Options Pricing The Black-Scholes ModelMore or .docx

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Options Pricing: The Black-Scholes ModelMore or less, the
Black-Scholes (B-S) Model is really just a fancy extension of
the Binomial Model.
(Fancy enough, however, to win a Nobel Prize…).
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How B-S extends the Binomial Model1. Instead of
assuming two possible states for future exchange rates, and thus
returns (i.e., “up” and “down”), B-S assumes a continuous
distribution of returns, R, so that returns can take on a whole
range of values.
Binomial B-S
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How B-S extends the Binomial ModelIn fact, exchange rate
returns are approximately normally distributed, so this is a
“reasonable” assumption:
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How B-S extends the Binomial Model2. Instead of just one
time period, B-S assumes multiple time periods and that the
time between periods is instantaneous (i.e., continuous).
(See lecture)
Also, the time between periods t=0, t=1, t=2, etc. shrinks to
zero, so that spot rate is changing at every instant.
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How B-S extends the Binomial ModelThis is more realistic,
since actual currency trades take place on a second-to-second,
nearly continuous basis.
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How B-S extends the Binomial ModelIt turns out that these

two extensions are enough to make the math very hard. Thus,
deriving the B-S model is no easy task.
The most important thing to recognize is that despite the above
complications, the basic underlying approach of the B-S model
remains the same…
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How B-S extends the Binomial Model3. Create a
replicating portfolio and price the option using a no-arbitrage
argument.Calculate NS and NB: Now, since these are constantly
changing over time, this process is called “dynamic
hedging”.Replicating portfolio:It turns out that it is possible to
use a combination of foreign currency and USD, and now in
addition, options themselves, to form a riskless portfolio (i.e.,
return is known for sure).No-arbitrage: Riskless portfolios must
have the same price as risk-free securities, otherwise arbitrage
is possible. Use this fact to figure out c.
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The Black-Scholes Options Pricing FormulaPutting the
above all together, we get the Black-Scholes formula for pricing
a European call option on foreign currency:
where
and S, X, T as before
r = domestic risk-free rate, r* = foreign risk-free rate
s = volatility of the foreign currency (sd of returns).

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The Black-Scholes Options Pricing Formula
Also, N(x) = Prob that a random variable will be less than x
under the standard normal distribution (i.e., cumulative
distribution function).Calculate in EXCEL using
“=NORMSDIST(x)”.
represents discounting when interest rates are continuously
compounded, so basically it corresponds to:
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+
Currency DerivativesA derivative is a financial instrument
that derives its value from some other underlying asset.
Benefit: Allow for the transfer of risk from those who do not
want exposure to an underlying asset (hedgers) to those who
want increased exposure (speculators) and hope to generate
abnormal profits.MNCs often assume the hedging role, as their
core competency usually does not involve currency
speculation.As a result, derivatives allow MNCs to eliminate or
significantly reduce exchange rate risk, thus making them
comfortable to engage in international business on a much
larger scale than they otherwise would.
The downside: Derivatives have a very large leverage
effectSpeculation in derivatives somewhat resembles betting, so
prone to excessive risk taking by some participantsSome
derivatives are, admittedly, very complex and hard to
understand
Currency DerivativesWe want to look atCurrency forwards
and futures (Readings: p. 135-146)Currency options
Currency Forwards and FuturesCurrency forward contract:
a negotiated agreement between an MNC and a bank
to:exchange a specified amount of currency,at a specified
exchange rate (the forward rate)at a specified date in the future
(the maturity or expiration)
Hedging with forwards: If the MNC has net foreign currency

inflows, then it will be receiving foreign currency sometime in
the future; lock in the rate at which this foreign currency can be
sold by selling forward contracts.If the MNC has net foreign
currency outflows, then it will be paying out foreign currency
sometime in the future; lock in the rate at which this foreign
currency can be obtained by buying forward contracts.
Currency Forwards and FuturesEX1: Suppose MNC USA
has a €4 million receivable from a French customer due in 1
month. The current spot rate is $1.30/€ and forward rate is
$1.35/€.Since the receivable is a cash inflow, to hedge against
exchange rate risk MNC USA will sell €4 million forward at
$1.35/€.In 1 month, MNC USA will receive €4 million and sell
it to receive €4 mil x $1.35/€ = $5.4 million.Note, if the euro
had appreciated above $1.35, then MNC USA would have been
better off without the forward contract.However, if the euro had
depreciated, then MNC would obviously be been worse
off.Instead of speculating, the forward contract allows MNC
USA to lock in the cash inflow of $5.4 million in 1-month
regardless of what happens to the euro, thus eliminating
exchange rate risk.
Currency Forwards and FuturesFutures contracts have
actually been around for a long time; commodity futures like
corn, wheat, pork bellies, gold, etc.
Currency futures contracts are very similar to currency forward
contracts in that they represent the obligation to purchase or sell
currency on a specific date in the future (e.g., 30, 60, 90 day
maturities are most common).

Currency Forwards and FuturesHowever, differ importantly
from forward contracts in the following ways:Futures are
standardized contracts that specify the number of units of
foreign currency per contractExchange traded, e.g., on the
Chicago Mercantile Exchange (CME).Counterparty in a futures
contract is not a bank but instead is the party on the other side
of the transaction (i.e., each contract has a buyer and
seller).Exchange acts as a clearinghouse between buyers and
sellers, who must maintain a margin requirement with the
exchange. Gains and losses from futures positions are then
added to or deducted from this margin account on a daily
basis.Eliminates counterparty risk: the risk that the counterparty
will default (credit risk).
Currency Forwards and FuturesHowever, differ importantly
from forward contracts in the following ways:Since traded on an
exchange, greater liquidity than forward contracts; futures
contracts can be bought and sold, unlike forward contracts.
In fact, futures positions are usually closed by making an
offsetting transaction rather than taking or making physical
delivery of currency.For example, a buyer of a futures contract
closes her position by selling an identical contract. She does
not take physical delivery of currency from the seller of the
futures contract.
Larger MNCs and investors, which have larger exposures and
closer relationships with large banks, have the “luxury” of tailor
made forward contracts; smaller MNCs and investors most often
operate in the futures market.

Valuation of currency futures contractsTwo important
relationships in the valuation of currency futures contracts1.
Due to arbitrage, the futures price equals the forward rate, so
2. Also, at expiration of a contract (say, at time T), the futures
price equals the spot price, or
FutT = ST
(again due to arbitrage).
Think about these…
Currency Forwards and Futures
Fut0 = S0 [(1+ih)/(1+if)]
(Fut = S at expiration T = 1)
Spot & futures price convergence at expiry
Futures prices converge to spot prices at expiration. This
convergence can be seen through the interest rate parity
condition.
Futt,Td/f = Ft,Td/f = Std/f [(1+id)/(1+if)]T-t
As time to expiry (T-t) approaches zero, the [(1+id)/(1+if)]T-t
term goes to one and forward and futures prices converge to the
spot price.
If interest rates do not change, then the convergence of futures
prices to spot prices is linear in time. In particular, the futures
price converges to the spot price at a rate of (1+id)/(1+if) per
period.

This nearly linear convergence makes futures contracts and
forward contracts nearly identical in their ability to hedge
exposure to currency risk.
0
1
Fut1 = S1
Forward

premium
Fut0
S0
Currency Forwards and FuturesSimilar to forward
contracts, futures contracts essentially lock in the price at which
a currency is bought or sold at some specified time in the
future, although there are some differences (see EX2 on the next
slide)
Thus, hedging with futures is similar to hedging with forwards:
hedge a foreign currency… Inflow by selling futures
contracts.Outflow by buying futures contracts.
Currency Forwards and FuturesEX2: As in EX1, suppose
MNC USA has a €4 million receivable from a French customer
due in 1 month. The current spot rate is $1.30/€ and 1-month
futures price is $1.35/€.A) At expiration, suppose the spot rate
depreciates to $1.28/€. What is MNC USA’s dollar cash
flow?B) At expiration, suppose the spot rate appreciates to
$1.40/€. What is MNC USA’s dollar cash flow?As before, to
hedge MNC USA must sell futures contracts. But how

many?Each euro futures contract is for €125,000 (standard
size). Thus, to hedge €4 million exposure, must sell
€4mil/€125,000 = 32 contracts[Rest done in Lecture]
Currency Forwards and FuturesIt’s the same either way
(and the same as EX1)!
From EX2, notice that it does not matter whether the euro
appreciates or depreciates, MNC USA’s USD cash flow is $5.4
million regardless of the exchange rate.
Thus, illustrates that futures contracts can also be used to
eliminate exchange rate risk.
Also, notice that while futures work in a slightly different
manner, the end result is essentially the same as with using
forwards – locking in the exchange rate at which to buy or sell
foreign currency in the future.
Currency Forwards and FuturesSpeculating with currency
futures (also see next two slides)One last difference between
forwards and futures is that futures can be more easily utilized
for speculationRecall, speculators are assuming risk from
hedgers and thus are in it to generate profits from trading.If
they buy (sell) futures, profit when futures price rises (fall).
Finally, note that trading in derivatives is a zero sum game:In
EX2 B) MNC USA sold futures contracts and it lost -$.20m in
the futures market.In contrast, the counterparty (i.e., the buyer
of the futures contracts sold by MNC USA) makes a profit of
$.20m.Thus one counterparty’s gain is the other’s loss and vice
versa (giving the flavor of a “side bet”).
Speculating and hedging with futures contractsExample of

speculating with currency futures: Suppose the counterparty to
MNC USA is a currency futures speculator, who is then
necessarily long €4 million. Then, due to the zero sum nature
of futures contracts:If spot rate depreciates to $1.28/€, then
speculator loses $.28 million, or $280,000.If spot rate
appreciates to $1.40/€, then speculator gains $.20 million, or
$200,000.(Note, these are exactly the opposite of the
gains/losses to MNC USA’s futures positions).
Speculating and hedging with futures contractsExample
also illustrates the high degree of leverage in derivatives
trading.To trade futures, investors are required to set up a
margin account with the exchange. Typically, the margin
requirement is very small relative to the notional value of
contracts tradedFor example, an initial margin of $10,000 would
be sufficient to start trading one euro contract with a size of
€125,000 par value (representing roughly 5% of the contract
value in USD terms).In our example, 32 contracts then requires
roughly $320,000 of margin, giving access to €4 million in
contract (notional) value.Thus, there is a high degree of
leverage:Profit of $200,000 is less than 5% of contract value,
but actual return = $200,000/$320,000 = 62.5%Loss of $280,000
is less than 7% of contract value, but actual return = -
$280,000/$320,000 = -87.5%.

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MNC Exposure to Exchange Rate RiskMotivations for
hedgingTransaction ExposureEconomic ExposureTranslation
ExposureHow to measure exchange rate exposure
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Relevance of Exchange Rate RiskFirst, theoretical
arguments for why it should not matter:Investor Hedge
Argument: exchange rate risk is irrelevant because investors can
hedge exchange rate risk on their own.Currency Diversification
Argument: if U.S.-based MNC is well diversified across
numerous currencies, its value will not be affected by exchange
rate riskStakeholder Diversification Argument: if stakeholders
are well diversified, they will be somewhat insulated against
losses due to MNC exchange rate risk.
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Relevance of Exchange Rate RiskWhy it actually does
matter:To the extent that exchange rate fluctuations cause an
MNC’s cash flows to become more volatile, it will face higher
borrowing costs and a lower firm value. Thus, MNCs have a
strong incentive to hedge their exposure to currency risk.
And in fact, they do. From Procter & Gamble Co.’s annual

report: “The primary purpose of the Company’s hedging
program is to manage the volatility associated with foreign
currency purchases of materials and other assets and liabilities
created in the normal course of business. Corporate policy
prescribes a range of allowable hedging activity.”
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Relevance of Exchange Rate RiskWhy it actually does
matter:In a survey of U.S. corporations and corporate
treasurersCurrency risk: 75 percent of respondents said they
faced currency risk. Transaction exposure is viewed by
corporate treasurers in the U.S. as the most important currency
risk exposure
Source: Jesswein, Kwok and Folks, “Adoption of Innovative
Products in Currency Risk Management: Effects of Management
Orientations and Product Characteristics,” Journal of Applied
Corporate Finance (1995).
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Transaction ExposureDefinition: change in the value of
contractual cash flows from unexpected changes in exchange
ratesContractual cash flows are those arising from contracted
transactions related to business operations (e.g., receivables and
payables) and financing (e.g., interest payable).Example:
Suppose MNC USA has payables of €1,000,000 due in 1 month
to a Eurozone supplier. If in one month the euro appreciates
(depreciates) against the dollar, then MNC USA will be worse
off (better off).If instead, MNC USA had receivables of
€1,000,000 due in 1 month. Then, a euro appreciation
(depreciation) would make MNC USA better off (worse off).In
this sense, having positive (negative) foreign currency cash
flows is like having a long (short) position in the foreign

currency.
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Measuring Transaction ExposureFirst, MNC must
determine the net cash flow position in each foreign
currency.An MNC may have subsidiaries in several countries,
each with contractual transactions denominated in two or more
currencies.Many of these subsidiaries individual exposures may
offset each other when consolidated.Netting out each individual
subsidiaries cash flows avoids redundancy in hedging, which is
costly.
German
subsidiary
U.K.
subsidiary
U.S.
parent
$100m
Exchange rates $1.5000/€
$1.6000/£
$200m
£75m
€160m
£150m
€60m
Measuring Transaction Exposure
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Example: The parent firm is located in the U.K. and uses the

pound as its functional currency. Each affiliate invoices in its
local currency.
Of course, something of value must have been transferred in the
other direction for each of these cash flows.
Ask students to translate these cash flows into pounds. The
solution appears on the next slide.
German
subsidiary
U.K.
subsidiary
U.S.
parent
$100m
$200m
$120m
$240m
$240m
$90m
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This slide shows the gross cash flows in pound sterling. This
captures the gross change in value of each affiliate and of the
parent.
If all of these transactions are executed, then a total of £600
million must be transferred.
Ask students to identify the net cash flows from this slide. The
solution appears on the next slide.

German
subsidiary
U.K.
subsidiary
U.S.
parent
$10m
$80m
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This slide shows the net transfer of value within the
corporation.
After multinational netting, only £200 million need be
transferred rather than the £600 million in value in the original
position.
This should reduce transaction fees by about two-thirds.
In this example, Treasury can avoid the external currency
markets entirely by using bookkeeping entries at the home
office to indicate transfers of value to/from each affiliate. Cash
can then be transferred where and when it is needed. Of course,
there will still be cash flows to and from the firm’s external
partners.
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Measuring Transaction ExposureThus, after netting out all
the subsidiaries cash flows, this US-based MNC has a $10m
exposure to the euro (from its German subsidiary) and a $80m

exposure to the pound (from its UK subsidiary).In effect, this is
like holding a $90m portfolio, with a proportion of (10/(10+80))
= .11 invested in euros and (80/(10+80)) = .89 invested in
pounds.The MNCs net exposure is then measured by the
standard deviation of the portfolio, sp:
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Measuring Transaction ExposureMeasurement of currency
variability and variability over time (see notes)Measurement of
currency correlationsCorrelation coefficient, CORR measures
the strength of the linear relationship between currency returns.
It lies in between -1 to +1.Most currencies are positively
correlated with each other, with similar currencies (e.g.,
European currencies) being more highly correlated.Applying
currency correlations to net cash flowsAll else equal, if an MNC
has net cash flows in different currencies that are either all
positive or all negative, then the more highly correlated the
currencies, the higher the exchange rate risk.On the other hand,
exchange rate risk might be reduced if the MNC has positive net
cash flows in some currencies and negative net cash flow in
others (see pp. 328-331, and Exhibits 10.4-10.7).Currency
correlations over timeNote that like currency volatility,
currency correlations can change over time.
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Measuring Transaction ExposureA widely used measure of
exposure is Value at Risk (VaR)VaR measures the probability
that losses on a currency position over a specified horizon will
be greater than some lower bound.Assume currency returns are
normally distributed with a mean of zero and standard deviation
of s.Then, using properties of the normal distribution, there is
5% chance that returns will be less than -1.65s ; a 2.5% chance

that returns will be less than -1.96s; and 1% chance that returns
will be less than -2.33s. Where do these numbers come from?
The cumulative distribution function, N, of the standard normal
distribution, which has mean = 0 and s = 1. Specifically, N(-
1.65) = 5%, N(-1.96) = 2.5%, and N(-2.33) = 1%.
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Measuring Transaction ExposureExample: Suppose an
MNC has a positive net cash flow in the Mexican peso (MXP).
Calculate the 1-day VaR at the 95 and 99 percent confidence
levels if the 1-day standard deviation sMXP = 1.2% and the
expected exchange rate return over the next day, E(et), is 0% (a
common assumption):
5%: VaR = E(et) – (1.65*sMXP) = 0% - (1.65*1.2%) = -
1.98%
1%: VaR = E(et) – (2.33*sMXP) = 0% - (2.33*1.2%) = -
2.79%
This means that there is a 5% (1%) chance that the value
of the MXP position will decline by 1.98% (2.79%) or more
over the next day.
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Measuring Transaction ExposureExtensions:To extend to
longer horizons, calculate appropriate returns and standard
deviation. For example, for 1-month VaR, use 1-month returns
and standard deviation.To extend to portfolios of currencies,
use the formula for the standard deviation of the portfolio, sP
(see p. 332-333).Limitations of VaR analysisAssumes returns
are normally distributed. This is a good approximation, but it

turns out that normal distribution gives to small of a probability
to extreme events, and with VaR analysis we are precisely
interested in extreme events.Again, volatility is not constant
over time.
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Recap of Transaction Exposure and HedgingTransaction
exposure is the change in the value of contractual cash flows
(i.e., those arising from contracted transactions related to
business operations and financing) due to unexpected changes in
exchange rates.After netting out, the MNC’s net foreign
currency cash flows can then be treated as a portfolio of foreign
currencies.Transaction exposure then measured as portfolio
standard deviation or VaR.Also, saw that MNCs view
transaction exposure to be most important and actively hedge
against it (more later).Now, more on economic and translation
exposure…
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Economic ExposureDefinition: Economic (or operating)
exposure is the change in the value of non-contractual cash
flows due to unexpected changes in exchange rates.
Simply put, non-contractual cash flows are cash flows that are
not contractual. For example: An MNC’s revenue is an example
of a non-contractual cash flow. Revenues depend on the general
level of sales, which are not contractual in nature.(However,
once a sale is made, then actual payment for the sale is
contractual (i.e., in the form of a receivable). Thus, a
receivable is an example of a contractual cash flow).Thus, cash
flows arising from factors such as an MNC’s general level of
sales and/or purchase of inputs are examples of non-contractual
cash flows

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Economic Exposure (examples)US-based MNC’s exposure
to US dollar appreciationDomestic (US) revenues will decrease
as foreign goods become less expensive relative to US goods.
(Decline in cash inflows)Export (foreign) revenues will
decrease as US goods become more expensive relative to
foreign goods. (Decline in cash inflows).Cost of imported goods
and/or supplies decreases. (Decline in cash outflows).US-based
MNC’s exposure to US dollar depreciationDomestic (US)
revenues will increase as foreign goods become more expensive
relative to US goods. (Increase in cash inflows)Export (foreign)
revenues will increase as US goods become less expensive
relative to foreign goods. (Increase in cash inflows).Cost of
imported goods and/or supplies increase. (Increase in cash
outflows).Note, a purely domestic US firm with zero transaction
exposure can still have economic exposure if it competes in the
domestic market with foreign competitors.
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Measuring Economic ExposureSensitivity
AnalysisBasically, calculate cash flows (e.g., revenues –
operating costs – interest expense) under different exchange
rate scenarios. Easy if foreign sales and costs are invoiced in
foreign currency (all you then have to do is to convert foreign
revenues and costs at the different exchange rates). See
discussion on p.337-339.Note, more difficult if foreign sales are
invoiced in dollars, because then must also estimate change in
demand (i.e., sales volume) as a result of change in exchange
rate.

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Measuring Economic ExposureRegression AnalysisUsing
past data, estimate a linear relationship between changes in the
exchange rate and the firms cash flows
Instead of PCF, can also use percentage changes in MNC’s
stock price.
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Comparison of Transaction Exposure and Economic
ExposureDue to the non-contractual nature of economic
exposure, it is more difficult to hedge precisely. That is,
because non-contractual cash flows are unknown beforehand
and must be estimated, it is hard to know how much to hedge.
On the other hand, transaction exposure is much more easy to
hedge because contractual cash flows are known beforehand. In
this case, MNCs know precisely how much to hedge. This
explains the popularity of hedging transaction exposure.
As we will see, currency derivatives are highly useful for
hedging transaction exposure, while the hedging of economic
exposure entails other strategies.
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Translation ExposureDefinition: Translation exposure is

the change in values on an MNC’s consolidated financial
statements due to unexpected changes in exchange rates. For
example, consolidated earnings per share is affected by the
exchange rate used to translate each individual subsidiary’s
earnings.Main question: Does translation exposure matter?Cash
flow perspective: No. Translation is for accounting purposes
and does not represent a real cash flow. That is, a subsidiary’s
earnings do not really have to be converted to the parent’s
currency, and could instead be reinvested locally.Stock price
perspective: YesTo the extent that stock market participants pay
attention to measures like a firm’s earning per share or value
shares based on price-earnings ratios, then translation exposure
is important.
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Translation ExposureDeterminants of translation
exposure:The proportion of business conducted by foreign
subsidiariesThe more the MNC is engaged in international
business, the higher the translation exposure.The locations of
foreign subsidiariesFor example, Canada (low exposure) vs.
Mexico (high exposure).The accounting methods usedFASB 52
(see p. 340)
See p. 341-342 for discussion of how MNCs stock price can be
affected by translation exposure.
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Finishing up Exchange Rate DeterminationExchange Rate
Volatility
Central Bank (Government) Intervention
Exchange Rate Systems

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Exchange Rate VolatilityUp to now, we have been looking
at factors that cause exchange rates to change.
However, investors and MNCs are also very interested in the
magnitude or degree to which exchange rates changes.
In other words, we are interested in exchange rate volatility.
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Factors that influence FX volatilityLiquidity Exchange
rates for currency pairs that have smaller markets and less
transactions (e.g., USD-RUB) tend to have higher volatility.Due
to the fact that changes in the equilibrium exchange rate must
be larger in order to equate quantity supplied and quantity
demanded.
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Factors that influence FX volatilityIncreased speculative
activityMomentum trading: If yen appreciates today, speculators
take this as a positive signal and will buy more yen tomorrow,
which causes further appreciation of the yen, and so on
(positive feedback). At some point, yen will be too strong
relative to fundamentals.Overreaction: Traders might overreact
to news so that the resulting market exchange rate overshoots
its fundamental value Specifically, it will be too optimistic on
the upside; too pessimistic on the downside.
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Factors that influence FX volatilityCrisisDuring a crisis, a
combination of the above two factors occur: A loss of liquidity

because of panic selling of the foreign currency and not many
willing buyers.Quite simply, panic => overreaction.
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Measures of FX volatility
Historical standard deviationThe “sigma” from statistics (i.e.
proportional to sum of squared deviations from the mean).
Straightforward to calculate.Drawback: Relies on past historical
data over an arbitrary length of time in the past (month, quarter,
year, etc.) to calculate a single number.Thus, for predictions,
volatility is assumed to be constant and similar to what it was
over the past period used in the calculation.
A convenient, useful alternative: Absolute value of returns,
|returns|:See volatility handout in Isidore (Misc01/009).Notice
“volatility clustering” phenomenon – periods of high volatility
tend to clump together. Much higher than normal volatility
during late-2008 period due to the credit crisis. Signs of
overreaction?
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Central Bank InterventionCentral bank intervention to
“calm disorderly markets”:
To smooth exchange rate movementsToo much volatility is bad
for the economy, especially for export-dependent countries
To establish implicit exchange rate boundariesAs in a “managed
float”, where central bank tries to keep exchange rate within a
band. Example: Swiss National Bank’s policy on the Swiss
franc and euro.
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Central Bank InterventionCentral bank intervention to
“calm disorderly markets”:To respond to temporary
disturbances: e.g.,Thailand during the Asian financial crisis of
1997:Asset/real estate bubble burst, foreign investors engage in
“flight to safety”, selling baht for USD and causing extreme
depreciationHowever, important for Thai gov’t to keep baht
strong b/c of large amount of USD denominated debt (i.e., to
avoid massive default).Hedge funds (led by George Soros) bet
that Bank of Thailand unable to defend baht; launched
“speculative attacks” by selling baht en masse.Thai defenses in
response: strengthen baht by (1) Raising interest rates, and (2)
Intervening in FX market to buy baht (sell dollars). Ultimately
unsuccessful…not enough USD foreign reserves; massive baht
depreciation, default on bonds, and bank collapses across Asia
(large holders of Thai gov’t debt). Then, IMF rescue packages,
austerity, etc.
*
Central Bank InterventionCentral bank intervention as a
policy tool:Intervention to weaken currency:Weaker currency
makes exports more competitive and helps export industries.A
potential drawback is higher inflation. Since foreign goods will
be more expensive, domestic firms face less competition and
may raise their prices as well.Intervention to strengthen
currency:Stronger currency can help keep inflation low, because
foreign goods will be more competitive, causing domestic
producers to lower their prices as well.Potential drawback is
higher unemployment as firms must cut costs to compete.
*
Direct InterventionWith direct intervention, the central

bank intervenes directly in the foreign exchange market to buy
or sell its currency.
Effectiveness of intervention depends on: For strengthening the
currency: the amount of foreign reserves that a central bank has
at its disposal signals to currency markets how serious and
credible its actions are.
For weakening the currency: the willingness of the central bank
to sell their own currency in FX markets, along with the
possibility of “printing money” for this purpose; what is the
credibility of such a move with respect to inflation?
*
Direct InterventionEffectiveness also depends on whether
sterilized or non-sterilized:Sterilized intervention leads to no
change in the overall supply of a currency. For
example:Suppose the Fed intervenes by buying $100 billion in
FX markets, thus reducing the supply of dollars available
throughout the world.At the same time, it purchases $100
billion in Treasury bonds in the open market, thus increasing
the supply of dollars in the economy.Overall, the money supply
(of USD) is unchangedNon-sterilized intervention leads to an
actual change in the overall supply of a currencyCentral bank
intervenes in FX markets but does not “sterilize” the
intervention with offsetting sale/purchase of T-bonds.Japanese
intervention in article was non-sterilized.
*
Direct InterventionA note on money supply (MS) and FX
intervention:To increase MS, central banks purchase gov’t
bonds from market => Injects money into economy (increase in
MS) => decline in int. rates (expansionary).To decrease MS,
central banks sell gov’t bonds to market => Takes money out of

economy (decrease in MS) => rise in int. rates
(contractionary).Sterilized: Central bank offsets FX market
purchases (sales) with corresponding purchases (sales) of gov’t
bonds => no overall change in MS and thus int. rates. Non-
sterilized: No offsetting; leads to actual change in MS and int.
rates.EX: BoJ sell yen to weaken => Increase in yen money
supplySterilized: To offset, BoJ sells equivalent amount of
Japanese gov’t bonds (taking yen out of economy) => no overall
change in yen MSNon-sterilized: Let yen MS increase with FX
intervention; equivalent to monetary policyPurpose of
sterilization: try to change value of currency only w/o also
affecting other domestic macro variables that can have broader
consequences on rest of economy.
*
Direct InterventionSpeculation on direct
intervention:Sometimes, traders can anticipate intervention
(e.g., rumors began swirling in the week preceding the Japanese
intervention in article).However, can be difficult because
central banks, especially the Fed, are often highly secretive
about their intervention operations. Also, note that the Fed has
no stated official exchange rate policy on the value of the USD.
Does it work?In the short term yes, in the long term…not
really.Depends in part on whether sterilized or non-
sterilized.Might signal future monetary policy stance and
interest rates.Ultimately, it is a numbers game: The global daily
turnover in FX markets exceeds the combined reserves of all
central banks in the world. Thus, intervention can be easily
overwhelmed by market forces.
*
Exchange Rate SystemsFixedFreely floatingManaged

floatPegged
*
Fixed Exchange Rate SystemExchange rates are either held
constant or allowed to fluctuate only within very narrow
boundaries.
Central bank can reset a fixed exchange rate by devaluing or
reducing the value of the currency against other currencies.
Central bank can also revalue or increase the value of its
currency against other currencies.
Examples:Bretton Woods Agreement 1944 – 1971Smithsonian
Agreement 1971 – 1973
*
Freely Floating Exchange Rate SystemIn a purely floating
system, exchange rates are determined by market forces without
government intervention.
See p. 189-192 for discussion of advantages/disadvantages of
fixed vs. floating exchange rate.
*
Managed Float Exchange Rate SystemIn the real world, it
lies somewhere in between…
Governments sometimes intervene to prevent their currencies
from moving too far in a certain direction.
Critics suggest that managed float allows a government to
manipulate exchange rates to benefit its own country at the
expense of others; “beggar-thy-neighbor” policies.
Unlike other countries, US has no stated official policy stance
on the value of the dollar. Critics argue, however, that the Fed

has a large degree of control over the USD exchange rate
through monetary policy (“indirect intervention”).
*
Pegged Exchange Rate SystemA country’s currency value
can be pegged to a foreign currency or to an index of foreign
currencies.Example: The Hong Kong dollar (HKD) is pegged to
the USD. This means that the exchange rate between the HKD
and USD is fixed, but the HKD moves with the USD against all
other currencies.
Advantages: may attract foreign investment because exchange
rate is expected to remain stable.
Disadvantages: weak economic or political conditions can cause
firms and investors to question whether the peg can be
sustained.
*
Pegged Exchange Rate SystemExamples (see
book):Europe’s Snake Arrangement 1972 – 1979European
Monetary System (EMS) and Exchange Rate Mechanism (ERM)
1979 – 1992Precursors to the formal introduction of the euro, in
which EU members’ currencies were pegged to the German
mark.German mark had a vaunted reputation as a stable
currency due to the German Bundesbank’s aggressive anti-
inflation stance in the post-war era.Mexico’s Pegged System
1994China’s Pegged Exchange Rate 1996 – 2005Venezuela’s
Pegged Exchange Rate, 2010
*
Pegged Exchange Rate SystemFamous episodes of

speculative attacks usually involve attacks on a country’s
currency peg. For example, the EMS crisis of 1992: why the
UK is an EU member but does not use the euro.After German
reunification in 1990, German economy boomed and
Bundesbank became worried about inflation and raised interest
rates to very high levels.
To maintain peg, UK officials would have to raise interest rates
and intervene to strengthen the pound.
The problem: stronger pound makes UK goods less competitive
and high interest rates (around 10%) slow economic activity.
And UK economy was already showing signs of slowing down,
Currency speculators bet that UK unwilling to maintain the peg
and would have to exit the EMS and devalue the pound in order
to avoid severe economic downturn.
Speculative attacks on the pound ensue with currency
speculators selling pounds en masse.
*
Pegged Exchange Rate SystemFamous episodes of
speculative attacks usually involve attacks on a country’s
currency peg:Asian Financial Crisis 1997:Thailand and
Indonesia unsuccessful at defending their pegsHong Kong
actually successful (see next slide).
In general, success of a peg depends on a government’s ability
and willingness to back it up, which in turn depends in large
part on foreign reserves (in the case of Thailand and Indonesia)
and political will (in the case of the UK).
*
Pegged Exchange Rate SystemCurrency Boards Used to
Peg Currency ValuesHKD is also an example of a currency
board: for every HKD in circulation, there is the equivalent

amount of USD in reserve backing it up. Most likely
contributed to successful defense of peg during AFC
1997.Interest Rates of Pegged CurrenciesAs the EMS episode
illustrates, interest rates of pegged currencies have to be quite
close and move in tandem, which can be a problem if the
countries involved face different economic conditions.Exchange
Rate Risk of a Pegged CurrencyA country pegs to USD for
stability, but if USD rises, the county’s exports become
uncompetitiveExample: Argentina during the 1990s. By 2000,
due to USD strength, there was a severe recession and debt
crisis (similar to current EU crisis).Ultimately, due to capital
flight and speculative attacks the peg failed.
*
DollarizationWhen a country’s currency in circulation is
partially or completely replaced by U.S. dollars.Official:
Foreign government adopts the US dollar as the official
currencyEl Salvador since 2001; to strengthen official ties
between nationsEcuador since 2000; to stabilize
economyUnofficial: Residents of the foreign country simply
start using US dollars instead of the domestic currency to carry
out transactions.Example: Argentina in the 1990s; loss in faith
in domestic currencyDollarization is a common phenomenon in
countries experiencing hyperinflationPersistent levels of
inflation above 25% per year, with rates higher than 10,000% -
prices doubling every two days - not uncommon). Also, hard to
combat.
*
A Single European CurrencyPlease read carefully p. 198-
203: A Single European Currency
Euro crisis important takeaways:Member nations give up their

monetary policy authority to the ECB, so they cannot adjust
interest rates and exchange rates in response to their own
domestic economic conditions.
Members do have fiscal policy authority and can set their level
of spending/borrowing/taxation (in theory, up to a point).
These above two facets are at odds and have contributed to the
Eurozone debt crisis and exposed a fundamental flawIn fairness,
borrowing is only tool “PIIGS” had to manage their economies;
at the same time, no enforceable rules against excessive
borrowing and investors (e.g., large European banks) were
happy to lend to them.
Policymakers and analysts recognize that stable currency union
must entail both monetary and fiscal union going forward. But
fiscal union gets into the domain of national sovereignty,
politics, and even culture….complicated.
International Financial MarketsReadings: Ch. 3
A closer look at international financial markets:Foreign
exchange marketInternational money marketsInternational bond
marketsInternational stock markets
Foreign Exchange MarketA brief history:Gold Standard,
1876 -1915: each country’s currency was convertible into gold
at a specified rate; currencies were backed by gold.WWI to
WWII, 1915-1944: on and off gold standard; attempts at
pegging to the US dollar and British pound. Period
characterized by instability and a large decline in foreign
trade.Bretton Woods era, Post-war to 1971: Fixed exchange
rates; exchange rates were pegged to the US dollar, which itself
was convertible to gold at the fixed rate of $35 per oz.

International transactions largely conducted in USD.By 1971,
due to a large current account and heightened inflation, USD
appeared overvalued (i.e., too strong) relative to other
currencies at initially established rates. Attempts to devalue
(weaken) via the Smithsonian agreement were “too little too
late”.Freely floating era after 1973: exchange rates are freely
determined in markets based on supply and demand.
Foreign Exchange TransactionsAn over the counter (OTC)
marketNo physical exchange like NYSE. Market is made up of
large money center banks linked through telecommunications
networks.Banks, or more specifically, foreign exchange dealers,
serve as intermediaries by exchanging currencies for
customers.Often exchange currencies with each other in the
interbank marketMajor trading centers are London, New York,
and Tokyo, although trading takes place worldwide.
Foreign Exchange TransactionsThe Spot Market: The
largest and most liquid segment of the FX marketTransactions
conducted in the spot market are for immediate delivery (i.e.,
“on the spot”).The exchange rate quoted in the spot market is
referred to as the spot rate.The spot market is truly a global, 24-
hour financial market.
Foreign Exchange TransactionsThe Forward
Market:Another important and major portion of the FX
market.Transactions in the forward market are agreed upon
today but, unlike the spot market, the actual exchange of
currencies takes place at a future date.Specifically, when an
MNC enters into a forward contract with a bank, the contract

specifies The future date at which currency is to be
bought/sold.The exchange rate at which the MNC can buy/sell
currency at the specified future date. This rate is called the
forward rate. Note, the forward rate is “locked in” at the time
of the contract.
Foreign Exchange TransactionsMNCs buy/sell currency
forward in order to hedge against currency riskEX: Suppose a
US-based MNC has euro payables due in 1 month. If the MNC
goes to the spot market one month from now:It will be exposed
to exchange rate risk because the $/€ exchange rate 1 month
from now is unknown (and so the amount of dollars it will take
to pay off the euro bill is also unknown). If the € appreciates
(depreciates), the MNC will have to pay more (less) dollars to
satisfy the euro payable.Instead, the MNC can enter into 1-
month forward contract today to buy euros at a specified
exchange rate 1 month from now. By locking in the price today
at which it buys euros tomorrow, the MNC knows exactly how
many dollars it will take to pay off the bill in euros, thus
eliminating exchange rate risk.
International Money MarketMNCs and governments around
the world always need and/or have short-term funds
denominated in a currency different from their home currency.
Reasons for international money market:Need to borrow funds
to pay for imports denominated in a foreign currency.Borrowing
in a currency in which the interest rate is lower.Have temporary
excess of foreign currency to deposit.Etc.
International Money MarketIn the beginning, the eurodollar

market:
Originally, a eurodollar deposit referred to a US dollar deposit
made in a European bank. Nowadays, it encompasses any US
dollar deposit made anywhere in the world besides the US.
It is also possible to borrow in the eurodollar market (i.e.,
borrowing in dollars from a bank outside the US).
International Money MarketNow, the eurodollar market has
evolved into the eurocurrency market:
A eurocurrency deposit is a deposit in any currency made in a
bank located outside of the home country of that currency. For
example, depositing Swiss francs in a Singaporean bank.
It is also possible to borrow in the eurocurrency market (i.e.,
borrowing any currency from a bank outside of the home
country of that currency). For example, borrowing Japanese
yen in Australia.
In fact, it is because the eurocurrency is so large and well
developed that the carry trade was able to grow to such large
proportions.
International Bond MarketMNCs engage in international
long-term borrowing (by issuing bonds in foreign markets) for
several reasons:Foreign bond markets may be larger and more
liquid than domestic bond market. Thus, able to get stronger
demand for their securities and thus lower interest rate.To
match cash flows: An MNC operating in a foreign country may
prefer to borrow in the currency of that country so that interest
payments are in the same currency as revenues. This eliminates
exchange rate risk.To borrow in the lowest interest rate
possible. However, subject to exchange rate risk.
Institutional investors (commercial banks, hedge funds, mutual
funds, pension funds) like investing in international bonds for

higher yields and diversification.
International Bond MarketTwo types of international bond
issues:
Foreign bonds: issued by borrower that is foreign to the country
where the bond is placed. For example:Bulldog Bond: A pound
sterling denominated bond issued in the UK by a non-British
companySimilarly: Samurai Bond, Kangaroo Bond, Yankee
Bond, Maple Bond, etc.
Eurobonds: bonds sold in countries other than the country of the
currency denominating the bondExample: a US dollar
denominated bond issued in Sweden by a Japanese company is
an example of a Sushi Bond.
Further ReadingsSection on Standardizing Global
Regulations and Crisis, p. 79Basel, Basel II, and Basel III
Accords
Section on International Credit Market, p. 77LIBOR (London
Interbank Offer Rate)Syndicated loans
Section on Int’l Bonds and Greek Crisis, p.83-85
Section on International Stock Markets, p. 85Including ADRs
(American Depository Receipts) up to p. 87
FIN 450
International Business Finance
Lecture Notes
School of Business Administration

University of Dayton
Fall, 2016
Part 1
The International Financial and Economic Environment
The Multinational CorporationReadings: Chs. 1 & 2
A multinational corporation (MNC) is a firm that engages in
some form of international business.Buying and/or selling goods
or services from a foreign country.Owning a foreign subsidiary
that requires financing from and/or makes remittances to the
parent.Investing and/or obtaining financing from a foreign
country.
To conduct international business at any level, MNCs must
engage in the foreign exchange market.
Why pursue international business?Theory of Comparative
Advantage: countries are better off if they specialize in
producing goods in which they have an advantage relative to
other countries, and then trading with each other.
Imperfect Markets Theory: factors of production (i.e., capital,
labor, resources, and land) are somewhat immobile, providing
an incentive to seek out foreign opportunities (e.g., cheaper
foreign labor).
Product Cycle Theory: as a firm matures, it recognizes
opportunities outside its domestic market.
How Firms Engage in International BusinessInternational

trade: Importing/exportingLicensing: Airport
StarbucksFranchising: McDonalds in FranceJoint Ventures:
Shanghai GMAcquisitions of existing operations: Daimler-
ChryslerEstablishing new foreign subsidiaries
Do you know what this is?
How Firms Engage in International BusinessInternational
trade, licensing, and franchising: Small capital requirement and
less risk, but less control over quality and brand image.
Joint ventures, foreign acquisitions and new foreign subsidiaries
(known collectively as DFI)More control over all aspects of
business, but requires large amount of capital and very
risky.Example: Daimler bought Chrysler in 1998 for $37
billion; sold for $7.4 billion in 2007.
Valuation Model for an MNCFirst, recall the domestic
model:
where E(CF$,t) represents expected cash flows to be received at
the end of period t,
n represents the number of periods into the future in which cash
flows are received, and
k represents the required rate of return by investors.
Value depends on economic, industry, firm-specific factors.

Valuation Model for an MNCFor an MNC, instead of
purely domestic cash flows, cash flows arise from various
foreign countries (j) in each period t, CFj,t, and these are
converted into dollars at the prevailing exchange rate for
country j, Sj,t:
Once all m foreign cash flows are summed up in terms of US
dollars at each t, discount the cash flows as before (i.e., plug
them into the previous model).
Valuation Model for an MNC
Thus, the value of the MNC now depends on Expected cash
flows, which now also depend on international and country-
specific economic and political conditions.Expected exchange
rates.
Any changes in these, as well as changes in k due to how
volatile cash flows are, will cause the MNCs value to rise or
fall; how much depends on the MNC’s exposure to these risks.
How do MNCs manage their exposure to these risks in order to
maximize V?

The Int’l Economic Environment and Flow of Funds
(Ch.2)Want to gain familiarity with:International
macroeconomics, trade, and investment.International agencies
that are involved in various aspects of multinational trade and
investment flows.
Balance of PaymentsThe Balance of Payments is a
summary of transactions between domestic and foreign residents
for a specific country (e.g., U.S.) over a specified period of
time (e.g., a quarter, year).Current Account: summary of flow
of funds due to purchases of goods or services (and the
provision of income on financial assets).Capital Account:
summary of flow of funds resulting from the sale of assets
between one specified country and all other countries over a
specified period of time.
Current AccountWhen speaking of the current account, we
are mainly referring to a country’s balance of trade in goods and
services. When a country exports more than it imports, it is said
to have a current account surplus (or, a trade surplus). When a
country imports more than it exports, it is said to have a current
account deficit (or, a trade deficit).
Capital (and Financial) AccountThe capital account
(technically, the “capital and financial accounts”) records
international flows related to investment.Direct foreign
investment: Foreign joint ventures, acquisitions, and
subsidiaries.Portfolio investment (i.e., cross-border purchase of
stocks and bonds).

U.S. capital account is typically in surplus: capital inflows into
the US from foreigners exceeds U.S. outflows abroad. Thus, we
are a net attractor of investment capital from the rest of the
world.
Investment, of course, has positive implications for the U.S.,
especially in the long-term.
The Balance of Payments IdentityIt is not a coincidence
that the U.S. current account is in deficit while the capital
account is in surplus. According to the balance of payments
identity:
Current Account = - Capital Account
Thus, when one is in surplus, the other is necessarily in deficit.
Explanation: when the U.S. receives more goods from
foreigners than we give them in return, we must make up the
difference by issuing them an “IOU” in the form of
securities.Example: Exports=50, Imports=75. To “pay” for the
excess of 25 in imported goods, issue securities worth 25.Thus,
Current Account = -Capital account = -25.
The fact that a current account deficit is balanced by a capital
account surplus (and vice versa) makes it hard to make a
definitive statement on whether a large trade deficit is
necessarily always good or bad.
The Balance of Payments IdentityAcademics and
policymakers:
We can run huge deficits for the time being, because
foreigners— in particular, foreign governments— are willing to
lend us huge sums. But one of these days the easy credit will
come to an end, and the United States will have to start paying
its way in the world economy.
Paul Krugman (2005)

My view is that the trade deficit is not a problem in itself but is
a symptom of a problem. The problem is low national saving.
Given that national saving is low, I am not eager for the trade
deficit to disappear, because that would mean that domestic
investment would need to fall to the low level of national
saving. But I do think it would be good if the trade deficit were
to disappear accompanied by an increase in national saving.
N. Gregory Mankiw (2006)
International TradeEvents that increased international
tradeRemoval of the Berlin WallSingle European Act of
1987North American Free Trade Agreement (NAFTA)General
Agreement on Tariffs and Trade (GATT)Inception of the
EuroExpansion of the European UnionOther Trade Agreements
International TradeTrade frictions and policy: although the
general trend is towards free trade, many countries/governments
have features or policies that differ with regard to international
business/trade. Some examples: Differences in environmental
restrictions NAFTA and cross-border truckingDifferences in the
acceptance of bribesWalmart in MexicoDifferences in labor
laws OSHA vs “sweatshops”Government subsidies For
agriculture/energy; national champions, etc.Tax breaksFor
exporters, companies that don’t outsource, etc.
International TradeFrictions/policy differences

con’t:Exchange rate policyGov’t controlled vs. market
basedOutsourcing See managerial decisions about outsourcing
in Madura.Using trade policies for security and political reasons
Sanctions against certain regimes/countries; prohibitions on
exporting “dual use” goods.Intellectual property
lawsPatent/copyright enforcement, ant-piracy measures.
Very good discussion on p. 43-47 in Madura; read
carefully.“The managers of each MNC cannot be responsible for
resolving international trade policy conflicts. However, they
should at least recognize how a particular international trade
policy affects their competitive position in the industry and how
changes to policy could affect their position in the future.”
International TradeFactors Affecting International Trade
Flows:Inflation: imports will increase relative to exports as
consumers and businesses will import more goods overseas (due
to high local prices). Current account is expected to decreases.
National Income: As a country’s income rises, consumption of
all goods, including foreign goods. The rise in imports is
expected to cause a decrease in the current account.
Government PoliciesSubsidies for exporters – allows firms to
produce at a lower costRestrictions on imports – tariffs and
quotasSee previous slide on frictions/policies
Exchange Rates: If US dollar strengthens, US consumers buy
more foreign goods, foreign consumers buy less US goods =>
CA declines towards deficit. If US dollar weakens => CA
increases towards surplus.Also see “…Correct a Balance-Of-
Trade Deficit” p. 49-51.
International Capital FlowsTwo main types of international
capital flows:Direct foreign investment (DFI): Joint ventures

with foreign firms, foreign acquisitions, foreign subsidiaries.As
a single nation, the Unites States is the largest initiator and
recipient of foreign direct investment.As a region, Europe is the
biggest initiator and recipient.
International portfolio investment: Buying and selling foreign
equity and debt securities.A large and ever-increasing portion of
exchange-rate transactions are being directed towards foreign
stocks.Explosive growth in foreign country ETFs.
Factors Affecting DFI Changes in RestrictionsSince the
1990s many countries have relaxed restrictions on foreign
ownershipPrivatizationThe selling of government-owned
assets/businesses to private companies (opposite of
nationalization or exporopriation).Potential Economic
GrowthNot surprisingly, large amount of DFI in emerging
markets.Tax RatesTax benefits for foreign investors (e.g.,
SEZs); Google’s “Double Irish”Exchange RatesMNCs prefer to
invest in countries where the local currency is expected to
strengthen against their own, which implies lower initial capital
outlays and higher future cash flows remittances.
Factors Affecting International Portfolio InvestmentTax
rates on Interest or DividendsInterest RatesHedge funds and
mutual funds are now engaged in global search for high yields.
Heavily engaged in the carry trade.The carry trade: borrow
currencies that have low interest rates (JPY) and buy currencies
with high interest rates (AUD).Exchange RatesIn addition to the
returns on foreign securities, international investors must be
cognizant of exchange rate movementsEx: If Sony stock
increases by 10 percent, but yen weakens by 15, then US dollar
return is (1+0.10)(1-0.15) – 1 = -0.065, or -6.5%.Thus, invest in
countries where local currency is expected to strengthen or use

currency derivatives to hedge exchange rate risk
Impact of International Flows on U.S. Interest RatesU.S.
relies heavily on foreign capital; as mentioned, we are a net
attractor of funds from around the world.Foreigners hold large
amounts of U.S. corporate and gov’t debt and own and operate
companies in the U.S.Foreign investors are attracted to the U.S.
because ofRelatively high interest rates compared to other
industrialized countries.Investment opportunities and high
returns: U.S. economy is world’s largest, high productivity and
technological innovation.Its reputation as safe-haven during
times of global crisis. Global investors seek a “safe harbor” for
their money in the U.S. (especially U.S. Treasuries, which are
considered risk free).The effect of all these foreign investment
flows into the U.S. is to increase the supply of funds in U.S.
credit markets, placing downward pressure on long-term U.S.
interest rates.
Agencies that Facilitate International Flows (p. 54-
57)International Monetary Fund (IMF)Established under the
Bretton Woods agreement of 1944 to oversee a post-war system
of fixed exchange rates. With freely-floating exchange rates,
role has come into question as of late.Especially important,
though, during international crises, e.g., Asian financial crisis
of 1997 and recent budget crises in Greece and Spain. IMF
bailouts come with unpopular strings attached: “austerity”
World BankA sister organization of the IMF. Provides long-
term loans to developing countries for infrastructure
projectsWorld Trade Organization (WTO)Bank for International
Settlements (BIS)Facilitates transaction b/w central banks;
“central banks’ central bank”Guidelines on the stability of

international financial institutions: Basel and Basel II accords
on bank capital adequacy requirements.G20 summit: Meeting of
central bankers and finance ministers from the world’s 20
largest economies to promote global financial stability and
economic growth.
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FIN 450 Prof. Chang
School of Business Administration Fall, 2016
University of Dayton
Take Home & Extra Credit I (10 pts)
Due November 22, 2016
Please complete Parts A and B below:
Part A: “Commanding Heights” , a documentary on the risks
and challenges faced by
the global economy and financial markets in the 21st century.
The video is available on
YouTube here:
https://www.youtube.com/watch?v=bSGAJTJzgLA
Please watch the following parts of this video:
Part I: From 0:00 minute mark to 28:00 minute mark.
Part II: From 48:00 minute mark to 1:20:10 minute mark .

The total time of these parts combined is roughly 1 hour. (I
highly encourage you to
watch the entire 2 hr video if you have time, but this is not
required).
Part B: "An open and shut case," a Special Report on the world
economy from The
Economist (October 1, 2016 issue). Please read the following
sections:
- "An open and shut case" (p.3-5)
- "The good, the bad and the ugly" (p.10-12).
- "The reset button" (p. 15-16)
(You are highly encouraged to read the entire article, but this is
not required).
Extra Credit (optional):
To receive extra credit, please complete the following questions
(1-2 pages typed):
1. List and describe four concepts -- two from the video and
two from the article --
that we covered in class that were discussed in detail in the
materials.
2. After watching this video and reading the article, what are
your thoughts on
globalization thus far, both in terms of finance and trade?
Discuss the pros and
cons as you see them. Going forward, do you agree/disagree
with (any of) the
three points for "fixing" globalization presented in "The reset
button"? Anything
you would add? Or, are we bound to see a decline in global

trade/finance with the
anti-global climate and sentiment that appears to be growing
recently? I am
interested to hear your thoughts.

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