Encyclopedic Dictionary of International Finance and Banking Phần 7 pptx

MNCs with assets and liabilities in more than one foreign currency may try to Cash Flows Year MONETARY APPROACH SL2910_frame_CM.fm Page 194 Thursday, May 17, 2001 9:06 AM... For example,

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EXAMPLE 78

Assume the following:

Computing IRR and NPV at 10% gives the following different rankings:

The difference in ranking between the two methods is caused by the methods’ reinvestment rate assumptions The IRR method assumes Project A’s cash inflow of $120 is reinvested at 20% for the subsequent 4 years and the NPV method assumes $120 is reinvested at 10% The correct decision is to select the project with the higher NPV (Project B), since the NPV method assumes

a more realistic reinvestment rate, that is, the cost of capital (10% in this example).

To calculate Project A’s MIRR, first, compute the project’s terminal value at a 10% cost of capital

120 T1(10%, 4 years) = 120 × 1.4641 = 175.69 Next, find the IRR by setting:

Now we see the consistent ranking from both the NPV and MIRR methods as shown above.

Note: Microsoft Excel has a function MIRR(values, finance_rate, reinvest_rate)

See also INTERNAL RATE OF RETURN; NET PRESENT VALUE

MONETARY APPROACH

See ASSET MARKET MODEL

MONETARY ASSETS AND LIABILITIES

See MONETARY BALANCE

MONETARY BALANCE

Monetary balance refers to minimizing accounting exposure It involves avoiding either a netreceivable or a net payable position If an MNC had net positive exposure (more monetaryassets than liabilities), it could use more financing from foreign monetary sources to balancethings out MNCs with assets and liabilities in more than one foreign currency may try to

Cash Flows Year

MONETARY APPROACH

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reduce risk by balancing off exposure in the different countries Often, the monetary balance

is practiced across several countries simultaneously Monetary assets and liabilities are those

items whose value, expressed in local currency, does not change with devaluation or

revalu-ation They are listed in Exhibit 80

A firm’s monetary balance can be looked at in terms of a firm’s position with regard to

real assets For example, the basic balance sheet equation can be written as follows:

Monetary assets + Real assets = Monetary liabilities + Equity

EXAMPLE 79

Consider the following two cases:

Firm A is a monetary creditor because its monetary assets exceed its monetary liabilities; its

net worth position is negative with respect to its investment coverage of net worth by real assets.

In contrast, Firm B is a monetary debtor because it has monetary liabilities that exceed its

monetary assets; its net worth coverage by investment in real assets is positive Thus, the monetary

creditor can be referred to as a firm with a negative position in real assets, and the monetary

debtor as a firm with a positive position in real assets Exhibit 81 summarizes these equivalent

relationships.

EXHIBIT 80 Monetary Assets and Liabilities

Prepaid insurance

Monetary Assets +

Real Assets =

Monetary Liabilities +

Equity (Net Worth)

EXHIBIT 81

Monetary Creditor versus Monetary Debitor

Firm A (Long position Monetary Monetary assets Negative position Balance of receipts

in foreign creditor exceed monetary in real assets in foreign currency

currency is positive

Firm B (Short position Monetary Monetary liabilities Positive position Balance of receipts in

in foreign debtor exceed monetary in real assets foreign currency less

currency is negative

MONETARY BALANCE

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Thus, if Firm A has a long position in a foreign currency, on balance it will be receiving

more funds in foreign currency, or it will have a net monetary asset position that exceeds its

monetary liabilities in that currency The opposite holds for Firm B, which is in a short position

with respect to a foreign currency Hence the analysis with respect to a firm with net future

receipts or net future obligations can be applied also to a firm’s balance sheet position A firm

with net receipts is a net monetary creditor Its foreign exchange rate risk exposure is

vulnerable to a decline in value of the foreign currency On the contrary, a firm with future

net obligations in foreign currency is in a net monetary debtor position The foreign exchange

risk exposure it faces is the possibility of an increase in the value of the foreign currency

In addition to the specific actions of hedging in the forward market or borrowing and lending

through the money markets, other business policies can help the firm achieve a balance sheet

position that minimizes the foreign exchange rate risk exposure to either currency devaluation

or currency revaluation upward Specifically, in countries whose currency values are likely to

fall, local management of subsidiaries should be encouraged to follow these policies:

1 Never have excessive idle cash on hand If cash accumulates, it should be used to

purchase inventory or other real assets

2 Attempt to avoid granting excessive trade credit or trade credit for extended periods

If accounts receivable cannot be avoided, an attempt should be made to chargeinterest high enough to compensate for the loss of purchasing power

3 Wherever possible, avoid giving advances in connection with purchase orders

unless a rate of interest is paid by the seller on these advances from the time thesubsidiary—the buyer—pays them until the time of delivery, at a rate sufficient tocover the loss of purchasing power

4 Borrow local currency funds from banks or other sources whenever these funds

can be obtained at a rate of interest no higher than U.S rates adjusted for theanticipated rate of devaluation in the foreign country

5 Make an effort to purchase materials and supplies on a trade credit basis in the

country in which the foreign subsidiary is operating, extending the final date ofpayment as long as possible

The reverse polices should be followed in a country where a revaluation upward in foreign

currency values is likely to transpire All these policies are aimed at a monetary balance position

in which the firm is neither a monetary debtor nor a monetary creditor Some MNCs take a

more aggressive position They seek to have a net monetary debtor position in a country

whose exchange rates are expected to fall and a net monetary creditor position in a country

whose exchange rates are likely to rise

See also CURRENCY RISK MANAGEMENT; TRANSLATION EXPOSURE

MONETARY/NONMONETARY METHOD

The monetary/nonmonetary method is a translation method that applies the current exchange

rate to all monetary assets and liabilities, both current and long term, while all other assets

(physical, or nonmonetary, assets) are translated at historical rates In contrast with the

current/noncurrent method,this method rewards holding of physical assets under devaluation

See also CURRENT RATE METHOD; CURRENT/NONCURRENT METHOD;

TEMPO-RAL METHOD

MONEY-MARKET HEDGE

Also called credit-market hedge, a money-market hedge is a hedge in which the exposed

position in a foreign currency is offset by borrowing or lending in the money market It

basically calls for matching the exposed asset (accounts receivable) with a liability (loan

MONETARY/NONMONETARY METHOD

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payable) in the same currency An MNC borrows in one currency, invests in the money

market, and converts the proceeds into another currency Funds to repay the loan may be

generated from business operations, in which case the hedge is covered Or funds to repay

the loan may be purchased in the foreign exchange market at the spot rate when the loan

matures, which is called an uncovered or open edge The cost of the money-market hedge is

determined by differential interest rates

EXAMPLE 80

XYZ, an American importer enters into a contract with a British supplier to buy merchandise

for £4,000 The amount is payable on the delivery of the good, 30 days from today The company

knows the exact amount of its pound liability in 30 days However, it does not know the payable

in dollars Assume that the 30-day money-market rates for both lending and borrowing in

the U.S and U.K are 5% and 1%, respectively Assume further that today’s foreign exchange

rate is $1.50/£ In a money-market hedge, XYZ can make any of the following choices:

1 Buy a one-month U.K money-market security, worth £4,000/(1 + 005) = £3,980.00 This

investment will compound to exactly £4,000 in one month.

2 Exchange dollars on today’s spot (cash) market to obtain the £3,980 The dollar amount

needed today is £3,980.00 × $1.50/£ = $5,970.00.

3 If XYZ does not have this amount, it can borrow it from the U.S money market at the going

rate of 1% In 30 days XYZ will need to repay $5,970.00 × (1 + 01) = $6,029.70.

Note: XYZ need not wait for the future exchange rate to be available On today’s date, the

future dollar amount of the contract is known with certainty The British supplier will receive

£4,000, and the cost of XYZ to make the payment is $6,029.70

MONEY MARKETS

Money markets are the markets for short-term (less than 1 year) debt securities Examples

of money-market securities include U.S Treasury bills, federal agency securities, bankers’

acceptances, commercial paper, and negotiable certificates of deposit issued by government,

business, and financial institutions

See FINANCIAL MARKETS

MORGAN GUARANTY DOLLAR INDEX

See CURRENCY INDEXES; DOLLAR INDEXES

MORGAN STANLEY CAPITAL INTERNATIONAL EUROPE, AUSTRALIA,

FAR EAST INDEX

See EAFE INDEX

MORGAN STANLEY EAFE INDEX

See EAFE INDEX

MULTIBUYER POLICY

See EXPORT-IMPORT BANK

MULTICURRENCY CROSS-BORDER CASH POOLING

Multicurrency cross-border cash pooling allows a facility to notionally offset debit balances

in one currency against credit balances in another For example, a corporation with credit

balances in British pounds and debit balances in German marks and French francs can use

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pooling to offset the debit and credit balances without the administrative burden of physicallymoving or converting currencies The concept of centralized cash pooling is to offset debitand credit balances within a currency and among different currencies without converting thefunds physically Without a centralized pooling system, local subsidiaries lose interest oncredit balances or incur higher interest expense on debit balances due to the high margins

on interest rates usually taken by local banks In many cases, credit balances in foreign currencyaccounts do not earn interest Through centralized pooling, cash-rich entities pledge theirbalances so that entities that need to overdraw their cash pool accounts can do so Credits inone currency may be used to offset debits in another prior to interest calculations—a strategythat often decreases the net amounts borrowed and increases interest yields The multicurrencysystem is managed per account on a daily basis Pooling is based on a zero-balance con-cept—the volume of credit balances equals the volume of debit balances When the overallposition of all the cash pool accounts is zero or positive, the subsidiaries that are in an

overdraft position will actually borrow at credit interest terms Note: Cash pooling does not

eliminate natural interest rate differences between currencies, but it does eliminate the margins

on debit balances, thus reducing borrowing costs Exhibit 82 summarizes goals of the system

The following example illustrates both the advantages of cash pooling and the return edgeprovided by a multicurrency approach

EXAMPLE 81

Assume that three subsidiaries operating in Australia, the United Kingdom, and the United States maintain multicurrency accounts in the pool Each has signed an offset agreement with its Amsterdam-based pooling bank The U.K company has a local non-interest-bearing DM account The interbank interest rates are 7.5% for Australian dollars, 4.25% for Deutsche marks, and 5.5% for U.S dollars The Australian company’s excess funds in A$ are transferred to its pooling account The U.K company has a receivable in DM and has instructed the payor to make the payment directly to its DM pooling account These pooled credit balances allow other pool members to overdraft their accounts in their preferred currency For example, the U.S pooling participant can overdraft its US$ account the countervalue of the available pool balance for investment Because the overall pooled balance is positive, the pooling mechanism applies credit conditions to all balances in the pool, including debit balances Consequently, borrowings from the pool are charged interest at credit rates The positive effect of the pooling is apparent for the U.K company, which earns interest on its DM balance at 4.25% Without pooling, no interest would have been earned Additionally, the U.S company can borrow from the pool at a rate of 5.5%, which is a credit interest rate.

See also FUTURES

EXAMPLE 83

Suppose that the 3-month forward rate for the French franc is $0.1457 per FFr However, if the French franc devalues over the next three months to, say $0.1357/FFr, the forward contract holder will have an opportunity cost of the difference between the forward rate and the (eventual) future spot rate (a difference of $0.01/FFr, or 6.4%).

2 Net benefit lost by rejecting some alternative course of action Its significance in decisionmaking is that the best decision is always sought, as it considers the cost of the bestavailable alternative not taken The opportunity cost does not appear on formal account-ing records

EXAMPLE 84

If $1 million can be invested in a Euro-commercial paper (Euro-P or EUP) earning 9%, the opportunity cost of using that money for a particular business venture would be computed to be

$90,000 ($1 million × 09).

OPTIMUM CURRENCY AREA

The optimum currency area is the best area within which exchange rates are fixed and betweenwhich exchange rates are flexible It is the region characterized by relatively inexpensivemobility of the factors of production (capital and labor)

OPTION

An option is a contract to give the investor the right—but not the obligation—to buy or sellsomething It has three main features It allows you, as an investor to “lock in”: (1) aspecified number of shares of stock, (2) at a fixed price per share, called strike or exercise

OLD ECONOMY VERSUS NEW ECONOMY

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price, (3) for a limited length of time For example, if you have purchased an option on astock, you have the right to “exercise” the option at any time during the life of the option.This means that, regardless of the current market price of the stock, you have the right tobuy or sell a specified number of shares of the stock at the strike price (rather than thecurrent market price) Options possess their own inherent value and are traded in secondary markets You may want to acquire an option so that you can take advantage of an expectedrise in the price of the underlying stock Option prices are directly related to the prices ofthe common stock to which they apply Investing in options is very risky and requiresspecialized knowledge Options may be American style (i.e., they can be exercised at anytime up to the expiration date) or European style (i.e., exercisable only at maturity) Almostall exchange traded options are American style; over-the-counter may be either American

or European style, but are often European

All options are divided into two broad categories: calls and puts A call option gives youthe right (but not the obligation) to buy:

1 100 shares of a specific stock,

2 at a fixed price per share, called the strike or exercise price,

3 for up to 9 months, depending on the expiration date of the option

When you purchase a call, you are buying the right to purchase stock at a set price Youexpect price appreciation to occur You can make a sizable gain from a minimal investment,but you may lose all your money if the stock price does not go up

EXAMPLE 85

You purchase a 3-month call option on Dow Chemical stock for $4 1/2 at an exercise price of

$50 when the stock price is $53.

On the other hand, a put option gives you the right to sell (and thus force someone else

to buy):

1 100 shares of a specific stock,

2 at a fixed price, the strike price,

3 for up to 9 months, depending on the expiration date of the option

Purchasing a put gives you the right to sell stock at a set price You buy a put if you expect

a stock price to fall You have the chance to earn a considerable gain from a minimal investment,but you lose the whole investment if price depreciation does not materialize The buyer of thecontract (called the holder) pays the seller (called the writer) a premium for the contract Inreturn for the premium, the buyer obtains the right to buy securities from the writer or sellsecurities to the writer at a fixed price over a stated period of time

Option Holder = Option Buyer = Long PositionOption Writer = Option Seller = Short Position

Buy (long)

The right to call (buy) from the writer

The right to put (sell) to the writer

Sell (short)

Known as writing a call,

being obligated to sell if called

Known as writing a put, if the stock or contract is put

OPTION

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Calls and puts are typically for widely held and actively traded securities on organizedexchanges With calls there are no voting privileges, ownership interest, or dividend income.However, option contracts are adjusted for stock splits and stock dividends

Calls and puts are not issued by the company with the common stock but rather by optionmakers or option writers The maker of the option receives the price paid for the call or putminus commission costs The option trades on the open market Calls and puts are writtenand can be acquired through brokers and dealers The writer is required to purchase or deliverthe stock when requested

Holders of calls and puts do not have to exercise them to earn a return They can tradethem in the secondary market for whatever their value is The value of a call increases as theunderlying common stock goes up in price The call can be sold on the market before itsexpiration date

A More on the Terms of an Option

There are three key terms with which you need to be familiar in connection with options:the exercise or strike price, expiration date, and option premium The exercise price for acall is the price per share for 100 shares, at which you may buy For a put, it is the price atwhich the stock may be sold The purchase or sale of the stock is to the writer of the option.The striking price is set for the life of the option on the options exchange When stock pricechanges, new exercise prices are introduced for trading purposes reflecting the new value

In case of conventional calls, restrictions do not exist on what the striking price should

be However, it is usually close to the market price of the stock to which it relates But inthe case of listed calls, stocks having a price lower than $50 a share must have striking prices

in $5 increments Stocks between $50 and $100 must have striking prices in $20 increments.Striking prices are adjusted for material stock splits and stock dividends

The expiration date of an option is the last day it can be exercised For conventional options, theexpiration date can be any business day; for a listed option there is a standardized expiration date.The cost of an option is referred to as a premium It is the price the buyer of the call orput has to pay the seller (writer) In other words, the option premium is what an option costs

to you as a buyer Note: With other securities, the premium is the excess of the purchaseprice over a determined theoretical value

B Why Do Investors Use Options?

Why use options? Reasons can vary from the conservative to the speculative The most commonreasons are:

1 You can earn large profits with leverage, that is, without having to tie up a lot ofyour own money The leverage you can have with options typically runs 20:1 (eachinvestor dollar controls the profit on twenty dollars of stock) as contrasted withthe 2:1 leverage with stocks bought on margin or the 1:1 leverage with stocks boughtoutright with cash Note: Leverage is a two-edge sword You can lose a lot, too That

is why it is a risky derivative instrument

2 Options may be purchased as “insurance or hedge” against large price drops inunderlying stocks already held by the investor

3 If you are neutral or slightly bullish in the short term on stocks you own, you cansell (or write) options on those stocks and realize extra profit

4 Options offer a range of strategies that cannot be obtained with stocks Thus,options are a flexible and complementary investment vehicle to stocks and bonds

C How Do You Trade Options?

Options are traded on listed option exchanges (secondary markets) such as the Chicago Board Options Exchange, American Stock Exchange, Philadelphia Stock Exchange, and Pacific Stock Exchange They may also be exchanged in the over-the counter (OTC) market Option exchanges

OPTION

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are only for buying and selling call and put options Listed options are traded on organizedexchanges Conventional options are traded in the OTC market The Options Clearing Corporation (OCC) acts as principal in every options transaction for listed options contracts As principal itissues all listed options, guarantees the contracts, and is the legal entity on the other side of everytransaction Orders are placed with this corporation, which then issues the calls or closes the position.Because certificates are not issued for options, a brokerage account is required When an investorexercises a call, he goes through the Clearing Corporation, which randomly selects a writer from

a member list A call writer is obligated to sell 100 shares at the exercise price Exchanges permitgeneral orders (i.e., limit) and orders applicable only to the option (i.e., spread order)

D How Do You Use Profit Diagrams?

In order to understand the risks and rewards associated with various option strategies, it isvery helpful to understand how the profit diagram works In fact, this is essential for under-standing how an option works The profit diagram is a visual portrayal of your profit in relation

to the price of a stock at a single point in time

EXAMPLE 86

The following shows the profit diagram for 100 shares of Nokia stock if you bought them today

at $80 per share and sold them in 3 months (Commissions are ignored in this example.)

Nokia Stock Price in

3 months

Profit (Loss)

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Note that all stocks have the same shape on the profit diagram at any point in the future You

will later see that this is not the case with options.

EXAMPLE 87

Assume that on April 7, you become convinced that Nokia stock which is trading at $80 a share

will move considerably higher in the next few months So, you buy one call option on Nokia

stock with a premium of $2 a share Since the call option involves a block of 100 shares of stock,

it costs you a total of $2 times 100 shares or $200 Assume further that this call option has a

striking price of $85 and an expiration date near the end of September What this means is that

for $200 you have the right to buy:

1 100 shares of Nokia stock

2 at $85 a share

3 until near the end of September.

This may not sound like you are getting much for $200, but if Nokia stock goes up to $95 a

share by the end of September, you would have the right to purchase 100 shares of Nokia stock

for $8500 ($85 times 100 shares) and to turn right around and sell them for $9500, keeping the

difference of $1000, an $800 profit That works out to 400% profit in less than five months.

However, if you are wrong and Nokia stock goes down in price, the most you could lose would

be the price of the option, $200 The following displays the profit table for this example.

The profit diagram will look like this:

You are “long 1 Nokia Sep 85 call” option.

Notice where the profit line bends—at $85, unlike stocks that have the same shape on the profit

diagram at any point in the future This is not the case with options You start making money

after the price of Nokia stock goes higher than the $85 striking price of the call option When

this happens, the option is called “in-the-money.”

If the Nokia Stock Price

in Sep Turns Out to be:

The Value of the Call Option would be:

And Your Profit could be:

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On the other hand, the profit diagram for a put option looks like this:

So, a put is typically used by an investor who is bearish on that particular stock The put option can

also be used as “insurance” against price drops for the investor with a long stock position.

E How Much Does an Option Cost?

The premium for an option (or cost of an option) depends primarily on:

• Fluctuation in price of the underlying security (A higher variability means a higher

premium because of the greater speculative appeal of the option.)

• Time period remaining before the option’s expiration (The more time there is until

the expiration, the greater the premium you must pay the seller.)

• Price spread between the stock compared to the option’s strike price (A wider

difference translates to a higher price.)

EXAMPLE 88

ABC stock is selling at $32 a share today Consider two options: (1) Option X gives you the

right to buy the stock at $25 per share and (2) Option Y gives you the right to buy the stock at

$40 per share Because you would rather have an option to pay $25 for a $32 stock instead of

$32, Option X is more valuable than Option Y Thus, it will cost you more to buy Option X than

to buy Option Y.

Other factors that determine the cost of an option are:

• The dividend trend of the underlying security

• The volume of trading in the option

• The exchange the option is listed on

• “Going” interest rates

• The market price of the underlying stock

F In-the-Money and Out-of-the-Money Call Options

Options may or may not be exercised, depending on the difference between the market price

of the stock and the exercise price

Let P= the price of the underlying stock and S= the exercise price

There are three possible situations:

1 If P > X or P−X > 0, then the call option is said to be in the money. (By exercising

the call option, you, as a holder, realize a positive profit, P−X.) The value of thecall in this case is:

Value of call = (market price of stock – exercise price of call) × 100

OPTION

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2 If P−X = 0, then the option is said to be at the money.

3 If P − X < 0, then the option is said to be out of the money It is unprofitable The

option holder can purchase the stock at the cheaper price in the market rather thanexercising the option and thus the option is thrown away Out-of-the-money calloptions have no intrinsic value

If the total premium (option price) of an option is $14 and the intrinsic value is $6, there

is an additional premium of $8 arising from other factors Total premium is composed of the

intrinsic value and time value (speculative premium) based on variables such as risk, expected

future prices, maturity, leverage, dividend, and fluctuation in price

Total premium = intrinsic value + time value (speculative premium)

Intrinsic value = In-the-money option (i.e., P − S > 0 for a call and S − P > 0 for a put

option) For in-the-money options, time value is the difference between premium and intrinsic

value For other options all value is time value Exhibit 83 shows the time value and intrinsic

value associated with a call option

G In-the-Money and Out-of-the-Money Put Options

A put option on a common stock allows the holder of the option to sell (put) a share of the

underlying stock at an exercise price until an expiration date The definition of in-the-money

and out-of-the-money are different for puts because the owner may sell stock at the strike

price For a put option, the option is in the money if P − X < 0

Its value is determined as follows:

Value of put = (exercise price of put – market price of stock) × 100

And the option is out of the money when P − X > 0 and has no value.

EXAMPLE 89

Assume a stock has a market price of $100 and a strike price of the put is $116 The value of

the put is $1,600 If market price of stock exceeds strike price, an out-of-the money put exists.

EXHIBIT 84 Time Value and a Call Option

Tiêu đề	Monetary Approach
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