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INTERNATIONAL INTERNATIONAL FINANCEFINANCE
LECTURE NOTESLECTURE NOTES
MM IPMI
Prof. Roy Sembel, Ph.DOctober 2009 – February 2010
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Last week’s (January 16) AGENDA
Review of course outline, assignments, and last-week materials
Book Review presentation, 25-30 minutes per group
USD forecast results
Simulation: temporary results
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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)
Average 9266 9257 9270 9245 9253
Random walk == Exch Rate on 10/1
Actual 9233 9157 9174 9165 9165
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Error of Forecast
Group Dates
11 12 13 14 15 Total
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2
3
4
Average
Rd Wk
17 93 76 85
27 123 141 125
43 67 67 2
46 118 100 111
33,25 100,25 96 80,75
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January 23 AGENDA
Course Review
Simulation: temporary results
Currency Risk Exposure: Transaction, Translation, Economic Exposure
Managing Currency Risk with Derivatives
Discussion: Barings, SocGen
Case: Vogl
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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 23:
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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Assignment agenda January 30:
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 23 AGENDA
Course Review
Simulation: temporary results
Currency Risk Exposure: Transaction, Translation, Economic Exposure
Managing Currency Risk with Derivatives
Discussion: Barings, SocGen
Case: Vogl
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Investment Simulation Results
Group Portfolio value Main contributor
19/12 9/1 16/1 23/1
1 105,4 106,3 106,6 105.1 Mexico, Indonesia
2 100,8 102,1 101,2 100.1 South Kor, Hong Kong
3 97,9 100,4 99,8 98.7 China, Indonesia
4 101,2 103,1 98,8 100.6 Indonesia, DJIA
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January 23 AGENDA
Course Review
Simulation: temporary results
Currency Risk Exposure: Transaction, Translation, Economic Exposure
Managing Currency Risk with Derivatives
Discussion: Barings, SocGen
Case: Vogl
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Currency risk exposure
• Exchange rate exposure may affect financing costs¤ volatile cash flow from exchange rate
changes increases risk
• Transaction exposure¤ reflects the exposure of an MNC’s future
cash transactions to exchange rate movements
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Currency risk exposure
• Economic exposure¤ measures the direct and indirect risks to
cash flows from exchange rate movements
• Translation exposure¤ focuses on consolidated financial
statements
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January 23 AGENDA
Course Review
Simulation: temporary results
Currency Risk Exposure: Transaction, Translation, Economic Exposure
Managing Currency Risk with Derivatives
Discussion: Barings, SocGen
Case: Vogl
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DERIVATIVE SECURITIESDERIVATIVE SECURITIES
SECURITIES WHOSE VALUES DEPEND SECURITIES WHOSE VALUES DEPEND ON OTHER MORE ELEMENTARY ASSET.ON OTHER MORE ELEMENTARY ASSET.
USES OF DERIVATIVE:USES OF DERIVATIVE:
SPECULATIONSPECULATION
ARBITRAGEARBITRAGE
HEDGINGHEDGING
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DERIVATIVES:
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FORWARDS
CONTRACT BETWEEN TWO PARTIESCONTRACT BETWEEN TWO PARTIESTO BUY/SELL AN UNDERLYING ASSETTO BUY/SELL AN UNDERLYING ASSETWITH PRESPECIFIED AMOUNT, PRICE,WITH PRESPECIFIED AMOUNT, PRICE,AND DELIVERY TIME IN THE FUTURE.AND DELIVERY TIME IN THE FUTURE.
LONG VS SHORTLONG VS SHORT
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FORWARDS
EXAMPLES OF FORWARDS:EXAMPLES OF FORWARDS:
PRE-HARVEST SALE (IJON)PRE-HARVEST SALE (IJON)
PRE-ARRANGED MARRIAGEPRE-ARRANGED MARRIAGE(KAWIN SITI NURBAYA)(KAWIN SITI NURBAYA)
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FORWARDS
LONG VS SHORTLONG VS SHORT
Long positionLong position
Spot Price Spot Price at maturityat maturity
Short positionShort position
PayoffPayoff
Delivery priceDelivery price
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HEDGING
A shoe manufacturer in Indonesia has just received an order to export several containers of shoes to Japan as soon as possible and will receive payment of 100 million yen six months from now. She estimates that the total cost (including insurance and transportation costs) of the exported shoes is
Rp 8 billion rupiah.
Yen may appreciate or depreciate against rupiah. Now, the spot price is Rp 100 / yen and six-month forward price is Rp 102 / yen
What should she do ?
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HEDGING
SITUATION:
Long yen position (will receive yen)
RISK:
Yen depreciate against rupiah
SOLUTION:
Concentrate on shoe business
Hedge the currency risk: take short yen position (sell yen forward) to cover the long yen position
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FORWARDSHEDGING YEN RECEIVABLESHEDGING YEN RECEIVABLES
Long yen positionLong yen positionin shoe businessin shoe business
Rp / yen Rp / yen in six monthsin six months
Short yen positionShort yen positionin derivative marketin derivative market
PayoffPayoff
Rp 102 /yenRp 102 /yen
Net resultNet result::Currency fluctuation will not affect profitCurrency fluctuation will not affect profitThe Rp 2.2 billion profit is locked in from the shoe business, i.e.,The Rp 2.2 billion profit is locked in from the shoe business, i.e.,Rp 10.2 billion (or yen 100 million x Rp 102/yen) - Rp 8 billion Rp 10.2 billion (or yen 100 million x Rp 102/yen) - Rp 8 billion
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FORWARDS VS FUTURES
FORWARDS: FORWARDS: TAILOR MADE BETWEEN TWO PARTIESTAILOR MADE BETWEEN TWO PARTIES
FUTURES:FUTURES: STANDARDIZED, TRADED ON ORGANIZED EXCHANGESTANDARDIZED, TRADED ON ORGANIZED EXCHANGE
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OPTIONS
CONTRACT THAT GIVES ITS HOLDER A RIGHTCONTRACT THAT GIVES ITS HOLDER A RIGHT TO BUY TO BUY ((CALLCALL) OR SELL () OR SELL (PUTPUT))
A CERTAIN AMOUNT OF A CERTAIN UNDERLYING A CERTAIN AMOUNT OF A CERTAIN UNDERLYING ASSETASSET WITH A CERTAIN PREDETERMINED PRICE WITH A CERTAIN PREDETERMINED PRICE
(STRIKE/EXERCISE PRICE)(STRIKE/EXERCISE PRICE)AT A CERTAIN TIME IN THE FUTUREAT A CERTAIN TIME IN THE FUTURE
AMERICAN VS EUROPEAN OPTIONSAMERICAN VS EUROPEAN OPTIONS
PRICE (PREMIUM) OF OPTIONS PRICE (PREMIUM) OF OPTIONS VS PRICE OF UNDERLYING ASSETVS PRICE OF UNDERLYING ASSET
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CALL VS PUT
CALL OPTIONS
Right to BUY
• S
• At a price X
• At time T
PUT OPTIONS
Right to SELL
• S
• At a price X
• At time T
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How does it work? CALL
NOW MATURITYSellerShort SELL SWriter
Rp Premium S Rp X
Buyer BUY S Long Taker
Expired
CALL OPTIONS
Right to BUY
• S
• At a price X
• At time T
Right to BUY•S•At price X•At time T
Hak digunakan
Hak tidak digunakan
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How does it work? PUT
NOW MATURITYSeller Short BUY SWriter
Rp Premium S Rp X
Buyer SELL S Long Taker
PUT OPTIONS
Right to SELL
• S
• At a price X
• At time T
Right to SELL•S•At price X•At time T
Hak digunakan
Hak tidak digunakanExpired
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INTRINSIC VS TIME VALUE
• INTRINSIC VALUE:¤ MAX (0, | S – X | )
• TIME VALUE:¤ PREMIUM ABOVE INTRINSIC VALUE
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OPTIONSPAY-OFFPAY-OFF
X=30X=30Price of asset at Price of asset at maturity of optionsmaturity of options
Strike priceStrike price
Pay-off Long Pay-off Long Call OptionsCall Options
Pay-off Short Pay-off Short Call OptionsCall Options
-C-C
Profit Long Profit Long Call OptionsCall Options
CC
Profit Short Profit Short Call OptionsCall Options
BEPBEP = X + C= X + C
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OPTIONSPAY-OFFPAY-OFF
X=30X=30
Strike PriceStrike Price
Pay-off Long Pay-off Long Put OptionsPut Options
Pay-off Short Pay-off Short Put OptionsPut Options
-P-P
Profit Long Profit Long Put OptionsPut Options
PP
Profit Short Profit Short Put OptionsPut Options
BEPBEPPrice of asset at Price of asset at maturity of optionsmaturity of options
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CASE STUDY
PT Bank Bangkrut plans to expand its operation to the USPT Bank Bangkrut plans to expand its operation to the USand offer to buy a US bank at US$ 10 million. The US bankand offer to buy a US bank at US$ 10 million. The US bankneeds 3 months to consider the offer. Bank Bangkrut givesneeds 3 months to consider the offer. Bank Bangkrut givesthe US Bank 3 months to decide.the US Bank 3 months to decide.
1. WHAT FINANCIAL RISKS ARE FACED BY BB ?1. WHAT FINANCIAL RISKS ARE FACED BY BB ?2. WHAT SHOULD IT DO TO HEDGE THE RISK ?2. WHAT SHOULD IT DO TO HEDGE THE RISK ?
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CASE STUDY
RISK EXPOSURERISK EXPOSURE::
PayoffPayoff
Rp/$Rp/$10,00010,000
HEDGINGHEDGING
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January 23 AGENDA
Course Review
Simulation: temporary results
Currency Risk Exposure: Transaction, Translation, Economic Exposure
Managing Currency Risk with Derivatives
Discussion: Barings, SocGen, Local Disputes
Case: Vogl
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CASE: BARINGS
• What caused Barings’ debacle?
• Explain the risks of Leeson’s transactions!
• What lessons we learned from Barings?
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January 23 AGENDA
Course Review
Simulation: temporary results
Currency Risk Exposure: Transaction, Translation, Economic Exposure
Managing Currency Risk with Derivatives
Discussion: Barings
Case: Vogl
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VOGL
• Currency exposure?
• Tools: Forwards? Options? Why?
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THANK YOU VERY MUCH FOR YOUR ATTENTION
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Assignment agenda January 30:
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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LEARNING LOG
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PREMIUM OPTIONS
FACTORFACTOR EFFECT ONEFFECT ONCALLCALL PUT PUT
SS ++ --
++ ++
XX -- ++
TT ++ ++DD -- ++
rr ++ --
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OPTION VALUATION
BINOMIAL MODEL BINOMIAL MODEL
BLACK-SCHOLESBLACK-SCHOLES
C = N(d1) S - N(d2) X eC = N(d1) S - N(d2) X e(-Rf * T)(-Rf * T)
SIMULATIONSIMULATION
d1 = [ log(S/X) + Rf * T + d1 = [ log(S/X) + Rf * T + 22 * T/2] / [ * T/2] / [ * T * T0.50.5]]
d2 =d2 = d1 - d1 - * T * T0.50.5
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