7/29/2017kisi.deu.edu.tr/ozge.ozgen/ckr_ib4_inppt_09.pdf · •This shift made the rupee less expensive for Americans, ... Euro vs. the Dollar •Suppose, ... 7/29/2017 3 Factors

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Copyright © 2017 Pearson Education, Inc.

International Business: The New Realities, 4th Edition

by

Cavusgil, Knight, and Riesenberger

The International Monetary

and Financial Environment

Learning Objectives

9.1 Learn about exchange rates and currencies in

international business.

9.2 Explain how exchange rates are determined.

9.3 Understand the emergence of the modern.

exchange rate system.

9.4 Describe the monetary and financial systems.

9.5 Identify the key players in the monetary and

financial systems.

9.6 Understand the global debt crisis.

Copyright © 2017 Pearson Education, Inc. 9-2

Currencies and Exchange Rates

• More than 150 currencies in use worldwide.

• Currency regimes are simplifying. e.g., The euro in

Europe; the dollar in Panama and Belize.

• Most currencies are not very convertible. The dollar,

yen, pound, euro are hard currencies – universally

accepted and preferred in international transactions.

• Exchange rate: Price of one currency in terms of

another.

• Exchange rates affect the fortunes of the firm in various

ways – costs of inputs, sales performance, which market

entry strategies to use, etc.


Constantly fluctuating exchange rates require

international managers to keep in mind three facts

• The prices the firm charges can be quoted in the

firm’s currency or in the currency of each foreign

customer.

• Because several months can pass between

placement and delivery of an order, fluctuations in

the exchange rate during that time can cost or earn

the firm money.

• The firm and its customers can use the exchange

rate as it stands on the date of each transaction, or

they can agree to use a specific exchange rate.


Recent Exchange Rates against the Dollar

Copyright © 2017 Pearson Education, Inc. 9-5Source: Adapted from www.x-rates.com.

The Four Risks of International Business


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Foreign Exchange Markets

• Foreign exchange: All forms of internationally-traded monies

including foreign currencies, bank

deposits, checks, and electronic transfers.

• Foreign exchange market: The global

marketplace for buying and selling national currencies.

Exchange rates are in constant flux. In 2012, for example, the

Indian rupee was trading at 48 rupees to the U.S. dollar. By

2013, the rate had depreciated to 58 rupees—the rupee’s

value went down relative to the dollar by more than 20

percent.

• This shift made the rupee less expensive for Americans, and

the U.S. dollar more expensive for Indians. Such shifts can

complicate international business.

$


Exchange Rates Over Time

Sources: Based on data from the International Monetary Fund and World Bank.


Example: Euro vs. the Dollar

• Suppose, last year, the exchange rate was 1 = $1.

• Now, suppose the rate has gone to: 1.50 = $1.

• What is the effect of this change on Europeans?

Effect on European Firms:

➢European firms pay more for inputs from the U.S.

➢Higher costs reduce profitability; require higher prices.

➢European firms can increase their exports to the U.S.

➢European firms can raise their prices to the U.S.

➢Increased exports to the U.S. lead to higher revenues.

What is the effect on European consumers?

€$


How Exchange Rates Are Determined

In a free market, the “price” of any currency (the exchange rate) 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.Copyright © 2017 Pearson Education, Inc. 9-10

Source: david_franklin/Fotolia

Equilibrium Price of Euros for Dollars


Factors that Influence

the Supply and Demand for a Currency

Economic growth is the increase in value of the goods and

services produced by an economy.

• Measured as the annual increase in real GDP (in which the

inflation rate is subtracted from growth).

• Driven by entrepreneurship and innovation.

• The nation’s central bank regulates

the money supply, issues currency

and manages the exchange rate, to

accommodate economic growth.

Market psychology refers to investor behavior,

such as herding behavior or momentum trading.


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Factors that Influence the

Supply and Demand for a Currency (cont’d)

Example: If inflation is 10%, banks must pay more than 10% to attract deposits.

Inflation refers to increases in the prices of goods and

services; thus, money buys less than before.

• Some countries (e.g., Argentina, Israel, Russia)

have experienced hyperinflation.

• High inflation erodes a currency’s purchasing power.

• Interest rates and inflation are positively related; high inflation

forces banks to pay high interest.

• That is, investors expect to be

compensated for inflation-

induced decline in the value

of their money.


Inflation in Selected Countries, 1985-2015

Annual percentage rate of inflation. Left-hand scale is for Turkey, Venezuela, and the United States; right-hand scale is for

Argentina, Brazil, and Poland.


9-14Sources: Based on International Monetary Fund, World Economic Outlook Database, 2015, at http://www.imf.org;

and CIA WorldFactbook, at http://www.cia.gov.

Factors that Influence the

Supply and Demand for a Currency (cont’d)

• Government action – Governments intervene to

influence the value of their own currencies, e.g., the

Chinese government regularly intervenes in the foreign

exchange market to keep the renminbi undervalued, to

help ensure exports.

• Balance of payments is the nation’s

balance sheet of trade, investment,

and transfer payments with the rest

of the world. It reflects the difference

between the total amount of money

coming into and going out of a country.


Source: Arto/Fotolia

Value of the Currency

and Trade Surplus vs. Trade Deficit

• Trade surplus – Exports exceed imports; may result when the

exporter’s currency is undervalued, as in China’s official policy

regarding its currency.

• Trade deficit – Imports

exceed exports; the

government may devalue

the nation’s currency to

correct a trade deficit.

• Balance of trade – The

difference between the

value of a nation’s

exports and its imports.

Example:

Japan exports cars to the U.S. Car

importers in the U.S. pay exporters in

Japan, resulting in a surplus item in

Japan’s balance of trade and a deficit

in the U.S. balance of trade.

If the total value of U.S. imports from

Japan exceeds the total value of U.S.

exports to Japan, then Japan will have

a trade deficit with the U.S.

What other factors cause trade deficits?


Development of the

Modern Exchange Rate System

• After the Great Depression and World War II, the world

economy and trading system were in a sorry state.

• At war’s end, seeking stability in the international

monetary and financial systems, 44 countries signed

the Bretton Woods agreement.

• Bretton Woods established a fixed exchange rate

system in which the U.S. dollar was pegged to a set

value for gold ($35 per ounce), and other major

currencies were pegged to the dollar.

• For nearly 30 years, the system kept exchange rates of

major currencies at a fixed level.Copyright © 2017 Pearson Education, Inc. 9-17

Bretton Woods Agreement

The Bretton Woods Agreement, which set the course for contemporary global

financial relations, was conceived by 44 nations at the Mount Washington Hotel in

Bretton Woods, New Hampshire, United States, in 1944.


9-18

Source: Chee-Onn Leong/123RF

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Breakdown and Legacy of Bretton Woods

Bretton Woods dissolved in 1971, as the world economy was evolving and governments could no longer maintain fixed exchange rates on the gold standard. Bretton Woods established the:

• Concept of international monetary cooperation, especially aimed at minimizing currency risk.

• International Monetary Fund (IMF): Agency that promotes exchange rate stability, monitors exchange systems, provides funding to developing economies.

• World Bank: Agency that provides loans and technical assistance to combat global poverty around the world.


The Exchange Rate System Today

• Today, advanced economy currencies (dollar, euro,

pound, yen) float according to market forces, their

value determined by supply and demand.

• Conversely, most developing and emerging

economies use fixed exchange rate systems.

• In fixed regimes, the value

of a currency is pegged to

the value of another, or to a

basket of currencies, at a

specified rate.

Examples▪ China pegs its currency to a basket of currencies▪ Belize pegs its currency to the dollar.


The International

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. It includes the

national and international

banking systems, the

international bond market,

and national stock markets.


Source: Gang Liu/Shutterstock

Globalization of

Financial and Monetary Activities

Growing integration of financial and monetary global activity is due to:

• Evolution of monetary and financial regulations,

worldwide.

• Emergence of new technologies and payment

systems in global finance, e.g., the Internet.

• Increased global and regional

interdependence of financial

markets.

• Growing role of single-currency

systems, e.g., the Euro.Copyright © 2017 Pearson Education, Inc.

9-22

Source: Tan Kian Khoon/Shutterstock

Key Participants and Relationships

in the Global Monetary and Financial Systems


9-23

• The Firm. International transactions require firms to

deal with huge sums of foreign exchange.

• National Stock

Exchanges and

Bond Markets.

Facilities for trading

securities and bonds.

Key Participants in the


The stock exchange in Santiago, Chile


Source: Tifonimages/Fotolia

http://en.wikipedia.org/wiki/File:International_Monetary_Fund_logo.svg

http://en.wikipedia.org/wiki/File:World_Bank_Logo.svg

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Central Business District in Singapore


9-25

Source: Perfect Illusion/Shutterstock

Key Participants in the


• Commercial Banks. Lend money to finance

business activity, play a key role in nations’ money

supplies, and exchange foreign currencies.

• Central Banks. Regulate money supply, issue currency,

manage exchange rates, control national reserves.

• Bank for International Settlements. Supervises

Central Bank monetary policy and other activities.



You Can Do It: Maria Petit

• Maria got her undergraduate degree from a state

university a few years ago. Read her profile in

Chapter 9.

• Maria’s majors: Finance, International Business, and

Spanish

• Maria’s jobs: All at Motorola

-- Credit analyst and auditor (based in the United

States, but frequent travel to Latin America)

-- Finance manager (United Kingdom)

-- Financial controller (Dubai, United Arab

Emirates)9-27 Copyright © 2017 Pearson Education, Inc.

You Can Do It: Maria Petit (cont’d)

Challenges

• Understanding current and evolving regulations in the

finance and accounting area across numerous countries

• Not knowing the local language slows the pace of meetings

• Being a women in countries with fewer female managers

Maria’s Success Factors

• Develop a deliberate career strategy

• Cultivate relationships with helpful people, both in college

and in the work world

• Work hard to maximize your job performance

• Establish yourself as a knowledgeable professional helps

overcome gender stereotypes

9-28

Global Financial Crisis

• In 2008, a major crisis emerged in the global

financial and monetary systems.

• It initially arose in the U.S., when investors lost

confidence in the value of securitized home

mortgages.

• Banks, lenders and insurance companies became

volatile, and stock markets crashed worldwide.

• Many national economies sank into recession.

• The world experienced sharp declines in consumer

wealth, economic activity, and international trade. Copyright © 2017 Pearson Education, Inc.

9-29

Global Financial Crisis (cont’d)

• A key factor was the availability of “easy money”,

from the U.S. Federal Reserve Bank.

• Also, China had been investing huge sums in U.S.

government securities.

• These trends fostered a vast global money supply,

which facilitated high demand for housing and

commodities such as oil and food, leading to

inflation.

• Much of the money was used to finance huge U.S.

trade deficits.


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• Many bad mortgages were “securitized” – bundled

into investment assets and sold in global financial

markets.

• Over time, investors realized that many loans were

high-risk, which led to capital flight.

• Like a contagion, the crisis spread quickly to Europe

and beyond.

• As the global economy slowed, demand for exports

shrank and export-dependent countries floundered

(e.g., Japan, Mexico, countries in Eastern Europe).



• National governments, the IMF, and World Bank

took corrective measures, such as injecting massive

sums into national economies and launching aid

packages.

• Some countries imposed trade and investment

barriers.

• The crisis highlights the importance of strong

regulation, transparency, and supervision of

institutions in the global financial system.


Gross Government Debt as a Percentage of GDP, 2015

Source: Based on International Monetary Fund, World Economic Outlook Database, 2015


9-33


9-34

Documents

7/29/2017kisi.deu.edu.tr/ozge.ozgen/ckr_ib4_inppt_09.pdf · •This shift made the rupee less expensive for Americans, ... Euro vs. the Dollar •Suppose, ... 7/29/2017 3 Factors