Monday, May 19, 2014

Jacque, International Corporate Finance

Laurent L. Jacque, Walter B. Wriston Professor of International Finance & Banking at the Fletcher School, has written a first-rate textbook, appropriate for both the classroom and self-study. Investors would do well to put aside some time to read and learn from it. I suspect it will fill in some crater-sized gaps in their (I’m loath to make this personal and use the pronoun “your”) understanding of investing in the global economy.

At over 700 pages International Corporate Finance: Value Creation with Currency Derivatives in Global Capital Markets (Wiley, 2014) may appear to be a daunting book, best left to aspiring CFOs. But it’s eminently readable.

The book is divided into six parts: the international monetary environment, the foreign exchange market and currency derivatives, international financing, managing foreign exchange risk, cross-border valuation and foreign investment analysis, and managing the multinational financial system. Each chapter concludes with questions for discussion, references, and (in most cases) problems.

Let’s look very briefly at a single issue that is dealt with in the book: currency hedging. We often hear multinational corporations cite foreign currency headwinds as a reason for suboptimal performance. How should these firms handle their foreign currency exposure?

This question is the theme of the fourth part of the book, which “develops a risk-management framework and offers operational guidelines within which currency risk can be (1) consistently hedged across different risk situations and over time, (2) tightly integrated with other types of financial risk such as interest rate and commodity price risk, and (3) managed consistently with the firm’s overall strategic plans so that the financial engineering dimensions of risk hedging are fully integrated with strategic management.” (pp. 399-400) No mean feat.

What benefits does the corporation gain from hedging its currency risk? Jacque suggests that hedging lowers the cost of financial distress, decreases taxes, reduces agency costs between shareholders and managers, and decreases the firm’s cost of capital. But currency hedging, to the extent that it is “associated with surgical strikes aimed at neutralizing exposure to foreign exchange risk through a forward contract, a currency swap, or some fancy currency derivatives,” is not an end in itself. Moreover, since no one can forecast exchange rates with great accuracy, making individual currency hedging bets cannot be a stand-alone solution. Rather, hedging “is best embedded in a year-round and year-in, year-out management process, which is far more than the case-by-case use of derivative instruments to neutralize specific transaction, translation, or economic exposures.” (p. 407)

Once upon a time I had a fleeting thought that I would make a good CFO. As this book clearly demonstrates, I was wise to let that thought go. But, even investors have to deal with some of the same issues as the CFO of a global company, albeit on a smaller scale. Which makes this book a valuable guide for them as well. So dig in!

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