International Business Strategy, Management

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International BusinessStrategy, Management the
New Realities by Cavusgil, Knight and
Riesenberger

• Chapter 10
• The International Monetary and Financial
  Environment

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Currencies and Exchange Rates

• There are some 175 currencies in use worldwide.
• Currency regimes are simplifying many countries
  in Europe use the euro several countries have
  adopted the dollar.
• Exchange rate the price of one currency
  expressed in terms of another.
• Exchange rate fluctuations impact company
  profitability in various ways

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Currency Risk

• Currency risk arises from changes in the price of
  one
• currency relative to another, complicating
  international
• transactions. Issues
• ? Currency exposure
• ? Asset valuation
• ? Foreign taxation
• ? Inflationary and transfer pricing
• For example,
• If a suppliers currency appreciates, you pay a
  larger amount of your currency for your purchase.
  
• If a foreign buyers currency depreciates, you
  receive a smaller payment amount in your currency

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The Four Risks of International Business
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Convertible and Nonconvertible Currencies

• Convertible currency can be readily exchanged for
  other currencies.
• Hard currencies are the most convertible
  currencies e.g., U.S. dollar, Japanese yen,
  Canadian dollar, British pound, and the European
  euro. Most transactions use these currencies and
  nations prefer to hold them as reserves because
  of their strength and stability.
• A nonconvertible currency is not acceptable for
  international transactions

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Capital Flight

• Capital flight The (often rapid) sale of
  holdings in a nations currency or conversion
  into a foreign currency. Governments impose
  restrictions on currency convertibility to
  prevent capital flight and preserve their supply
  of hard currencies. Capital flight diminishes a
  countrys ability to service debt/ pay for
  imports.
• In 1979-1983, some 90 billion left Mexico when
  foreign lenders lost confidence in the Mexican
  economy and investors withdrew their investments

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Foreign Exchange Markets

• Foreign exchange all forms of internationally-tra
  ded
• monies including currency, bank deposits, checks,
  and
• electronic transfers.
• Foreign exchange market the global marketplace
  for
• buying and selling national currencies
• Exchange rates fluctuate constantly. E.g.,
  yen-dollar
• exchange rate
• 1985 - 240 yen to the U.S. dollar.
• 1988 - 125 yen to the dollar (nearly 50
  appreciation).
• Result Decrease in Japanese exports to U.S.
  Increase in
• U.S. exports to Japan

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How Exchange Rates are Determined

• In a free market, the price of any currency
  (rate of
• exchange) is determined by supply and demand
• The greater the supply of a currency, the lower
  its price
• The lower the supply of a currency, the higher
  its price
• The greater the demand for a currency, the higher
  its price
• The lower the demand for a currency, the lower
  its price

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Appreciation and Depreciation Example

• Euro appreciation If the euro-dollar exchange
  rate goes from one euro 1.25 to one euro
  1.50, the euro becomes expensive to Americans
• Euro depreciation If the euro-dollar exchange
  rate goes from one euro 1.25 to one euro
  1.00, the euro then becomes cheaper to Americas

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Factors That Influence the Supply and Demand of
a Currency

• Economic growth
• Interest rates and inflation
• Market psychology
• Government action

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1. Economic Growth

• The increase in value of the goods and services
• produced by an economy.
• Typically measured as the annual increase in real
  GDP.
• Innovation and entrepreneurship drive business
  activity and demand.

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2. Interest Rates and Inflation

• Inflation a rise in the prices of goods and
  services.
• Reduces the purchasing power of the affected
  currency
• Interest rates and inflation are positively
  related. I.e., high inflation high interest
  rates, because investors expect a return that
  exceeds inflation rate.
• Where inflation or interest rates are rising, the
  value of the currency generally falls

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3. Market Psychology

• Herding the tendency of investors to mimic each
  others actions
• Momentum trading investors buy stocks whose
  prices have been rising and sell stocks whose
  prices have been falling- usually done via
  computers set to do massive buying/selling when
  asset prices reach certain levels.
• For example, in early 2000s, Argentina
  experienced a massive flight of capital
  investment when the government announced it would
  default on its international bank loans.

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4. Government Action

• Governments intervene to influence the value of
  their own currencies. E.g., the Chinese
  government regularly intervenes to keep the
  renminbi undervalued, ensuring that Chinese
  exports remain strong.
• Intervention is conducted via the nations
  Central Bank, by buying and selling currency in
  the foreign exchange market

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Valuation of Currency Affects Trade Surplus or
Deficit

• Trade surplus countrys exports exceed its
  imports may result when currency is
  undervalued.
• Trade deficit nation's imports exceed its
  exports, causing net outflow of foreign exchange.
  
• Balance of trade difference between the value of
  a nations exports and its imports.

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The Bretton Woods Agreement

• Signed by 44 countries in 1944
• Pegged value of the dollar to an established
  value of gold, at 35 per ounce.
• U.S. government agreed to buy and sell gold to
  maintain the fixed rate.
• All other signatories pegged their currencies to
  the U.S. dollar, and agreed to maintain this
  value via central bank intervention.
• System kept exchange rates stable for 25 years.
• Broke down in early 1970s

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The Bretton Woods Legacy

• Instituted the concept of international monetary
  cooperation among central banks.
• Established the concept of fixing exchange rates
  to minimize currency risk.
• Created the International Monetary Fund (IMF) and
  the World Bank, agencies that aim to stabilize
  currencies and reduce global poverty.

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The Exchange Rate System Today

• Most advanced economies (e.g., Europe, Japan,
  U.S.) use the floating exchange rate system. The
  value of a currency floats according to market
  forces, with little government intervention.
• Many developing economies and emerging markets
  use the fixed exchange rate system. The value of
  a currency is set at a specified rate to the
  value of another currency, or basket of
  currencies. E.g., China, African countries.

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Monetary and Financial Systems

• International monetary system the institutional
  framework, rules, and procedures by which
  national currencies are exchanged for one
  another.
• Global financial system the collection of
  financial institutions that facilitate and
  regulate the flows of investment and capital
  funds worldwide, incorporating the national and
  international banking systems, the international
  bond market, national stock markets, and the
  market of bank deposits denominated in foreign
  currencies. Has become huge since the 1990s.
  E.g., 15 of U.S. equity funds are invested abroad

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Globalization of Finance

• Advantages
• Reduces cost of capital for firms
• More financing alternatives for firms
• More investment opportunities for people
• More financing options for emerging markets and
  developing economies
• Facilitating trends
• Monetary and financial deregulation worldwide
• New technologies and the Internet
• Growing role of single-currency systems, e.g.,
  euro

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Risks in the Globalization of Finance

• Contagion tendency of a financial or monetary
  crisis in one country to spread rapidly to others
  due to worldwide financial integration. E.g., SE
  Asia crisis in late 1990s
• Capital flows are much more volatile than
  FDI-type investments
• Financial instability is worsened due to
  underdeveloped regulatory frameworks, and
  insufficient monitoring of banking and financial
  sectors.

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