Part 2 forum nexus finance class summer 2011

Brian Butler’s lecturesPart #2Welcome (to Spain, to Catalonia, to the EU, to FORUM-NEXUS!)

Brian David ButlerProfessor of international finance and global entrepreneurship with Forum-Nexus Study Abroad. Guest lecturer with the IQS Business School of the Ramon Llull University in Barcelona, and the Catholic University of Milan. Previously, Brian taught finance, economics and global trade courses at Thunderbird’s Global MBA program in Miami, and worked as a research analyst with the Columbia Business School in New York City. Brian currently lives in Recife, Brazil where he is teaching classes on “Global Entrepreneurship” at the university FBV.

A global citizen, Brian was born in Canada, raised in Switzerland (where he attended international British school), educated through university in the U.S., started his career with a Japanese company, moved to New York to work as an analyst, married a Brazilian, and has traveled extensively in Latin America, Asia, Europe and North America.

briandbutler@gmail.com

LinkedIn/briandbutler

Skype: briandbutler

Find my slides:

www.slideshare.net/briandbutler

Expectations:

▫Attend classes – exams will be from lectures, from assigned readings and from guest lecturers/ professional visits

▫Turn in assignments before class ▫Be prepared for class discussions – lots of small

group assignments during class▫Contribute to group assignment (team grading /

peer review)▫No sleeping, no laptops, no phones (sorry) ▫If your tired… standup, go get a drink, come back

review

•Discussion

1. Homework while in Spain…

•Be ready for class discussion on today…

•Each student –tell one thing about Spanish economy they noticed so far + class discuss

▫(source- wall street journal, other)

2. Professional visit review

•Banco Sabadell; most important in Catalonia

•What did you learn?•Any questions?

Quotes for discussion:

•When talking about the risks of global markets, he said …“money responds to fear… When political turmoil occurs… money disappears”

•Q. How does this relate to our discussion of the “dangers of international finance”? Of “portfolio money”?

Potential exam material – covered in professional visit:

•2 tier banking - Difference between “banks” like Santander and Sabadell…. and “savings banks” as relates to crisis

•Banking business model and fragility - Liquidity, Solvency (will discuss today)

•Regulation in Spain

3. Guest Lecture – yesterdayProf. Ricardo Ubeda, IQS

•What did you learn? •Questions?•Confusions?•(insults )

Discussion - Questions

•Q: Who are the “PIGS” of Europe? Why are they called this? What do they have in common?

•Q. When he said: “When I say Europe, I mean Germany”… what did he mean? Did it sound like Spanish might be upset? What is risk to Spain?

Discussion - Questions

•Q: He said that monetary policy set in Germany might not be appropriate for Spain (one suit jacket for all body sizes). Why is this a problem?

Discussion - Questions

•Q: He said that (for Spain, Greece, etc)… “the Euro is the problem”. Why?

Discussion - Questions

•Other questions?

Hedging examples

•Hedging FX risk

Core of our class:

•International finance = risk •We will outline those risks, and offer:•Tools to protect•Hedging techniques:

▫Forward, Futures, options, etc…▫tools to PROTECT (and potentially

speculate)

Small group exercises

•Break into groups of 2-3•Names on paper, keep notes today

•Turn in ALL problems at end of class (one page for group)

Terms you need to know….• Appreciation:

▫Currency gets STRONGER vs other

• Depreciation:▫Currency gets WEAKER vs other

USING USD/ EURO …. If todays rate is 1.4 dollars per euro… GIVE ME AN EXAMPLE OF USD “APPRECIATION” AND USD “DEPRECIATION”

Terms you need to know….• Appreciation:

▫ Currency gets STRONGER vs other▫ Example:

US Dollar Appreciates Goes from 2.0 USD per Euro to 1.0 USD per Euro

So, it takes LESS US dollars to buy one Euro Goes from 1 usd buys 0.5 Euro…. Now; 1 usd buys 1

Euro So, it 1 USD buys MORE Euros

• Depreciation:▫ Currency gets WEAKER vs other▫ Example:

US dollar Depreciates Goes from 1.0 USD per Euro to 2.0 USD per Euro

So, it takes MORE US dollars to buy one Euro

0 6 mo.

$R100k

Risk - in foreign currency•Example:

▫You are a German company… buying a container of furniture from Brazil (to resell at fixed prices in Germany)

▫You agree to pay 100,000 Reais (Brazilian currency) in 6 months to the Brazilian company

▫Assume the currency exchange rate is currently 2:1 (R$ to Euro)

▫How many Euros will you expect to pay in 6 months? (if FX doesn’t change)

0 6 mo.

$R100k

Risk - in foreign currency•Easy:

▫You expect to owe 100,000 / 2

▫= 50,000 Euros (if FX doesn’t change)

▫But what is the risk???▫(euro appreciates? Or depreciates?)▫(BRL appreciates? Or depreciates?)

Risk - in foreign currency

▫Forget the numbers for a minute…

▫Conceptually…You owe foreign currency in the future… What is your risk?

Risk - in foreign currency

•…if the exchange rate goes from 2:1 to 1:1

▫ You now need 100,000 Euros… (instead of 50,000 Euros…ouch!!!)

▫Question: how could you have avoided that risk?

Avoiding Risk

1. Don’t buy foreign goods (avoid risk)2. Negotiate contract so currency is based

in YOUR currency (transfer risk)3. How else?

Avoiding Risk – tools to use:

You could…1. Convert your money to R$ today…and deposit

that money in a Brazilian bank account (deposit hedge)… and pay the Brazilian supplier in 6 mo.

2. Contract with your bank to buy $R forward (sell Euros forward) in 6 months at a fixed rate (approx 2:1) for a fee (forward contract)

3. Buy Future contracts on exchange (if you can find them) to sell Euros forward

4. Buy Options contracts (most expensive, but with option to tear up, don’t execute trade) to sell Euros forward

•Key lesson of international finance:•Currencies change, so…

1. Danger in owing $$ in foreign currencies

* Solution: be aware, and hedge to protect!

Core of our class:

•International finance = risk •We will outline those risks, and offer:

•Tools to protect•Hedging techniques:

▫Forward, Futures, options, etc…▫tools to PROTECT (and potentially

speculate)

Another Hedging example

Hedging (to protect against risk)

Hedging foreign currency riskAssume… you are a US based company…

buying machinery from a company in Germany

▫You agree to pay 1mm Euros in 6 months▫Assume the currency exchange rate is

currently 1.25 USD for each 1 Euro

▫Team assignment:1. Assume the exchange rate, doesn’t change…

how many US dollars do you expect to pay in 6 months?

2. Draw it out…

Hedging foreign currency risk

Next question: In 10 words or less, describe “What is your currency risk”? (you could be harmed if WHAT happens?... Be specific!!)

0 6 mo.

US$ 1.25mm

Hedging foreign currency risk

▫Answer: Risk = US dollar will depreciate (Euro will

appreciate)… and you would owe more USD (for same bill in Euros)

You always owe 1mm Euros

•Next question: ▫Assume the exchange rate changes from

1.25 USD$ / Euro… and becomes 1. 5 USD$ / Euro… how many US dollars will you owe in 6 months?

Hedging foreign currency risk

•Example:

▫Answer: Instead of owing $US 1.25mm You would owe $US 1.5 mm

•Next question: ▫What could you do to avoid that risk?

0 6 mo.

US$ 1.25mm

0 6 mo.

US$ 1.5mm

Hedging foreign currency risk▫Answer:

1. Purchase from local US suppliers only (risk avoidance)

2. Change money to Euros today, deposit in Euro bank account, pay liability in 6 mo. (deposit hedge)

3. Contract with your bank - forward contract to sell dollars (buy Euros) forward in 6 months at specified rate (example , 1.25:1) + fees

4. Similar choices: futures, options, etc…

Question -

•Which do you think is the most expensive way (and least common) to hedge currency risk?