Course Description

The course covers essential elements of international financial risk management with an emphasis on emerging markets. We discuss several outstanding problems of international financial management, including political risk, currency crisis, speculative craze, market manipulation, different accounting rules, cost of capital for international investment, and risk management. We will also cover currency hedging, international securities valuation, portfolio diversification, various derivatives instruments, different asset allocation and securities selection strategies, and international capital budgeting. The objective here is to train highly skilled financial analysts and managers with strong theoretical background and practical knowledge in international finance. 

Prerequisites Finance core courses for MBA

Textbooks:

1. Richard Levich, International Financial Markets, Irwin, 1998

2. Malkiel and Mei, Global Bargain Hunting (Simon and Schuster 1998).

Internet Resources:

1. J.P. Mei's "Emerging Market Finance" Supersite at http://www.stern.nyu.edu/~jmei/
 
It is most important that students keep up to date with the reading for the course. The closed-book midterm and final examination questions will be taken from the readings that appear in the Syllabus and from graded assignments that are distributed on a regular basis. Most readings will be assigned through my international finance website. There will he a midterm (30%), a final examination (30%), and several assignments (40%). The final exam will not be cumulative except it may require conceptual knowledge from the first half of the quarter.

2. PPT

3. Sample Mid-term
 
Lecture 1: Macro-Fundamental Analysis

Discuss why emerging market provide the great growth opportunities available anywhere in the world. Will this growth continue in the new millennium? We will discuss four reasons: 1. From Marx to markets. 2. An educated, low cost labor pool with a strong work ethic will fuel the development. 3. Technology is easily transferred from the developed to the developing world. 4. It appears that capital will be available to finance the rapid growth of many of the emerging markets. Finally, we will discuss some structural problems in EM economies.

Assigned reading:

1. World Economic Forum's Global Competitiveness Report 1998 

Assignment 1:

Trend in international labor statistics and their implication for international investment

 
Lecture 2: Development of Global Finance

This lecture covers the size of various markets and foreign portfolio investment. We will discuss various forms of capital controls and their resulted price anomalies. We will then cover various share register systems and issues related to settlement and account custody. Finally, we will discuss some related transaction problems that may cause nightmares for EM traders.

Assigned Reading:

1. International Capital Markets: Developments, Prospects, and Key Policy Issues by IMF (9/98)
2. Investing in Emerging Market: Lessons from the Turn of 20th Century, J.P. Mei (Study Packet)

Lecture 3: Measuring Return And Volatility.

We will study the issues of measuring international equity returns, return distributions, and the general evidence of market volatility. We will examine short- vs. long-term correlations of various different markets. We will also study the relationship between risk and returns. Then, we will take a close look at the volatility of market valuations and how this volatility may affect asset allocation. Finally, we will discuss alternative measurement of risk and the impact of speculation on volatility.

Assigned readings:

1. "Global Bargain Hunting" by Burton Malkiel and J.P. Mei (Simon & Schuster) Chapter 5
2. The Behavior of Emerging Market Returns, Campbell Harvey.
3. Exploratory Investigation of Country Returns, Campbell Harvey
4. The Making of an Emerging Market, Erb, Harvey, Viskanta (Study packet)
 

Lecture 4 & 5 & 6: Currency Risk

These lectures cover issues related to exchange rate determination. We will examine currency market volatility and contagion. We will also discuss various models for exchange rate forecasting. We will also study currency hedging from both corporate finance and portfolio investment perspective.

Assigned readings:

1. Richard Levich, International Financial Markets, Chapter 4-8.
2. Identifying, measuring, and hedging currency risk at Merck, JACF (Study packet)
3. Currency Risk Management in Emerging markets, G. Fong, EMQ, (Study packet)
4. "What Happened to Asia?" by Paul Krugman
5. Can Investors Profit From Devaluations?
6. Leading Indicators of Currency Crises by Graciella Kaminsky, Saul Lizondo and Carmen Reinhart

Assignment 2:

Currency trading (filter rules), risk measurement and international Fisher relationship.

Lecture 7: Managing Political and Legal Risk

This lecture will cover a brief history of submerged markets (e.g. Russia, Argentina, Mexico) and survivorship bias. We will also examine the impact of political risk on EM today. We will outline major political risk in the past and present. Finally, we will cover issues related to measuring and insuring political risk.

Assigned readings:

1. "Global Bargain Hunting" by Burton Malkiel and J.P. Mei (Simon & Schuster): Chapter 3 & 4
2. "Political Risk, Financial Crisis and Market Volatility", J.P. Mei (Study Packet)
3. Political Risk, Economic Risk and Financial Risk, by Campbell Harvey.
 

Lecture 8: Containing The Risk: Diversification

This lecture will begin by studying short-term and long-term correlations across various markets. We will give a practical illustration of diversification. Next we will answer the following questions: Will diversification into foreign and emerging markets continue to offer risk-reduction benefits? Why not just invest in domestic firms (such as Boeing) doing emerging market business? Finally, we will discuss the home country bias and the likely future flow of funds into emerging markets.

Assigned readings:

1. "Global Bargain Hunting" by Burton Malkiel and J.P. Mei (Simon & Schuster): Chapter 6
2.  Correlation Trends in Global markets, Chris Littell, EMQ (Study Packet)

Exercise:

Constructing minimum variance portfolios. Mean-Variance Analysis Tool by Harvey

 
Lecture 9: The Top-Down Approach to Country Risk Management

This lecture will begin by studying various ways of gauging valuation levels of emerging markets. We will then discuss the country allocation method of Bekaert, Erb, Harvey and Viskanta (EMQ, 1997). Finally, we will discuss the Smith Barney Global Asset Allocator Model and its performance. The application of this model in a single market is also discussed.

Assigned readings:

1. Richard Levich, International Financial Markets, Chapter 15.
2. Global Asset Allocation with Equities, Bonds, and Currencies, Black and Litterman (Study packet)
3. Have You Tried P/G? Thomas Easton, Forbes (Study packet)
4. Going Global, William N. Goetzmann
 
 

Lecture 10: In Class Midterm

Lecture 11: International Corporate Finance

We will then study the ADR market and its pricing with respect to the local market. We will study various steps in security analysis and some Technical Trading Rules and Indicators.

 Assigned readings:

1. Richard Levich, International Financial Markets, Chapter 15.
2. Investing in Emerging Markets using Depository Receipts, Jorion and Miller, (Study packet)
3. Michael Pomerleano, 1999, The East Asia Crisis and Corporate Finance, Emerging Market Quarterly. (Study Packet)
4. The Valuation of Mexican Stocks, Mariscal and Lee (Study packet)
5. R.J. Reynolds International Financing, (Study packet)

 
Lecture 12: International Capital Budgeting and Project Finance

We will begin by discussing the cost of capital for international investment. We will then cover several different models for capital budgeting and project evaluation.

 Assigned readings:

1. Campbell Harvey, The International Cost of Capital and Risk Calculator
2. Campbell Harvey, "The International Cost of Capital and Project Finance" Lecture Notes

 
Lecture 13: Mutual Funds and Indexing

We will begin our first topic by offering a breakdown by fund characteristics. Next, we will study the pricing of closed-end fund and determinants of their discounts. We will show that closed-end funds--when available at discounts--are more attractive alternative than index funds. We will also discuss the performance of off-shore funds. The lecture then covers the uses of securities-market indexes, the IFC index-weighting of sample members, and comparison of indexes over time. We will discuss various forms of survivorship bias and cover some local market indices. Next, we will compare the performance of the Vanguard index fund with other actively managed funds. We will then discuss other index products, such as WEBS, which are open-end investment companies but trade on a stock exchange.

 Assigned readings:

1. "Global Bargain Hunting" by Burton Malkiel and J.P. Mei (Simon & Schuster): Chapter 7&8
2. The IFC Equity Index Methodology

Assignment 3:

Evaluating the performance of International funds and Computing Cost of Capital. (data provided)
 
 

Lecture 14: International Real Estate

We will first cover the Long-term fundamentals for EM Real Estate. We will then discuss the risk and returns of EM real estate from a portfolio perspective. We will also cover emerging markets real estate speculation, which lies at the center of Southeast Asia's financial troubles. Finally, we will show how to invest in EM real estate. The lecture will also cover briefly EM commodities & collectibles.

Assigned Readings:

1. "Global Bargain Hunting" by Burton Malkiel and J.P. Mei (Simon & Schuster): Chapter 10
2. Asian Real Estate in A Portfolio Context: Long-term Opportunities, J.P. Mei, (Study Packet)

                                                                                                ***** 
 

Lecture 15: International Debt

We will start by studying the history of international debt. We will then show how fixed income securities work and how they are valued. We will focus on the Brady bond market. We will then examine the relationship between credit risk and bond yields. We will also study the determination of credit ratings and default risk. Finally, we will cover various bond trading strategies.

Assigned readings:

1. Richard Levich, International Financial Markets, Chapter 14.
2. "Global Bargain Hunting" by Burton Malkiel and J.P. Mei (Simon & Schuster): Chapter 10
3. Measuring the duration of an internationally diversified Portfolio, Thomas and Willner (Study packet)
3. Brady Bonds and Default Probabilities, Izvorski, Ivailo, IMF

Lecture 16: Managing Risks of International Banks

We will begin by discussing the financial crisis in many EM banks. We will outline the major risks faced by these banks. In managing these risks, we will discuss capital adequacy, risk based capital ratios, deposit insurance, and other liability guarantees. We will cover liquidity and liability management, product and geographic diversification, risk management using derivatives, and securitization.

Assigned readings:

1. Economic Crises and the Financial Sector by Stanley Fischer (9/98)

 
Lecture 17&18: International Derivatives Markets

This lecture will cover the rationale for using the derivatives. We will study currency, bond futures, options, swaps, and other custom-made derivative instruments. The emphasis will be how to use these products to manage risk and enhance performance.

Assigned readings:

1. Richard Levich, International Financial Markets, Chapter 11-13 and 16.
2. Basic Strategies for Managing U.S. Dollar/Brazilian Real Exchange Rate Risk for Dollar-Denominated  Investors, CME
3. Notes on Foreign Currency Swaps, Harvard Case, 9-292-043
4. Neat Options Simulation by Campbell Harvey

Assignment 4:

Currency Hedging (Data provided)
 

 
 Lecture 19&20: VaR: A Systematic Approach to Global Risk Management

RiskMetrics®, the world's most popular portfolio model for evaluating market risk. The RiskMetrics methodology enables a risk manager to calculate Value-at-Risk (VaR) on a portfolio of financial instruments

Assigned readings:

1. J.P. Morgan's Risk & CreditMetrics
2. CSFB Credit Risk Plus Publications