Imad A. MoosaDepartment of Accounting and FinanceMortash University

Boston Burr Ridge, IL Dubuque, IA Madison, Wl New York

San Francisco St. Louis Bangkok Bogota Caracas Kuala Lumpur

Lisbon London Madrid Mexico City Milan Montreal New Delhi

Santiago Seoul Singapore Sydney Taipei Toronto

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ABOUT THE AUTHOR

PREFACE

ACKNOWLEDGEMENTS

MAJOR CHANGES IN THE THIRD EDITION

TEXT AT A GLANCE

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xiv

1. AN OVERVIEW 11.1 The Importance of International Finance 2

1.2 International Finance and the Role of the

Financial Manager 5

1.3 Indicators of the Intemationalisation of Finance 7

1.4 Post-War Economic, Financial and

Institutional Developments 8

1.5 The Global Financial Crisis 23

Summary 29 Key Terms 29 Review Questions 30

2. THE FOREIGN EXCHANGE MARKET 332.1 Definition and Characteristics of the Foreign

Exchange Market

2.2 Market Participants

2.3 The Size and Composition of the Foreign

Exchange Market 37

2.4 The Mechanics and Technology of Foreign

Exchange Trading 43

2.5 The Spot Exchange Rate 44

2.6 Spot Foreign Exchange Position Keeping 57

2.7 The Forward Exchange Rate 59

Summary 63 Key Terms 64 Review Questions 65 Problems 66

34

35

4.4.1

4.2

Appendix 2.1: More Foreign Exchange Jargon

Appendix 2.2: Types of Trading Orders

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70

3. THE BALANCE OF PAYMENTS ANDEFFECTIVE EXCHANGE RATE 71

3.1 Definition of the Balance of Payments 72

3.2 Australian Balance of Payments Statistics 72

3.3 The Balance of Payments and the Foreign

Exchange Market 76

3.4 Factors Affecting the Balance of

Payments Position 81

3.5 The Real Effective Exchange Rate 87

Summary 96 Key Terms 96 Review Questions 97 Problems 97

EXCHANGE RATE DETERMINATION 101Some Stylised Facts about Exchange Rates 102

Factors Affecting Supply and Demand in

the Foreign Exchange Market 103

Speculation in the Spot Foreign

Exchange Market 113

Purchasing Power Parity 115

The Monetary Model of Exchange Rates 122

Determination of the Bid-Offer Spread andthe Forward Spread 125

Factors Affecting the Australian Dollar

Exchange Rate 127

Summary 132 Key Terms 133 Review Questions 133 Problems 135

4.3

4.4

4.5

4.6

4.7

THE INTERNATIONAL MONETARYSYSTEM AND EXCHANGE RATEARRANGEMENTS

5.1 Definition and Criteria of Classification

5.2 Flexibility of Exchange Rates as a Criterion

for Classification

5.3 The Classical Gold Standard

5.4 The Inter-War Period

5.5 The Bretton Woods System

5.6 The Present System

5.7 The European Monetary System

5.8 The Australian Dollar Exchange Rate

Arrangements

5.9 Fixed versus Flexible Exchange Rates

5.10 The Future of the International

Monetary System

137138

138

144146146

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152

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156

7.17.2

7.3

7.4

7.5

7.6

7.7

7.8

7.9

7.10

7.11

157

Summary 159 Key Terms 160 Review Questions 161

6. THE EUROCURRENCY MARKET ANDINTERNATIONAL BANKING

6.1 The Eurocurrency Market

6.2 Eurocurrencies and Eurocurrency

Banking Centres

6.3 The Evolution and Growth of the

Eurocurrency Market

6.4 Some Features of Eurobanking

6.5 Interest Rate Determination

6.6 International Banking

6.7 The Organisational Set-up of

International Banking

Summary 176 Key Terms 177 Review Questions 178

7. INTERNATIONAL BANKING REGULATIONAND THE BASEL ACCORDS 179Why Banks are Important 180

The Kinds of Risk Facing Banks 181

Operational Risk 182

The Pros and Cons of Banking Regulation 186

Regulatory Functions and Forms of

Regulation 187

Some Capital-Related Concepts 191

The Basel Committee 195

The Basel I Accord 197

The Basel II Accord: Introduction 199

The Pillars of Basel II 200

A Critique of Basel II 206

Summary 210 Key Terms 211 Review Questions 211 Problems 212

8.

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172

8.1

8.2

8.3

8.4

8.5

8.6

8.7

8.8

8.9

8.10

EXCHANGE RATE FORECASTING,TECHNICAL ANALYSIS ANDTRADING RULES 215What is Forecasting? 216

Why Do We Need Exchange Rate Forecasting? 216

Econometric Forecasting Models

Time Series Forecasting Models

Market-Based Forecasting

Judgmental Forecasting

Composite Forecasting

Forecasting Performance Evaluation

Technical Analysis

Trading Rules

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Summary 252 Key Terms 253 Review Questions 254 Problems 255

9. CURRENCY FUTURES AND SWAPS 2579.1 Currency Futures: Definition and Origin 258

9.2 Futures and the Problematic Properties of

Forward Contracts 258

9.3 A Comparison of Forward and Futures Markets 266

9.4 Specifications of Currency Futures Contracts 269

9.5 Currency and Interest Rate Swaps 270

9.6 Swap Terminology 278

Summary 279 Key Terms 280 Review Questions 280 Problems 280

10. CURRENCY OPTIONS 28310.1 Origin and Basic Concepts 284

10.2 Description of Currency Options Contracts 295

10.3 Option Positions 296

10.4 Determinants of Option Premiums 305

10.5 Exotic Options 308

Summary 310 Key Terms 310 Review Questions 311 Problems 311

11. INTERNATIONAL ARBITRAGE 31311.1 Two-Point Arbitrage 314

11.2 Three-Point and Multi-Point Arbitrage 316

11.3 Commodity Arbitrage 321

11.4 Covered Interest Arbitrage 323

11.5 Uncovered Interest Arbitrage 331

Summary 340 Key Terms 341 Review Questions 341 Problems 342

12. FOREIGN EXCHANGE RISKAND EXPOSURE

12.1 Definition of Risk

12.2 Value at Risk

12.3 Definition of Exposure

12.4 Volatility of the Australian Dollar

Exchange Rates

12.5 Transaction Exposure

12.6 Economic Exposure

12.7 Translation Exposure

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351

355

360

361

363

364

Summary 366 Key Terms 367 Review Questions 367 Problems 368

13. FOREIGN EXCHANGE RISK

13.1

13.2

13.3

13.4

13.5

13.6

13.7

13.8

13.9

Why Worry About Foreign Exchange Risk?

Hedging Short-Term Transaction Exposure

with Forward and Futures Contracts

Money Market Hedging of Short-Term

Transaction Exposure

Option Hedging of Short-Term

Transaction Exposure

Hedging a Contingent Exposure

Hedging Long-Term Transaction Exposure

Other Techniques of Managing

Transaction Exposure

Managing Economic Exposure

Managing Translation Exposure

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Summary 411 Key Terms 412 Review Questions 412 Problems 413

14. INTERNATIONAL SHORT-TERMFINANCING AND INVESTMENT

14.1 International Short-Term Financing

14.2 International Short-Term Investment

14.3 The Effective Financing Rate and EffectiveRate of Return

14.4 Introducing the Bid-Offer Spreads

14.5 Implications of International Parity Conditions

14.6 Introducing Probability Distributions

14.7 Financing and Investment withCurrency Portfolios

14.8 Centralised Versus Decentralised CashManagement

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432

16.1

16.2

16.3

16.4

16.5

16.6

16.7

16.8435

436

Summary 441 Key Terms 441 Review Questions 442 Problems 442

15.

15.1

15.2

15.3

15.4

15.5

15.6

15.7

15.8

INTERNATIONAL LONG-TERMFINANCING AND INVESTMENT

International Bank Loan Financing

International Bond Financing

International Equity Financing

Other Sources of Long-Term Financing

Bond Investment

Equity Investment

The Benefits of International PortfolioDiversification

International Capital Asset Pricing Model

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449

453

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471

Summary 474 Key Terms 475 Review Questions 476 Problems 477

16. FOREIGN DIRECT INVESTMENT ANDINTERNATIONAL CAPITAL BUDGETING 479

Background 480

Approaches to International Business 480

Theories of Foreign Direct Investment 482

Evaluating Direct Investment Projects 487

Evaluating Foreign Direct Investment Projects 492

More About Taxation 496

Foreign Direct Investment and Country Risk 499

Transfer Pricing 501

Summary 504 Key Terms 506 Review Questions 506 Problems 507

USEFUL WEBSITES

ABBREVIATIONS

CURRENCY SYMBOLS

LIST OF FORMULAE

GLOSSARY

INDEX

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