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10-1Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Chapter Ten

The Determination of ExchangeRates

Part Four

World Financial Environment

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Chapter Objectives

• To describe the International Monetary Fund and its rolein the determination of exchange rates

• To discuss the major exchange-rate arrangements thatcountries use

• To explain how the European Monetary System worksand how the euro came into being as the currency of theeuro zone

• To identify the major determinants of exchange rates

• To show how managers try to forecast exchange-ratemovements

• To explain how exchange-rate movements influencebusiness decisions

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The International Monetary Fund

• Originally organized in 1945

• Objectives:

To promote international monetary

cooperation, exchange stability, and orderlyexchange arrangements

To foster economic growth and high levels ofemployment

To provide temporary financial assistance tocountries to help ease balance-of-paymentsadjustment

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IMF History

• The Bretton Woods Agreement set a fixed

exchange rate against gold & the US

dollar

• The Jamaica Agreement (1976) eliminated

par values against gold and the US dollar

and permitted greater flexibility.

• Voting is through the Quota system

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Special Drawing Right

• The Special Drawing Right (SDR) is a

special asset the IMF created to increase

international reserves

• The value of the SDR is based upon the

weighted average of a basket of four

currencies: the U.S. dollar, the euro, the

Japanese yen, and the British pound.

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Exchange Rates

• The world can be divided into:

Countries that basically let their currenciesfloat according to market forces with minimal

or no Central Bank intervention Countries that do not but rely on heavy

Central Bank intervention and control

• Anyone involved in international business

needs to understand how the exchangerates of countries with which they dobusiness are determined

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The Euro

• European Monetary System (EMS): established by theEU (then the EC) in 1979 as a means of creatingexchange rate stability within the bloc

• European Central Bank: established by the EU on July

1, 1998, to set monetary policy and to administer theeuro

• Euro: the common European currency established onJan. 1, 1999 as part of the EU’s move toward monetaryunion as called for by the Treaty of Maastricht of 1992

• European Monetary Union (EMU): a formal arrangementlinking many but not all of the currencies of the EU

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Africa

• African countries are committed to

establishing a common currency by 2021,

but there are many obstacles to

accomplishing this objective

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The Determination Of Exchange

Rates

• Currencies that float freely respond to supplyand demand conditions free from governmentintervention

• The demand for a country’s currency is afunction of the demand for its goods andservices and the demand for financial assetsdenominated in its currency

• Fixed exchange rates do not automaticallychange in value due to supply and demandconditions but are regulated by their CentralBanks

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Central Banks

• Central banks are the key institutions in countries thatintervene in foreign-exchange markets to influencecurrency values

• The Bank for International Settlements (BIS) in

Switzerland acts as a central banker’s bank.• It facilitates communication and transactions among the

world’s central banks

• A central bank intervenes in money markets byincreasing a supply of its country’s currency when itwants to push the value of the currency down and bystimulating demand for the currency when it wants thecurrency’s value to rise

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Black Markets – The Result of Fixed

Exchange Rates

• Many countries that strictly control and

regulate the convertibility of their currency

have a black market that maintains an

exchange rate that is more indicative ofsupply and demand than is the official rate

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Foreign-Exchange Convertibility

• Fully convertible currencies, often called hard

currencies, are those that the government allows

both residents and nonresidents to purchase in

unlimited amounts• Currencies that are not fully convertible are often

called soft currencies, or weak currencies

• They tend to be the currencies of developing

countries

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Exchange Controls

• To conserve scarce foreign exchange,

some governments impose exchange

restrictions on companies or individuals

who want to exchange money, such as

import licensing

multiple exchange rates

import deposit requirements

quantity controls

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Factors that determine exchange

rates

• purchasing-power parity

• differences in real interest rates

• confidence in the government’s ability tomanage the political and economic

environment

• certain technical factors that result fromtrading

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Forecasting Exchange-Rate

Movements

• Fundamental forecasting uses trends in

economic variables to predict future rates.

The data can be plugged into an

econometric model or evaluated on amore subjective basis.

• Technical forecasting uses past trends in

exchange rates themselves to spot futuretrends in rates.

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Factors to Monitor

• Major factors that managers shouldmonitor when trying to predict the timing,magnitude, and direction of an exchange-

rate change include the institutional setting

fundamental analysis

confidence factors

events

technical analysis

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Business Implications of Exchange-

Rate Changes

• Exchange rates can affect business

decisions in three major areas:

Marketing

Production

Finance

Documents

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