Republic of the Philippines

PARTIDO STATE UNIVERSITY

Goa, Camarines Sur

College of Business and Management

Name of Campus/ College

Module 4
INTERNATIONAL FINANCE THEORY

Name of Student: ____________________________ Week No: 7

Course Code: FMELECT4 Name of Faculty: Camille E. Bacares, CPA
Course Title: Global Finance with Electronic Banking

Hello, dear students! Let’s continue our Global Finance with Electronic Banking journey!

I. OBJECTIVES
Before we proceed, allow me to orient you of our desired outcomes that we need to achieve at the end of
the course. Here are our learning objectives:
 Determine and discuss the theories of international finance.

II. LESSON
Let’s discuss the different theories regarding International Finance. Let’s do it altogether. The following
discussions have complementary & additional course lectures in synchronous/asynchronous mode of
learning. You may refer to activity section for complete details. Here we go!

Note: Join the scheduled synchronous sessions via Zoom/google meet for the lecture and discussion on this
topic. ATTENDANCE IS A MUST. For asynchronous lectures, pre-recorded are uploaded in the Moodle. The
key concepts and ideas are found below.

International Finance Theory

Broadly this theory may be discussed under 5 sub theories, they are:

1) Interest Rate Parity

2) Purchasing Power Parity
3) Fisher Effect
4) International Fisher Effect
5) Expectation Theory

1) Interest Rate Parity

This theory states that the interest rate differential between two countries (say $ interest and Rs. interest should
be same for exchange risk.) should be equal to the percentage difference between forward exchange rate and
spot exchange rate. This theory holds till there is no restriction on moving money from one
economy/country/currency to another. Practically, dealers set the forward prices by comparing the differences
between $ interest and Rs. interest.

To be precise, when money market and currency are in equilibrium then any interest rates differential should be
equal to the % difference in forward exchange rates and spot exchange rate, i.e., there won’t be any question of
earning riskless profit otherwise arbitrageurs will earn riskless profit.

IRP Theory relates to a condition of equality of returns on comparable money market instruments.
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IRP relates Spot Rate and Forward Rate using two countries’ risk free rates.

For clarity we may take an example:

Suppose an investor has $100,000 at the beginning of the year to be invested for a period of 1 year.

Let us say $ interest rates on deposits equals 2% p.a. on the other hand Indian deposits offer attractive interest
rate of 10% and exchange rate is Rs.50 per $. Now it is to be decided where the amount should be invested.

Solution:

Case I: If the investor invests in US: Amount at the end of the period will be as 100,000*102%=$102,000
(100,000 as principal plus 2,000 as interest)

Case II: If he wishes to invest in India:

-First he has to convert the $ amount into Rupee amount, i.e. he has to buy corresponding rupees, hence he can
buy 100,000*50=Rs. 5,000,000.

-Now he will invest the amount @ 10%, finally at the year-end he will have Rs. 5,000,000*110%=5,500,000
(5,000,000-principal + 500,000-interest) in his hand.

Hence at last the investor has to convert the Rs. amount generated into $, and we do not know what will be the
exchange rate at the year end.

Some Formulae in computing Forward Rate:

[Satisfying the first line of the theory]

(ii) FR=SR*[1+ (Rq– Rb)] [This formula will give approximate result]

(iii) (1+Rb) = SR* (1+ Rq)/FR [This formula will give exact result-use this for your activities and quizzes]

Now see how this theory helps us. As per this theory we can fix today the price at which the Rs. amount to be
sold. Such rate(price) fixed today is the forward rate. The one year forward rate is 53.9216*. Therefore, by
selling Rupees generated at the year end, the investor will be sure to earn 5,500,000/53.9216=$101,999.

Talking about the conclusion we can say that these two investments are offering almost exactly same rate of
return.

Meanings:
forward exchange forward trade: an
rate: the agreed upon agreement to
exchange exchange currency at
rate to be used in a some time in future
forward trade

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 Republic of the Philippines
PARTIDO STATE UNIVERSITY
Goa, Camarines Sur

spot exchange Spot trade:

rate: an agreement to
the exchange rate on trade currencies
a spot trade based on today’s
exchange rate for
settlement within two
business days

2) Purchasing Power Parity:

Basically, we have seen that IRP theory is used in obtaining Forward Rate. But we have not discussed how spot
rate is determined. Thus, this theory helps in this issue.

There are two forms of PPP-(i) Absolute Form of PPP & (ii) Relative Form of PPP

 Absolute Form of PPP:

The basic idea behind this theory is that a commodity costs the same regardless of what currency is used to
purchase it or where it is selling. This is a straight forward concept. Loosely, speaking as per this theory 1$ will
buy same number of say, burger anywhere in the world.

Assumptions required to hold absolute PPP true

 The transaction cost of trading – shipping, insurance, spoilage & so on must be zero.
 There must be no barrier on trading-no tariffs, taxes or other political barriers.
 The goods traded (burgers) in one place (economy) must be identical to the burger traded in another
economy.

Let’s be clear with some cases:

If the burger in India costs Rs. 100 in India and exchange rate is Rs.50 per $, then the same burger should cost
Rs.100/50=$2 in America.

If in case the actual exchange rate is Rs.40/$ then with$2 a trader in America would buy a burger in America
and ship it to India and sell the same in India @ Rs.100 per burger and convert the Rs.100 into $, as a
result of which he will get 100/40 =$2.5, hence he is gaining $0.5 in this transaction.

Since, the trader is making riskless profit and the burgers start moving from US Market to India as a result of
which there will be reduced supply of burgers in US and the prices will start rising in US economy at the same
time India will lower the price of burger due to increased supply, this will continue till equilibrium is
maintained in these two economies. At last the exchange rate quoted will be expected to rise form Rs.40.

Practically, Absolute PPP will not hold true (ignoring some exceptions) because the assumptions of this theory
are rarely met.

 Relative Form of PPP

This theory does not tell us about what determines the absolute level of exchange rate, moreover, it tells what
determines the change in the exchange rate over the given period.
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 Republic of the Philippines
PARTIDO STATE UNIVERSITY
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Strictly speaking, this theory implies that the differential inflation rate is always identical to the change in spot
rate.

Hence change in exchange rates is determined by the difference in the inflation rates of two countries, i.e. any
difference in the rates of inflation will be offset by a change in exchange rate.

Now by definition, [E(St )- S0 ]/ S0 =[iq-ib]

Solving this we get, E(St )= S0 *[1+{ iq-ib}]
E(St )= S0 *(1+iq )/(1+ib )

Note: For validity of Relative PPP, validity of Absolute PPP is not mandatory. It is already discussed that
Absolute PPP will hold true for rare goods, we shall be focusing more on relative PPP.

For example, if prices are rising by 1.0% in the United States and by 6.0% in Mexico, the number of pesos that
you can buy for $1 must rise by 1.06/1.01 – 1, or about 5.0%. Therefore, purchasing power parity says that to
estimate changes in the spot rate of exchange, you need to estimate differences in inflation rates.

Note: If inflation and interest differential are equal then PPP and IRP would give same result.

3) Fisher Effect:

“A change in the expected inflation rate causes the same proportionate change in the nominal interest rate; it has
no effect on the required real interest rate.”

This theory tells us the relationship between nominal rates, real rates and inflation. Thus with the help of this
theory we can review more carefully the relation between inflation and interests. It is obvious that the investors
are ultimately concerned with what they can buy with their money, they need compensation for inflation.

Nominal Return (Money Return): It indicates the rate which money is growing. Nominal rates are called
nominal because they have not been adjusted for inflation. It includes inflation. Transactions can be done in the
market taking the basis of this return.

Real Return: This return is without inflation. It indicates the rate at which the purchasing power is growing.
These are the rates which have been adjusted for inflation.

Example: You have Rs. 1000 today and if you invest the same amount you will be with Rs. 1155 at the year
end. And with the same Rs. 1000 you can buy 20 hamburgers at the beginning of the year. Assume the inflation
rate to be 5%. (i.e. the price is expected to go up by 5% during the year.)

Now the question arises here about the impact of inflation.

See the calculation here:

Investment at beg. =1000

At year end you will get 1155

Then we can say that nominal interest rate (money return) is (1155-1000)/1000=15.5%

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PARTIDO STATE UNIVERSITY
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At the beginning you can buy 20 hamburgers [cost per hamburgers is 1000/20=50]

Due to rise in price you have to pay 50*1.05=52.50 for 1 hamburger at year end.

If you want to buy the hamburgers at the end with your invested amount then you can buy 1155/52.50=22
hamburgers only.

What I would like to concentrate is that despite of 15.50% increase in my investment my purchasing
power have gone up by 10% only because of inflation. Frankly speaking I am really 10% rich only.

It can also be stated that with 5% inflation, each of the Rs. 1155 nominal dollars we get is worth 5% less in real
terms.

Hence the real Rs. Value of our investment is 1155/1.05=1100 only.

The nominal rate on an investment is the % change in number of rupees you have. The real rate of the
investment is the % change in how much you can buy with your rupees- ie, the % change in your buying power.

Now I would like to make relationship using these 3 terms (real rate, nominal rate & inflation) and the credit for
this goes to the great economist Irving Fisher.

Fisher effect tells,

(1+R)=(1+r)*(1+i) [This is the domestic Fisher effect]

Where,

R=Nominal Risk Free Rate

r= Real Risk Free Rate [Fisher assumed this rate to be constant across the countries]
i=Inflation Rate

Finally solving above equation we will get, r=(R-i)/(1+i)

{(1+i) is the discounting factor, r is constant, if we ignore (1+i) in the denominator because the denominator
will be slightly more than one, if done as said, then result of (R-1)/(1+i) will be approximately equal to (R-1),
the we will get R~r+i, means ‘R’ is directly proportional to ‘i’ since ‘r’ is constant}

Fisher on arriving to the conclusion says that investors are not foolish. They do care about the impact of
inflation &know that inflation reduces purchasing power and, therefore, they will demand an increase in the
nominal rate before lending money.

A rise in the rate of inflation causes the nominal rate to rise just enough so that the real rate of interest is
unaffected. In other words, the real rate is invariant to the rate of inflation.

Fisher is of the view that ‘r’ will remain constant irrespective of inflation but not all economists would agree
with Fisher that the real rate of interest is unaffected by the inflation rate. Practically ‘r’ differs as per economic
conditions of the country.

4) International Fisher Effect [also called common real interest rates]

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 Republic of the Philippines
PARTIDO STATE UNIVERSITY
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This theory is based on the idea that a country with a higher interest rate will have a higher rate of inflation
ultimately it causes its currency to depreciate. In theoretical terms, this relationship is expressed as an equality
between the expected % change in exchange rate and the difference between the two countries’ interest rates,
divided by one plus the second country’s interest rate.

This tells us that the difference in returns between the home country and a foreign country is just equal to the
difference in inflation rates.

Mathematically, (1+Rfc )/(1+ Rhc)=(1+ ifc)/(1+ ihc)

Because the divisor approximates 1, the expected percent exchange rate change roughly equals the interest rate
differential.
ifc− ihc= Rfc− Rhc

5) Expectation Theory
This theory tells that ‘today’s forward rate’ is going to be the ‘future spot rate’. If this theory, holds then
FR=E(S)
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 Republic of the Philippines
PARTIDO STATE UNIVERSITY
Goa, Camarines Sur

Economists and scholars based on their experience and research over the period have seen that forward rates
moreover exaggerate the likely change in the spot rate. When FR predicts that the SR will rise in future, then the
FR is over estimating the Future SR and vice versa then SR will change as per the prediction, however many
researchers have found that , when the forward rate predicts a rise, the spot rate is more likely to fall, and vice
versa. You may refer “K. A. Froot and R. H. Thaler, “Anomalies: Foreign Exchange,” Journal of Economic
Perspectives 4 (1990).

So, this finding is not consistent with the expectations theory. Because of this we say “forward rate is an
unbiased predictor of future spot rate”.

At a glance:

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 Republic of the Philippines
PARTIDO STATE UNIVERSITY
Goa, Camarines Sur

Theories of International Finance will give us

understanding how investments and transactions are
analysed in relation to different aspects of finance.
Having knowledge on these theories will explain
dealings in global finance as it explains different
scenarios and terminologies.

Classroom Policies:
(Based from the student handbook 2017 Edition)
1. Regular attendance and punctuality in all classes are important obligations of the students.
2. All students are required to wear the prescribed uniform and school ID.
3. Students are obliged to observe the code of conduct and discipline contained in the Student Handbook.
4. Assignments should be passed on time. Late assignments will not be accepted.
5. Projects should be passed on time. Late projects will only be accepted under meritorious excuses.
Students who fail to submit projects shall be marked INC (incomplete).
6. When asked to recite, students should stand up or go to the board/unmute and speak during online
sessions.
7. Students should take the two major examinations (midterm and finals). Students who do not take the
two major exams will be marked INC (Incomplete).
(House Rules for Online Learning)
8. Proper dress code and decorum are expected among all participants.
9. Students are obliged to observe the code of conduct and discipline contained in the Student Handbook.
Any act of disrespect and rudeness shall not be tolerated throughout the duration of the online classes.
10. Be mindful of your surroundings. Avoid any form of distractions such as unnecessary background
noise, chitchat, etc. that may cause inconvenience to the speaker/instructor and students/other
participants.
11. To minimize background noise, participants are encouraged to turn on their microphone ONLY when
necessary.
12. Cellular/Smartphones/Laptops should be efficiently utilized.
13. Kindly key in your questions and concerns in the chat box/messenger/emails. These will be answered
after the lectures of the instructor.
14. Speak clearly and audibly during the forum/open question portion. Ensure that no objects or coverings
are blocking your microphones.
15. Cheating/Fraud are strictly prohibited and punishable.
16. Submission and/or compliance of all requirements should be within the semester. Any requirement
submitted beyond the submission date will be considered LATE with corresponding deductions during
midterm or an INC grade for the final term requirement(s) of the semester.

Grading System (subject to BOR approval)

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 Republic of the Philippines
PARTIDO STATE UNIVERSITY
Goa, Camarines Sur

The new grading system that will be used is as follows:

Major Examination 40%
Modular Outputs 30%
A/synchronous Online Discussions/Forum 25%
Participation in F2F & Synchronous Classes 5%
TOTAL 100%

III. ACTIVITIES

General Instruction
Here are our general instructions, I hope you can follow. Regards!
1. Refer to the Course Syllabus for the topic, learning outcomes, references, and references.
2. Visit and log in to Moodle/FB Social Learning Group/Messenger Group chat for Operational
Management and TQM following the link/instruction provided hereunder:
a. ParSU LMS Moodle: BSBA-FM 4A Link BSBA-FM 4B Link BSBA-FM 4C Link
b. FB Social Learning Group:
c. Messenger Group chat: Please direct message me for the link to our group chat.
3. Download the Module/Instructional Material attached thereto:
a. Teacher-prepared Modules
b. Quizzes and Assignments/Online Tasks
4. Kindly study the modules/OERs which can be found in the virtual platforms.
5. Visit and Download the OERs and study thoroughly.
6. For distance learning participants/students, secure your copy of the module which will be distributed
through LGU linkages in your respective locality. Study the materials thoroughly and participate in all
activities. Please observe time limitations.

Specific Instruction
These are capsulized instructions that are highly relevant as we go through with our course. Take it
seriously!
7. Each topic is expected to be finished in one to two weeks, which should start with browsing the course
syllabus, reading the chapter and unit assigned, watching uploaded videos, answering the exercises
assigned per unit/chapter, answering the guide questions or performing tasks given, answering the
online quiz, and posting insights about the topic in the online learning/ social learning group.
8. Each student is encouraged to post a question, reflection or reaction about the assigned topic for the
week. This shall be evaluated as part of recitation or class participation.
9. Since not all students have reliable access to internet, you are advised to read all required activities
below, take note of them, and perform/accomplish them offline. Only the activities below shall be
strictly required from all students. However, in case of high vulnerability to COVID-19 or during the
duration of community quarantine/lockdown, everyone is strongly advised against going out of his/her
home to go to an internet shop or look for a strong signal or loading station.
10. Your professor shall be posting some simple tasks or questions in our class social learning group from
time to time. Answer by replying or commenting on such posts.
11. Download the assignment and problem-solving questions uploaded in various social online platforms.
12. You may post your concerns in our group chat, send me an e-mail or contact my mobile number: 09-
167825-830. Answer the assignment/problems and send/upload the solution/ answer in Google

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PARTIDO STATE UNIVERSITY
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classroom portal/via personal message in Messenger: Camille Bacares or email:

[email protected]
13. For distance learning participants/students, study the modules thoroughly and participate in all activities
involved. Please observe time limitations. Once you accomplished the requirements, please submit your
answer through the same LGU courier/linkage.
14. These guidelines are subject to change. Changes shall be made known to you through our Messenger
group chat/Moodle. Regularly check our online class/group.

Teaching and Learning Activities

We will be employing the following methodologies as we proceed with our discussion/activity proper!
1. Online Group Discussion
2. Virtual Lecture-Demonstration
3. Synchronous and Asynchronous mode of learning
4. Planning and preparation for Project(s)
5. Embedded Gender and Development aspects in e-learning

Instructional Materials/Resources
These items are necessary, timely and relevant in our course. I hope you can secure your own copy/item.
May you have question(s), please do not hesitate to ask.
A. General Materials: University Student Manual/Brochure/flyers (Softcopy)/College Leaflets (Softcopy);
Course Syllabus; Certificate of Enrolment (CE) Form; and Class Profile and records
B. Online Materials: Laptop/Desktop; Smartphone; PPT Presentations; Excel files; Zoom App; Google
Meet; Kotobee; Courseware (Moodle LMS); Google Docs/Forms; Messenger Group Chat; & Emails
C. Printed learning Modules/Packages for distance learning/blended education
D. Various Open Educational Resources (OERs)
E. Accounting Materials: (Columnar Books/Calculator – Electronic/Scientific/Long Brown
Envelope/Plastic Envelope/Black Pen/No.2 Pencil)
F. Review Materials/Hand-outs: (Online Reviewers Self-Made/Downloaded/From Review Centers)
G. Various Accounting Books, Studies and Literatures
H. Instructional Materials produced by BSA Core Faculty/FAR/IA Instructors

Now, we will be conducting exercises by applying the concepts we have learned from the discussion! Let’s
apply it in real-life scenarios! Let’s nail problems and hurdle class requirements! We can do it!

The activities that follow shall be accomplished by referring to our textbook, International Financial
Management by Jeff Madura, various OERs and references stated in our course syllabus and listed in
the references list of this module.

The exercises/assignment provided hereinbelow are anchored with our learning outcomes! When you
follow cordially, you will learn unflaggingly! So, what are you waiting for? Let’s perform it!

1. Participate in the recitation for our synchronous session.

2. Accomplish the following tasks/exercises.

Go to Moodle, Week 7 and answer ASSIGNMENT 4.

Please answer below question and answer in essay format:

 How do you see the importance of theories to global finance? (15 pts.)
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 Republic of the Philippines
PARTIDO STATE UNIVERSITY
Goa, Camarines Sur

 What is the purpose of these theories to global finance? (15 pts.)

3. Post your questions/clarifications through our Messenger group chat, Moodle or send me
an SMS/ e-mail.

The format for the output is given below:

1. Paper size - short size bond paper (8.5 x 11);
2. font style - Garamond font; font size – 11;
3. spacing - single spaced; and
4. margin – 1.0 All sides.

Deadline: See the deadline(s) in the Moodle LMS, classwork requirements

The activities/exercises that are required to submit are uploaded in our coursewares as
assignment/question/quiz. Upload the file of your answer in our Moodle containing your output using the
filename in this format: ASSIGNMENT4_FMELECT4_Section_(Surname_GivenName),e.g.
ASSIGNMENT4_FMELECT4_BSA1A_Bacares_Camille

However, for REAL-TIME QUIZZES, we will be using Moodle quiz, google forms or quizziz.com. Observe
timeliness and accuracy in answering because the portals/systems will not be accepting answers/responses when
the deadline arrived/the time allotted lapsed.

For complete instruction, please proceed to specific instruction section. Thank you!
I know that you can do the requirements of this course! Here end our activities. You may opt to apply
these concepts in your daily life!

How did you find our discussion & activity? Do you have any feedback? Send me a message right away. I
will appreciate it gladly!

IV. ASSESSMENT

To assess your answers/outputs, we will be applying the hereunder parameters/rubrics:

For Real-time Quizzes, Moodle quiz/google forms/quizziz.com will be utilized:

1. Kindly participate in our graded recitation activity during synchronous session.

Simple Rubric for grading the outputs in case analysis/essays:

In-depth analysis/reflection 40%

Style of presentation/writing 10%
Conciseness of personal opinion supported by facts/numbers 30%
Clarity of communication/information conveyed 20%
TOTAL 100

Detailed Rubric for grading the outputs in case of Accounting Showdown (Problem Solving):

Parameters/particulars Percentage (%)

C-ontent 40
P-resentation 20
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 Republic of the Philippines
PARTIDO STATE UNIVERSITY
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A-nalysis/Interpretation 40
Total 100

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 Republic of the Philippines
PARTIDO STATE UNIVERSITY
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V. SUGGESTED REFERENCES

Here are the primary references used in the discussion/preparation of course contents for this
subject:
 Madura, J. (2008). International Financial Management, Thomson South-Western, 9th edition
 Alminar-Mutya, Ruby F. (2010). Basic Business Finance: Management Approach. Mandaluyong,
Philippines: National Bookstore
 Lopez-Mariano, Norma D. (2014). Elements of Finance. Manila, Philippines: Rex Bookstore
 Medina, Roberto G. (2007). Business Finance. Second Edition. Manila Philippines: Rex Bookstore
 Melicher, Ronald W. (2005). Finance Introduction to Institutions, Investments and Management. New Jersey,
USA. John Wiley & Sons, Inc.
 Peter Rose, S.H. (2012). Bank Management and Financial Services, McGraw-Hill, 9th edition

Here are our suggested references. Please refer to the following OERs/Books for complete/additional
discussions about this subject. Thank you very much!
 Joshi, V. C. (2010). E-Finance: The Future is Here, SAGE Publications India Pvt Ltd.
 Helberg, J. (2020). Financial Management, Larsen and Keller
 https://corporatefinanceinstitute.com/resources/knowledge/finance/corporate-finance-industry/
 https://www.investopedia.com/ask/answers/021715/why-are-most-multinational-corporations-either-us-
europe-or-japan.asp
 https://www.gfmag.com/global-data/economic-data/largest-companies
 https://taxguru.in/finance/summary-international-finance-theory.html
 https://www.toppr.com/guides/business-studies/sources-of-business-finance/international-financing-and-
choice-of-sources-of-funds/
 https://www.encyclopedia.com/finance/encyclopedias-almanacs-transcripts-and-maps/electronic-
banking#:~:text=Electronic%20banking%20is%20a%20form,as%20banks%20and%20credit%20unions.
 https://www.investopedia.com/terms/t/transfer-pricing.asp
 https://www.investopedia.com/terms/a/assetmanagement.asp

Prepared by: Reviewed by: Approved:

CAMILLE E. BACARES, CPA ROSALIE MARIA V. CHAVEZ RINA A. ABNER, DBA, CPA
Faculty CMRT Chairperson Dean

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