
Sub 3B 18
Globalization
• Globalization – increasing connectivity and integration of countries and
corporations and the people within them in terms of their economic,
political, and social activities
• Multinational corporation – produces and sells goods or services in more
than one nation
• BRIC countries (Brazil, Russia, India and China) offer a lot of opportunities for
expansion
• International scope creates opportunities but also challenges
• Recent crises
• “I define globalization as producing where it is most cost-effective, selling
where it is most profitable, and sourcing capital where it is cheapest,
without worrying about national boundaries.”—Narayana Murthy, Former
President and CEO, Infosys.

19
Globalization: Major Trends and
Developments
1. Emergence of Globalized Financial Markets
2. Emergence of the Euro as a Global Currency
3. Europe’s Sovereign Debt Crisis of 2010
4. Trade Liberalization and Economic Integration
5. Privatization
6. Global Financial Crisis of 2008 to 2009
7. Brexit

20
Globalized Financial Markets
• Deregulation of foreign exchange and capital markets
• Financial innovations resulted in the introduction of various instruments:
• Currency futures and options.
• Multicurrency bonds.
• International mutual funds.
• Country funds.
• Exchange-traded funds (ETFs).
• Foreign stock index futures and options.
• Advances in computer and telecommunications technology

21
The Euro Currency
• Momentous event in history of world financial system
• Currently more than 300 million Europeans in 19 countries are using the common
currency on a daily basis
• Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland,
Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal,
Slovakia, Slovenia, and Spain.
• Transaction domain of the euro may become larger than that of the U.S. dollar in
the future.

22
Europe’s Sovereign Debt Crisis
• In December 2009, the new Greek government revealed that its budget deficit for
the year would be 12.7% of GDP, not the 3.7% previously forecast
• Investors sold off Greek government bonds, and the ratings agencies
downgraded them to “junk”.
• Panic spread to other weak European countries (especially Ireland, Portugal,
and Spain) and quickly escalated to a Europe-wide debt crisis.
• Revealed a profound weakness of the euro as the common currency; Lack of
fiscal discipline in a euro-zone country can always become a Europe-wide
crisis.

23
Trade Liberalization
• Principal argument for international trade is based on the theory of comparative
advantage
• It is mutually beneficial for countries if they specialize in the production of
those goods they can produce most efficiently and trade those goods among
them.
• Policy implication is that liberalization of international trade will enhance the
welfare of the world’s citizens.
• Over the years, international trade has been liberalized at both the global and
regional levels.

24
International Trade as Percent of GDP

25
International Trade as Percent of GDP

26
International Trade as Percent of GDP

27
Economic Integration
• General Agreement on Tariffs and Trade (GATT) is a multilateral agreement
among member countries that has reduced many barriers to trade
• The World Trade Organization (WTO) has the power to enforce the rules of
international trade
• Regional arrangements have also been instituted to promote economic integration
• The European Union (EU), for example, includes 28 member states that have
eliminated barriers to the free flow of goods, capital, and people.

28
FTA Example (1) : NAFTA
• North American Free Trade Agreement (NAFTA) called for phasing out
impediments to trade between Canada, Mexico, and the United States over a 15-
year period beginning in 1994
• In November 2018, the three countries signed a new accord, the U.S.-Mexico-
Canada-Agreement (USMCA), but the new accord needs to be ratified in three
countries.
• In Mexico, the ratio of export to GDP has increased dramatically from 2.2% in
1973 to 35.6% in 2017

29
FTA Example (2): CPTPP
• Comprehensive and Progressive Trans-Pacific Partnership (CPTPP):
Concluded in 2018 after the failed TPP agreement includes 11 countries
(Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru,
Singapore, and Vietnam)
• The 11 countries account for 13.4% of global GDP or about USD 13.5 trillion.
• Expansion of CPTPP:
• Current applicants: China, Ecuador, Taiwan, UK
• Potential applicants: Philippines, South Korea, Thailand

30
Privatization
• Privatization is the act of a country divesting itself of ownership and operation of
business ventures by turning them over to the free market system
• May be described as a denationalization process and often viewed as a means
to an end.
• Selling state-owned businesses brings in hard-currency foreign reserves to the
national treasury.
• Often seen as a cure for bureaucratic inefficiency and waste.
• Some economists estimate privatization improves efficiency and reduces
operating costs by as much as 20%.

31
Privatization in China
• State-owned enterprises (SOEs) have been listed on organized stock exchanges,
making them eligible for private ownership
• China launches two stock exchanges in the early 1980s
• As of 2018, approximately 3,600 companies are currently listed on China’s
stock exchanges.
• “A-shares” are primarily reserved for Chinese citizens, while foreigners may
invest in “B-shares” or “H-shares”.
• Chinese government still retains the majority stakes in most public firms

32
Global Financial Crisis 2008—2009
• Factors that drove the financial crisis:
• Households and financial institutions borrowed too much and took too much
risk.
• Crisis was amplified and transmitted globally by securitization; financial
engineers designed opaque and complex mortgage-based securities that could
be used for excessive risk-taking.
• “Invisible hands” of free markets apparently failed to
self-regulate excesses, contributing to the banking crisis.
• International financial markets are highly interconnected and integrated.

33
US Dow Jones and Unemployment Rate

Source: Bloomberg.
34
Brexit
• “Brexit” describes the voting decision of a majority of Britons to leave the EU
• Likely to weaken the United Kingdom and the EU, both economically and
politically.
• London’s position as the dominant center of European finance may deteriorate
if the UK loses unrestricted access to Europe’s single market.
• How did this happen?
• Majority of voters outside of London felt alienated from the globalized
economy and were worried about competition for jobs from immigrants.
• 60% of Londoners voted to remain in the EU; 45% of voters in the rest of
England voted the same way.

35
Growth of International Capital Flows
• Incredible growth in the number of MNCs after WWII
• 37,000 MNCs in 1990
• 82,053 in 2010
• Globalization of financial markets
• 1980s countries began to allow foreigners to invest in their markets
• Creation of new asset class – emerging markets, frontier markets

36
Multinational Corporations
• A multinational corporation (MNC) is a firm that has been incorporated in one
country and has production and sales operations in other countries.
• Approximately 60,000 MNCs in the world with over 500,000 foreign
affiliates.
• Benefit from the economy of scale in many ways:
• Spreading R&D expenditures and advertising costs over their global sales.
• Pooling global purchasing power over suppliers.
• Utilizing their technological and managerial know-how globally with
minimum additional costs.

37
How MNCs Enter Foreign Markets
• Exporting/Importing
• Licensing – gives local firms right to manufacture their products in exchange for a
fee
• Franchising – the firm provides sales or service strategies in exchange for fees
• Joint venture – two or more firms form a new legal entity, jointly owned by all of
the firms
• Greenfield – starting company from scratch

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Top Non-Financial MNCs by Foreign Assets

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