International Finance Final Exam 2022 with complete
solution
What's unique about international finance?
-foreign exchange risk
-political risk
-market imperfections
-expanded opportunity set
What is foreign exchange risk?
-foreign currency profits may decrease or evaporate in dollar terms due to
unanticipated, unfavorable exchange rate movements
-doesn't exist in a domestic setting
What is political risk?
-sovereign governments have the right to regulate the movement of goods, capital, and
people across their borders
-laws may change in unexpected ways
-changes in rules/regulations can change the value of your investment
What are market imperfections?
-legal restrictions on movement of goods, people, and money
-amplification of domestic issues
-transactions costs get heightened
-additional shipping costs
-tax systems vary around the world
What is an expanded opportunity set?
-take advantage of growth opportunities in foreign markets (especially if local markets
have become saturated)
-must adapt to other legal, institutional, and cultural environments
What are common goals for international finance?
-most developed economics have shareholder wealth maximization while developing
have stakeholder
-no matter the other goals, they cannot be achieved in the long term if the maximization
of shareholder wealth is not given due consideration
What are some trends in the globalization of the world economy?
-trade liberalization and economic integration
-emergence of globalized financial markets
-privatization
What is trade liberalization and economic integration as a trend in the
globalization of the world economy?
-international trade has increased about twice as fast as world GDP
-increased spillover effects (crisis in one market spills over to another market) from
foreign markets: can be economic, supply chain, political, positive or negative
What is emergence of globalized financial markets as a trend in the globalization
of the world economy?
-deregulation of financial markets & advances in technology
-reduced information and transaction costs
,-innovations: currency futures & options, multi currency bonds, cross border stock
listings, international mutual funds
What is privatization as a trend in the globalization of the world economy?
-selling of state run enterprises to investors known as denationalization
-increases the efficiency of the enterprise
-goal is to raise revenue
What is a multinational corporation?
-firm incorporated in one country with production and sales operations in other countries
-obtain raw materials from one nation, financial capital from another, produce goods in a
3rd country, and sell output in various other national markets
What is the key issue with governance and the public corporation?
-conflict of interest between managers & shareholders
-management friendly insiders dominate the board of directors with few outsiders who
can monitor the management
What is a public corporation?
-an efficient risk sharing mechanism that allows corporations to raise large amounts of
capital
-redistribution of risk
-shareholders benefits from their investment in the company
What happened with Enron in regards to governance and the public corporation
issue?
-the board of directors failed to safeguard shareholder interests
-significant agency problem
-free rider problem
What is the agency problem?
-shareholders allocate decision making to managers
-many shareholders are not qualified to make complex business decisions or have the
time
-managers often act in their short term best interest instead of the shareholder's long
term best interest
What are the remedies for the agency problem?
-US: shareholders have the right to elect the board of directors
-if the board remains independent of management, it can serve as an effective
mechanism for curbing the agency problem (the board can serve as a referee looking at
the process and decisions)
-concentrated ownership
What is the corporate board like in Germany?
-not legally charged with representing the interests of shareholders
-representing the interests of stakeholders as well as shareholders
What is the corporate board like in Japan?
-insider dominated
-concerned with the welfare of the keiretsu to which the company belongs
What is most important in corporate board interests?
-shareholder interests
-if you lose shareholders then you lose investment and company growth
What are the issues with incentive contracts?
, -difficult to design compensation giving executives incentive to work hard at increasing
shareholder wealth
-accounting based schemes are subject to manipulation
What is the outcome of stock options as an incentive contract?
-managers are more likely to take riskier bets because they are more likely to get
money
-if they are longer term (increased maturity) then this offsets the short term manipulation
to make them more valuable to management
What are executive stock options?
-exist to align the interests of shareholders and managers
-call options on the employer's shares
-inalienable: can't be sold
-typical maturity: 10 years
-typical vesting: 3 years
Where is concentrated ownership common?
everywhere in the world except the US and UK
What can have a major disciplinary effect on managers? How?
-borrowing (debt)
-motivating them to curb private perquisites and wasteful investments
-trim bloated organizations
-if managers fail to pay interest and principal then the company can be forced into
bankruptcy
Why do companies list their stock overseas?
-countries with weak investor protection can bond themselves credibly to better investor
protection by listing in countries with strong investor protection
-results in more transparency and greater value
-essentially the company has to follow the standards and share information of the
country with greater protection
What happens if the management team is out of control over time?
-share price will decline
-eventually a corporate raider will buy enough shares to gain control of the board
-fire managers & turn the firm around or sell it
What are the economic consequences of protection of investors' rights?
-the pattern of corporate ownership and valuation
-development of capital markets
-economic growth
What type of law is most beneficial to shareholders? least?
-most: English common law
-least: French and German
How do companies combat a country with weak investor protection? What are the
consequences?
-concentrated ownership as a substitute for legal protection
-consequences: large shareholders can abuse smaller shareholders
What does investor protection promote?
-development of external capital markets
-when investors are assured of receiving fair returns they will be willing to pay more
solution
What's unique about international finance?
-foreign exchange risk
-political risk
-market imperfections
-expanded opportunity set
What is foreign exchange risk?
-foreign currency profits may decrease or evaporate in dollar terms due to
unanticipated, unfavorable exchange rate movements
-doesn't exist in a domestic setting
What is political risk?
-sovereign governments have the right to regulate the movement of goods, capital, and
people across their borders
-laws may change in unexpected ways
-changes in rules/regulations can change the value of your investment
What are market imperfections?
-legal restrictions on movement of goods, people, and money
-amplification of domestic issues
-transactions costs get heightened
-additional shipping costs
-tax systems vary around the world
What is an expanded opportunity set?
-take advantage of growth opportunities in foreign markets (especially if local markets
have become saturated)
-must adapt to other legal, institutional, and cultural environments
What are common goals for international finance?
-most developed economics have shareholder wealth maximization while developing
have stakeholder
-no matter the other goals, they cannot be achieved in the long term if the maximization
of shareholder wealth is not given due consideration
What are some trends in the globalization of the world economy?
-trade liberalization and economic integration
-emergence of globalized financial markets
-privatization
What is trade liberalization and economic integration as a trend in the
globalization of the world economy?
-international trade has increased about twice as fast as world GDP
-increased spillover effects (crisis in one market spills over to another market) from
foreign markets: can be economic, supply chain, political, positive or negative
What is emergence of globalized financial markets as a trend in the globalization
of the world economy?
-deregulation of financial markets & advances in technology
-reduced information and transaction costs
,-innovations: currency futures & options, multi currency bonds, cross border stock
listings, international mutual funds
What is privatization as a trend in the globalization of the world economy?
-selling of state run enterprises to investors known as denationalization
-increases the efficiency of the enterprise
-goal is to raise revenue
What is a multinational corporation?
-firm incorporated in one country with production and sales operations in other countries
-obtain raw materials from one nation, financial capital from another, produce goods in a
3rd country, and sell output in various other national markets
What is the key issue with governance and the public corporation?
-conflict of interest between managers & shareholders
-management friendly insiders dominate the board of directors with few outsiders who
can monitor the management
What is a public corporation?
-an efficient risk sharing mechanism that allows corporations to raise large amounts of
capital
-redistribution of risk
-shareholders benefits from their investment in the company
What happened with Enron in regards to governance and the public corporation
issue?
-the board of directors failed to safeguard shareholder interests
-significant agency problem
-free rider problem
What is the agency problem?
-shareholders allocate decision making to managers
-many shareholders are not qualified to make complex business decisions or have the
time
-managers often act in their short term best interest instead of the shareholder's long
term best interest
What are the remedies for the agency problem?
-US: shareholders have the right to elect the board of directors
-if the board remains independent of management, it can serve as an effective
mechanism for curbing the agency problem (the board can serve as a referee looking at
the process and decisions)
-concentrated ownership
What is the corporate board like in Germany?
-not legally charged with representing the interests of shareholders
-representing the interests of stakeholders as well as shareholders
What is the corporate board like in Japan?
-insider dominated
-concerned with the welfare of the keiretsu to which the company belongs
What is most important in corporate board interests?
-shareholder interests
-if you lose shareholders then you lose investment and company growth
What are the issues with incentive contracts?
, -difficult to design compensation giving executives incentive to work hard at increasing
shareholder wealth
-accounting based schemes are subject to manipulation
What is the outcome of stock options as an incentive contract?
-managers are more likely to take riskier bets because they are more likely to get
money
-if they are longer term (increased maturity) then this offsets the short term manipulation
to make them more valuable to management
What are executive stock options?
-exist to align the interests of shareholders and managers
-call options on the employer's shares
-inalienable: can't be sold
-typical maturity: 10 years
-typical vesting: 3 years
Where is concentrated ownership common?
everywhere in the world except the US and UK
What can have a major disciplinary effect on managers? How?
-borrowing (debt)
-motivating them to curb private perquisites and wasteful investments
-trim bloated organizations
-if managers fail to pay interest and principal then the company can be forced into
bankruptcy
Why do companies list their stock overseas?
-countries with weak investor protection can bond themselves credibly to better investor
protection by listing in countries with strong investor protection
-results in more transparency and greater value
-essentially the company has to follow the standards and share information of the
country with greater protection
What happens if the management team is out of control over time?
-share price will decline
-eventually a corporate raider will buy enough shares to gain control of the board
-fire managers & turn the firm around or sell it
What are the economic consequences of protection of investors' rights?
-the pattern of corporate ownership and valuation
-development of capital markets
-economic growth
What type of law is most beneficial to shareholders? least?
-most: English common law
-least: French and German
How do companies combat a country with weak investor protection? What are the
consequences?
-concentrated ownership as a substitute for legal protection
-consequences: large shareholders can abuse smaller shareholders
What does investor protection promote?
-development of external capital markets
-when investors are assured of receiving fair returns they will be willing to pay more
