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INTERNATIONAL
FINANCIALMANAGEMENT
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International Financial ManagementSyllabus
Unit 1 Foreign Exchange Market
Unit 2 Foreign Risk
Unit 3 International Investment Decisions
Unit 4 Evaluation and Explanations of
Foreign Direct Investment
Unit 5 International Investing.
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Reference Books
International Finance: The Markets and Financial Management ofMultinational Business Mauric D.Levi, McGraw Hill Inc, Newyork (1990)
International Financial Management Dr.P.K.Jain & others, McMillan
Financial Management and Policy, James C Van Horne, Prentice Hall of IndiaPvt.Ltd.,New Delhi (1994)
Principles of Corporate Finance, Richard A Brealely, Stewart C.Myers,
McGraw Hill Book Company, Newyork (1988)
Management of Investments, Jack Clark Francies, McGraw Hill Inc (1993).
Modern Investments & Security Analysis, Russel J Fuller & fuller & James, L
Farrell Jr. McGraw Hill Inc.(1981).
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Foreign Exchange Markets
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Foreign ExchangeIt is the system or process of
converting one national currencyinto another, and of transferring
money from one country to another.
Dr. Paul Einzig
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Foreign ExchangeThe section of economic science
which deals with the means andmethods by which rights to wealth in
one countrys currency are converted
into rights to wealth in terms ofanother countryscurrency.
H.E. Evitt
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INTRODUCTION
Foreign exchange market: a market for converting the currency ofone country into the currency of another.
Exchange rate:
the rate at which one currency isconverted into another Foreign exchange risk: the risk that arises from changes in
exchange rates.
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THE FUNCTIONS OF THEFOREIGN EXCHANGE MARKET
The foreign exchange market serves twomain functions:
Convert the currency of one country intothe currency of another
Provide some insurance against foreignexchange risk
Foreign exchange risk: the adverseconsequences of unpredictable changes in theexchange rates.
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CURRENCY CONVERSION
Consumers can compare therelative prices of goods andservices in different countriesusing exchange rates.
International business have fourmain uses of foreign exchange
markets To exchange currency received in
the course of doing businessabroad back into the currency of itshome country.
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CURRENCY CONVERSION
To pay a foreign company for itsproducts or services in its countryscurrency
To invest excess cash for short terms
in foreign markets To profit from the short-term
movement of funds from onecurrency to another in the hopes of
profiting from shifts in exchangerates, also called currencyspeculation.
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THE NATURE OF THE FOREIGN
EXCHANGE MARKET
The foreign exchange market is a global network ofbanks, brokers and foreign exchange dealersconnected by electronic communications systems
The most important trading centers include: London,New York, Tokyo, and Singapore
Londons dominance is explained by:
History (capital of the first major industrializednation)
Geography (between Tokyo/Singapore andNew York)
Two major features of the foreign exchange market:
The market never sleeps Market is highly integrated
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FOREIGN EXCHANGE MARKETThe organizational setting within whichindividuals, businesses, government, and
banks buy and sell foreign currencies
and other debt instruments. It is an over-
the-counter market consisting of a global
network of inter-bank traders, primarily
the banks connected by
telecommunication facilities.
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TYPES OF FOREIGNEXCHANGE MARKETSInter-bank or wholesale market: Trading
between the banks where banks can obtainquotes, or they can contact brokers whosometimes act as intermediaries.
Retail market: It consists of travellers andtourists who exchange one currency to anotherin the form of travellers cheques or currencynotes. In retail markets, transaction size of retail
foreign exchange market is very small whereasthe spread between buying and selling prices islarge.
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Participants in the ForeignExchange
Market
Traders use forward contract to eliminate or cover the risk ofloss on export or import orders that are denominated inforeign currencies.
Hedgers are mostly multinational firms, engage in forwardcontracts to protect the home currency value of variousforeign currency-denominated assets and liabilities on theirbalance sheets that are not to be realized over the life of the
contracts.
Arbitrageurs seek to earn risk-free profits by takingadvantage of differences in interest rates among countries.They use forward contracts to eliminate the exchange risk
involved in transferring their funds from one nation to
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Exchange rate: The value of one currency in units of
another.
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EXCHANGE RATE QUOTATIONSSpot vs. Forward Quote
Spot rate: The price agreed for purchase or sale of foreign
currency with delivery and payment to take place not more
than two business days after the day the transaction has
been concluded.Forward rate: The price at which the foreign exchange
rate is quoted for delivery at a specified later date. The
date of maturity of a forward contract is more than two
business days in a future whereas the exchange rate is
fixed at the time of entering the contract.
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DIRECT VS. INDIRECT QUOTESDirect quotes: Units of the home currency per unit of a foreigncurrency.
For instance, Indian Rs. 39.5075 per US $ is a direct quote in Indiawhereas Yen 106.5050 per US $ is a direct quote in Japan.
Indirect quote: Units of foreign currency per unit of home currency.It may be arrived at by inversing the direct quote as follows:
Indirect quote = 1/direct quote
For instance, US$ 0.0253 per Indian Rupee is an indirect quote inIndia.
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Cross Rates
Sometime the value of a currency in terms ofanother currency may not be known directly.In such an event, one currency is sold for acommon currency and again the commoncurrency is exchanged for the desiredcurrency.
This is known as cross currency trading andthe rate established between the twocurrencies is known as the cross rate.
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An Indian corporate needs Canadian dollarsto buy Canadian goods, it is concerned about
the Canadian dollar relative to the Indianrupee. It receives a quote of USD/INR atRs.47.5010/47.6015 and a quote of USD/CADat 1.0367/1.0371.
Thus the rate of exchange between the rupeeand the Canadian dollar can be foundthrough the common currency the US dollar.
The technique is similar for both the spot andthe forward cross rates.
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BID VS. ASK QUOTATIONSBid rate: The price that a bank is willing to pay for a
foreign currency.
Ask or offer rate: The price at which a bank is willing to
sell the currency.
The bid-ask spread is the difference between the bid
and ask prices.
Bid/ask spread = (ask rate- bid rate)/ask rate
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Computation of Bid/Ask spread
The following are the q1uotes of the major currencies as on 23rd
June2010 at 12.30.
Calculate the spread percentage.
Bid/Ask spread = (Ask rate bid rate)/Ask rate X 100
Currency sell buy spread %
AUD/USD 0.8724 0.8726CAD/CHF 1.07 1.07
CAD/JPY 86.94 86.94EUR/CHF 1.3608 1.3611
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Dealings on the Foreign Exchange Market
Important types of transactions conducted in theforeign exchange market:
Spot and forward exchanges
Futures
Options
Swap operation
Arbitrage.
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In the spot market, foreign
exchange transactions arecompleted on the spot or
immediately.
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INSURING AGAINST FOREIGNEXCHANGE RISKA spot exchange occurs when two
parties agree to exchange currencyand execute the deal immediately
The spot exchange rate is the rate atwhich a foreign exchange dealerconverts one currency into anothercurrency on a particular day
Reported dailyChange continually
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Forward Market
In a forward market, contractsare delivered at a specifiedfuture date.
The rate of exchange applicable to theforward contract is called the forwardexchange rate and the market for
forward transaction is known as theforward market.
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INSURING AGAINST FOREIGNEXCHANGE RISK
Forward exchanges occur when two partiesagree to exchange currency and execute thedeal at some specific date in the future
Exchange rates governing such futuretransactions are referred to as forwardexchange rates
For most major currencies, forwardexchange rates are quoted for 30 days, 90days, and 180 days into the future.
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INSURING AGAINST FOREIGN
EXCHANGE RISK
When a firm enters into a forwardexchange contract, it is taking out
insurance against the possibility thatfuture exchange rate movements willmake a transaction unprofitable by the
time that transaction has beenexecuted.
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Forward exchange rate
With reference to its relationship with the spot
rate, the forward rate may be at par, discount
or premium.
At Par:
If the forward exchange rate quoted is exactly
equivalent to the spot rate at the time ofmaking the contract, the forward exchange
rate is said to be at par.
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At Premium:
The forward rate for a currency, say thedollar, is said to be at premium with respect
to the rate when one dollar buys more units
of other currency, say rupee, in the forwardthan in the spot market.
The premium is usually expressed as a
percentage deviation from the spot rate on a
per annum basis.
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At Discount:
The forward rate for a currency, say the
dollar, is said to be at discount with respect
to the spot rate when one dollar buys fewer
rupees in the forward than in the spotmarket.
The discount is usually expressed as apercentage deviation from the spot rate on
a per annum basis.
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The forward exchange rate is determined mostly by
the demand for and supply of forward exchange.
When the demand for forward exchange exceeds
its supply, the forward rate will be quoted at a
premium .
When the supply of forward exchange exceeds the
demand for it, the rate will be quoted at discount.
When the supply is equivalent to the demand for
forward exchange, the forward rate will be tend to
be at par.
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Forward cross rates
Here the selling rate of one currency is divided by
the buying rate of another currency and vice versa.
One month forward of two currencies are USD/INR
at 47.6010/47.9015 and that of USD/CAD at
1.1367/1.1371.
Determine the forward rate of Canadian dollar in
terms of the Indian rupee.
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Futures
Futures contracts have standardfeatures while a forward contract may
be customised.
Futures contract
It is the contract for buying and selling a
currency in the market for currency
futures.
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In terms of standardisation they havethe following characteristics:
1.The quantity, quality and the unit
price of the asset is clearlymentioned in the contract.
2.The date, month and place of
delivery3. The minimum amount and the time
duration by which the price wouldchange etc.
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Options
An option is a contract that gives theholder a right, without any obligation,
to buy or sell an asset, at an agreed
price, on or before a specified periodof time.
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Types of options
Call options
Put options
Call options:
An option to buy the underlying asset is known as acall option.
An option to sell the underlying asset is known as a
put option.
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The key provisions of the contract includes:
1.The number and type of common shares thatcan be purchased
2.The price at which the shares can be
purchased3.The last date at which they can be purchased4.Whether or not the shares can be purchased
only on the last date or on any date up to and
including the last date5.Who is obligated to sell the shares?
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Strike price
The price at which option can be exercised is called an exercise price or a strike
price.
Underlying asset
The asset on which the put or call option is created is referred to as the
underlying asset.
European option
When an option is allowed to be exercised only on the maturity date, is called a
European option.
American option
When the option can be exercised any time before its maturity, is called an
American option.
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INSURING AGAINST FOREIGN
EXCHANGE RISK
Currency swap: the simultaneous purchaseand sale of a given amount of foreign
exchange for two different value dates Swaps are transacted between international
businesses and their banks, between banks,and between governments when it is
desirable to move out of one currency intoanother for a limited period without incurring
foreign exchange risk .
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A common kind of swap is spot against forward. Consider a
company such as Apple Computer. Apple assembles laptop
computers in the United States, but the screens are made in
Japan.
Apple also sells some of the finished laptops in Japan. So, like
many companies, Apple both buys from and sells to Japan.
Imagine Apple needs to change $1 million into yen to pay its
supplier of laptop screens today. Apple knows that in 90 daysit will be paid 120 million by the Japanese importer that
buys its finished laptops.
It will want to convert these yen into dollars for use in the
United States. Let us say todays spot exchange rate is $1120 and the 90-day forward exchange rate is $1 110. Apple
sells $1 million to its bank in return for 120 million.
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Now Apple can pay its Japanese supplier. At the same time,
Apple enters into a 90-day forward exchange deal with its
bank for converting 120 million into dollars.
Thus, in 90 days Apple will receive $1.09 million (120
million/ 110 $1.09 million).
Since the yen is trading at a premium on the 90-day forward
market, Apple ends up with more dollars than it started with
(although the opposite could also occur).The swap deal is just like a conventional forward deal in one
important respect: It enables Apple to insure itself against
foreign exchange risk.
By engaging in a swap, Apple knows today that the 120million payment it will receive in 90 days will yield $1.09
million.
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Arbitrage:
Arbitrage is the simultaneous buying and
selling of foreign currencies with theintention of making profits from the
differences between the exchange rate
prevailing at the same time in different
markets.
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Assume the rate of exchange in London is 1= $ 2, while in New York 1 = $ 2.10.
This presents a situation wherein one can
purchase one sterling pound in London fortwo dollars and a yearn a profit of $ 0.10 by
selling the pound sterling in New York for $
2.10.
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International
Monetary System
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SIGNIFICANCE OF INTERNATIONAL FINANCEGlobalization has made understanding
international finance pertinent even to
business enterprises solely operating
domestically in order to assess the impact
of movements in exchange rates, foreign
interest rates, labour costs, and inflation onthe costs and prices of their foreign
competitors.
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The International MonetarySystem plays a crucial role inthe financial management of a
multinational business andeconomic and social policiesof each country.
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INTERNATIONAL MONETARY SYSTEMS
A set of rules, regulations, policies,
practices, instruments, institutions, and
mechanisms that determine exchange rates
between currencies.
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EVOLUTION OF THEIMS
Evolution of the InternationalMonetary System can be analysed infour stages:
The Gold Standard: 1875-1914
Inter-war Period: 1915-1944
Bretton Woods System: 1945-1972The Flexible Exchange Rate Regime:
1973-Present.
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THE GOLD STANDARD:1875-1914
The three important features of the goldstandard were: The government of each country defines its
national monetary unit in terms of gold.
There was two-way convertibility betweengold and national currencies at a stableratio.
Gold could be freely exported or imported. The exchange rate between twocountrys currencies would bedetermined by their relative gold
contents.
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GOLD STANDARD:1875-1914
For example, The United States declaredthe dollar to be convertible to at a rate of$ 20.67/ounce of gold. The British poundwas pegged at 4.2474/ounce of gold.
The dollar-pound exchange rate would bedetermined as:
$20.67/ounce of gold
4.2474/ounce of gold
= $4.86656/
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GOLD STANDARD:1875-1914
Highly stable exchange rates under thegold standard provided an environmentthat was conducive to international tradeand investment.
Misalignment of exchange rates andinternational imbalances of payment
were automatically corrected by theprice-specie-flow mechanism.
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PRICE-SPECIE-FLOW MECHANISM
Suppose Great Britain exported more to Francethan France imported from Great Britain.
This cannot persist under a gold standard.
Net export of goods from Great Britain to France willbe accompanied by a net flow of gold from France toGreat Britain.
This flow of gold will lead to a lower price level in
France and, at the same time, a higher price level inBritain.
The resultant change in relative price levels willslow exports from Great Britain and encourage
exports from France.
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The Inter-war period 1915-1944
The gold standard as an InternationalMonetary System worked well until WorldWar 1 interrupted trade flows and disturbed
the stability of exchange rates for currenciesof major countries.
There was widespread fluctuation incurrencies in terms of gold during World War1 and in the early 1920s.
I 1934 th U it d St t t d t difi d ld
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In 1934, the United States returned to a modified goldstandard and the US dollar was devalued from theprevious $20.67/ounce of gold to $35.00/ounce of gold.
The modified gold standard was known as the GoldExchange Standard.
Under this standard, the US traded gold only withforeign central banks, not with private citizens.
From 1934 till the end of World War II, exchange rateswere theoretically determined by each currencys valuein terms of gold.
World War II also resulted in many of the worlds majorcurrencys losing their convertibility. The only majorcurrency that continued to remain convertible was the
dollar.
Th h i i d
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Thus, the inter-war period wascharacterised by half-hearted
attempts and failure to restore thegold standard, economic andpolitical stabilities, widely
fluctuating exchange rates, bankfailures and financial crisis.The Great Depression in 1929 and
the stock market crash alsoresulted in the collapse of manybanks.
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BRETTON WOODS SYSTEM:1945-1972
Named for a 1944 meeting of 44 nationsat Bretton Woods, New Hampshire.
The purpose was to design a postwarinternational monetary system.
The goal was exchange rate stabilitywithout the gold standard.
The result was the creation of the IMFand the World Bank.
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BRETTON WOODS SYSTEM:1945-1972
Under the Bretton Woods system, theU.S. dollar was pegged to gold at $35 perounce and other currencies were pegged
to the U.S. dollar. Each country was responsible for
maintaining its exchange rate within 1%
of the adopted par value by buying orselling foreign reserves as necessary.
The Bretton Woods system was a dollar-based gold exchange standard.
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BRETTON WOODS SYSTEM:
1945-1972
German
markBritish
pound
French
franc
U.S. dollar
Gold
Pegged at
$35/oz.
Par
Value
INTERNATIONAL MONETARY FUND
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INTERNATIONAL MONETARY FUND
(IMF)
The IMF also known as the Fund, wasconceived at a UN Conference convened in
Bretton Woods, New Hampshire, US in July 1944
aimed to build a framework for economic
cooperation that would avoid a repetition of the
disastrous economic policies that had contributed
to the Great Depression of the 1930s.
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Objective
To promote exchange stability and orderlyexchange arrangements and to avoid
competitive devaluation.
Also it ensures devaluation is not used as aweapon of competitive trade policy.
However if a currency become too weak to
defend, a devaluation of up to 10% would beallowed without any formal approval of IMF.
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THE FLEXIBLE EXCHANGE RATE REGIME:1973-PRESENT.
Flexible exchange rates were declaredacceptable to the IMF members.
Central banks were allowed to intervene inthe exchange rate markets.
Gold was abandoned as an internationalreserve asset.
Non-oil-exporting countries and less-developed countries were given greateraccess to IMF funds.
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FLOATING EXCHANGE RATE SYSTEM
Currency prices are determined by market
demand and supply conditions without the
intervention of the governments.
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INDEPENDENT OR FREE FLOAT
The exchange rates are market-determined
and central banks intervene only to
moderate the speed of change or to prevent
excessive fluctuations without any attempt
to maintain it or drive it to a particular level.
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MANAGED FLOAT
Although currencies are allowed to
fluctuate on a daily basis with no official
boundaries, national governments
intervene to prevent their currencies
from moving too far in a certain direction.
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Pegged Exchange Rate System
In this system, currency values are fixed in relation to
another currency such as the U.S. dollar or euro.
Pegging value of home currency to a foreign currencyor a
basket of currencies and it is allowed to move in line with
that currency against other currencies.
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SOFT PEGSConventional fixed peg: The currency fluctuates for
at least three months within a band of less than 2
per cent or +/-1 per cent against another currency or
a basket of currencies.
Intermediate pegs
Pegs within horizontal bands: Currencies are
generally not allowed to fluctuate beyond +_1 per
cent of central parity.
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Crawling Peg: A currency is pegged to
a single currency or a basket of
currencies, but the peg is periodicallyadjusted with a range of less than 2
per cent in response to changes in
selective macro-economic indicators.
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EUROPEAN MONETARY SYSTEMEleven European countries maintain
exchange rates among their currencieswithin narrow bands, and jointly floatagainst outside currencies.
Objectives:To establish a zone of monetary stability
in Europe.
To coordinate exchange rate policies vis--vis non-European currencies.To pave the way for the European
Monetary Union.
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WHAT IS THE EURO?
The euro is the single currency ofthe European Monetary Union which
was adopted by 11 Member Stateson 1 January 1999.
These original member states were:
Belgium, Germany, Spain, France,Ireland, Italy, Luxemburg, Finland,Austria, Portugal and the
Netherlands.
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EURO CONVERSION RATES1 Euro is Equal to:
40.3399 BEF Belgian franc
1.95583 DEM German mark
166.386 ESP Spanish peseta
6.55957 FRF French franc
.787564 IEP Irish punt
1936.27 ITL Italian lira
40.3399 LUF Luxembourg franc
2.20371 NLG Dutch gilder
13.7603 ATS Austrian schilling
200.482 PTE Portuguese escudo
5.94573 FIM Finnish markka
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WHAT IS THE OFFICIAL SIGN OF THEEURO? The sign for the new single currency
looks like an E with two clearlymarked, horizontal parallel lines across
it.
It was inspired by the Greek letter
epsilon, in reference to the cradle ofEuropean civilization and to the first
letter of the word 'Europe'.
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WHAT ARE THE DIFFERENT DENOMINATIONS OFTHE EURO NOTES AND COINS ? There are be 7 euro notes and 8 euro
coins.
The notes are: 500, 200, 100, 50,20, 10, and 5.
The coins will be: 2 euro, 1 euro, 50 eurocent, 20 euro cent, 10, euro cent, 5 eurocent, 2 euro cent, and 1 euro cent.
The euro itself is divided into 100 cents,just like the U.S. dollar.
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THE MEXICAN PESO CRISIS On 20 December, 1994, the Mexican
government announced a plan to devaluethe peso against the dollar by 14 percent.
This decision changed currency tradersexpectations about the future value of thepeso.
They stampeded for the exits.
In their rush to get out the peso fell by asmuch as 40 percent.
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THE ASIAN CURRENCY CRISIS The Asian currency crisis turned out to
be far more serious than the Mexicanpeso crisis in terms of the extent of the
contagion and the severity of theresultant economic and social costs.
Many firms with foreign currency bonds
were forced into bankruptcy. The region experienced a deep,
widespread recession.
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Exchange rate determination
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ECONOMIC THEORIES OFEXCHANGE RATE DETERMINATION Exchange rates are determined by the
demand and supply of one currency relativeto the demand and supply of another.
Price and exchange rates:Law of One Price
Purchasing Power Parity (PPP)
Money supply and price inflation Interest rates and exchange rates.
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LAW OF ONE PRICE In competitive markets free of
transportation costs and trade barriers,identical products sold in different
countries must sell for the same pricewhen their price is expressed in termsof the same currency
Example: US/French exchange rate: $1= .78Eur
A jacket selling for $50 in New Yorkshould retail for 39.24Eur in Paris
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PURCHASING POWER PARITYBy comparing the prices of
identical products in differentcurrencies, it should be possible todetermine the PPP exchange rate -
if markets were efficient.
In relatively efficient markets (few
impediment to trade andinvestment) then a basket ofgoods should be roughly
equivalent in each country.
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PPP
In the absence of government control, exchange ratebetween two currencies is determined by the pricelevels in the respective countries.
While the value of the unit of one currency in terms
of another currency is determined at any particulartime by the market conditions of demand and supply,in the long run, that value is determined by therelative values of the two currencies as indicated by
their relative purchasing power over goods andservices(in their respective countries).
According to purchasing power parity theory, the
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exchange rate between one currency and another isin equilibrium when their domestic purchasingpowers at the rate of exchange are equivalent.
Example: a particular bundle of goods in India costsRs.48 and the same in USA costs $ 1. Then theexchange rate will be in equilibrium if the exchange
rate is $ 1 = Rs.48.00. If the exchange ranges to $ 1 =50 when the purchasing powers of these currenciesremain stable, dollar holder will convert dollars intorupees because, by doing so, they can save Rs.2
when they purchase a commodity worth $ 1. This willincrease the demand for the Indian currency and thesupply of dollars will increase in the foreignexchange market and ultimately, the equilibrium rateof exchange will be re-established.
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MONEY SUPPLY AND INFLATION PPP theory predicts that changes in relative
prices will result in a change in exchangerates.
A country with high inflation should expectits currency to depreciate against thecurrency of a country with a lower inflationrate.
Inflation occurs when the money supplyincreases faster than output increases.
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INTEREST RATES ANDEXCHANGE RATESTheory says that interest rates
reflect expectations about
future exchange rates.
Fisher Effect.
International Fisher Effect.
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Fisher Effect (FE) Theory
An American economist, Irving Fisherintroduced this theory. He bifurcatedthe nominal interest into two parts the real interest rate and the expectedrate of inflation and the relationshipbetween these two fundamentals is
known as the Fisher effect.The nominal interest rate is theamalgam of real interest rate and the
inflation rate.
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Fisher effect can be expressed as follows:
1 + r = (1 + ) (1 + I)
Where r = nominal interest rate
= real interest rate
I = expected rate of inflation.
Example : Suppose, the required real interest rate is 5% and
the expected rate of inflation is 8%, calculate the required
nominal interest rate.
1 + r = (1 + 0.05) (1 + 0.08)
r = 13.40%
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Fisher Effect (FE) Theory
The nominal interest rate r in a country is
determined by the real interest rate R and the
expected inflation rate i as follows:r = R + i
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Fisher Effect:
The proportion that the nominalinterest rate varies directly with theexpected inflation rate, known as theFisher effect.
International Fisher Effect:
The relationship between thepercentage change in the spot
exchange rate over time and thedifferential between comparableinterest rates in different national
capital markets is known as the INTERNATIONAL FISHER EFFECT (IFE)
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THEORYThe exchange rate movements are caused
by interest rate differentials. If real interest
rates are the same across the country, any
difference in nominal interest rates could
be attributed to differences in expected
inflation.
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The IFE theory suggests that the
spot rate will change inaccordance with the interest ratedifferentials.
The PPP theory suggests that thespot rate will change in
accordance with inflation ratedifferentials.
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Interest Rate Parity Theory (IRP)
The interest rate parity theory states thatequilibrium is achieved when the forward ratedifferential is approximately equal to the
interest rate differential.
The IFE states that the interest rate differentialshall equal the inflation rate differential .
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OTHER DETERMINANTS OF EXCHANGE RATESIn addition to inflation, real income and interest
rates, market fundamentals that influence the
exchange rates include bilateral trade
relationships, customer tastes, investment
profitability, product availability, productivity
changes and trade policies.