In this Presentation, we were looking at the International aspects of Financial Management, Terminology, Foreign Exchange Markets & Exchange Rates, Exchange Rates & Interest Rates, Purchasing Power Parity, Exchange Rate Risk and Political Risk.

1. INTERNATIONAL ASPECTS OF
FINANCIAL MANAGEMENT
PRESENTATION
BY
DABI DAVID GBIAUNDO, KAKULE,
USMAN

2. OUR AGENDA
1. Terminology
2. Foreign Exchange Markets & Exchange Rates
3. Purchasing Power Parity
4. Exchange Rates & Interest Rates
5. Exchange Rate Risk
6. Political Risk

3. 1. LEARNING THE LINGO
• ADR
• Cross-Rate
• Euro bound
• Eurocurrency
• Foreign Bonds
• Gilts
• Libor
• swaps

4. 2. FOREIGN EXCHANGE MARKETS
The worlds largest financial market participants:
1. Importers & Exporters
2. Portfolio Managers
3. Foreign Exchange Brokers
4. Traders
5. Speculators

5. EXCHANGE RATES
• The price of one country’s currency expressed
in terms of another country’s currency
All trading of currencies is in the form of US
dollars
Exchange rates are constantly changing

6. TYPES OF TRANSACTIONS
*Spot Trade: an agreement to exchange
currency on spot, or for the exchange rate today.
*Forward Trade: an agreement to exchange
currency at some time in the future.

7. 3. PURCHASING POWER PARITY
*Purchasing Power Parity (PPP)
• Adjustment of exchange of exchange rates
*2 Types of PPP:
• Absolute PPP
• Relative PPP

8. ABSOLUTE PURCHASING POWER
PARITY
• Commodity costs the same
• $1 buys same thing anywhere
 Pfc=So*Pus
 3 things must hold true
 No transaction costs
 No barriers to trading
 Items must compare

9. McPRICING
• The Big Mac Index: The Economist
• Over/Under valued
 Not priced equally
• Absolute PPP Example
 stock on NYSE & Other countries

10. RELATIVE PURCHASING POWER PARITY
• Determine change in exchange rates over time
through inflation rates
• E(S1)=So[1+(hfc-hus)]
E(S1)-expected rate
So-current rate
Hfc-foreign country inflation rate
Hus-US inflation rate
• Appreciation VS Depreciation

11. 4. EXCHANGE RATES & INTEREST RATES
• Covered Interest Arbitrage
• Arbitrage: the simultaneous purchase and sale
of the same securities , commodities, or
foreign exchange in different markets to profit
from unequal prices
• Covered refers to the fact that we are covered
in the event of a change in exchange rates
because we lock in on the forward exchange
rate today.

12. COVERED INTEREST ARBITRAGE
• Ft=Forward exchange rate for the settlement
at time t
• Rus=US nominal risk-free interest rate
• Rfc=Foreign country nominal risk-free interest
rate
• So=spot exchange rate

13. FINDING THE RETURN ON US
INVESTMENT
• Suppose we start with $1 and invest it in a US
investment with a 10% risk-free interest
rate(RUS=0.10)
• $ Value in 1 period=$1(1+RUS)
=$1(1+0.10)
=$(1.10)
• $ value in period=$1.10
• This means that in one period (one year), your original
investment of $1 will now be worth $1.10.
• The return on this investment is 10%.

14. TO FIND THE RETURN ON A FOREIGN
INVESTMENT
• Suppose we start with $1 and invest it a Uganda
investment with a 5% risk-free interest rate (RS=0.05)
• Convert the $1 into UShs. By multiplying it by the spot
exchange rate (So=2.0);
 $1(So)
 $1(2.0)=2.0 Ushs
• Invest our 2.0 Ushs at an interest rate of 5%
 Ugshs value in one year=Ushs3.5(1+RS)
 UShs2.0(1+0.05)
 Ushs2.0(1.05)
• UShs value in one year=Ushs2.10

15. TO FIND THE RETURN ON A FOREIGN
INVESTMENT
• Then , we have to convert our Ushs 2.10 back
into US currency at the previously agreed
upon forward exchange rate of Ushs1.90
$ value in one year=ushs2.10/1.90
$ value in one year=$1.1053%
• Return on this investment=10.53%, >10%
return on this US investment, meaning
arbitrage opportunity

16. TO FIND THE RETURN ON A FOREIGN
INVESTMENT
• You can sum up all of this into one big
formula;
 $ value in one year=$1xSox(1+Rs)/F1
 $ value in one year=$1x2.00x(1.05/1.9)
• $ value in year=$1.1053
• Parity: the equivalence in in the currency of
another country

17. INTEREST RATE PARITY
• Interest Rate Parity: states that the interest
rate differential between two countries is
equal to the % difference between the
forward exchange rate
• To prevent arbitrage, return on US investment
and foreign investment must equal
 (1+Rus)=Sox(1+Rfc)/F1

18. INTEREST RATE PARITY
IRF FORMULA Ft=Sox(1+(Rfc-Rus)}
• IRP tells us that any difference in interest rates
between two countries for a period is offset by
the change in the relative value of the currencies,
thereby eliminating any arbitrage possibilities.
• F1 indicates what the forward rate must be in
order to prevent covered interest arbitrage; i.e.,
return for US investment & foreign investment
equal

19. 5. EXCHANGE RATE RISK
*Three types of exchange rate risk
1. Short-run exposure
2. Long-run exposure
3. Translation exposure

20. SHORT RUN EXPOSURE
• Day-to-fluctuations create risk
• Different currencies create greater risk
• Ways to reduce short-exposure

21. LONG-RUN EXPOSURE
• The value of foreign operations can fluctuate
• Matching foreign currency inflows and
outflows
• Borrowing in a foreign country
• Automotive industry example

22. TRANSLATION EXPOSURE
• A firm must “translate” everything into
dollars
• 2 issues may arise from foreign operations
1. Determining the appropriate exchange rate
2. How gains and looses should be
determined
• Impact on an international company’s
reported EPS

23. 6. POLITICAL RISK
*Political RISK-risk related to changes in value
that arises because of political action
*Firms in riskier countries:
• May lend to higher returns on investment
• Critical operations interrupted
• Contracts abrogated
• Outright confiscation

24. NATURE OF THE BUSINESS
*Business not valuable in the hands of a
different owners are likely to be confiscated
*Examples:
• Specialized Manufacturing components-Low
Risk
• Natural Resource Developments-High Risk

25. HEDGING POLITICAL RISK
*Example: Use of local financing, perhaps from
government of thee foreign country
• Can refuse to pay debt if unfavorable political
activities

26. QUESTIONS?..............