Welcome to class offinancial forces

byDr. Satyendra Singh

University of WinnipegCanada

Learning Objectives

Foreign exchange (FX) terminology Foreign exchange rates Currency fluctuations Exchange rate forecasting Currency exchange controls How financial forces such as tariffs, taxes, inflation and

the balance of payments can affect international business

Objectives:

Foreign Exchange Terminology Foreign Exchange Quotation

The price of one currency expressed in terms of another

Reported in the world’s currency exchange markets

Central reserve asset Asset (currency) held by a government’s central bank

Vehicle currency Used as a vehicle for international trade or investment

Intervention currency Used by a country to intervene in the foreign currency

exchange markets, often to buy (strengthen) its own currency

Exchange Rates…

Spot rates The exchange rate between two currencies for delivery within two

business days

Forward currency market Trading market for currency contracts deliverable 30, 60, 90, or 180

days in the future

Forward rate The exchange rate between two currencies for delivery in the future,

usually 30, 60, 90, or 180 days

Exchange Rates… Trading at a premium A currency’s forward rate quote is stronger than the spot rate

Trading at a discount A currency’s forward rate quotes is weaker than the spot rate

Premium or a discount depends on the expectations of the world financial community, businesses, individuals, and governments about what the future will bring

Exchange Rates

Cross Rates

Currency exchange rates for trading directly between non-U.S. dollar

currencies

Bid price

Price offered to buy

Ask price

Sales price

Influences of Exchange Rate Fluctuation

Supply and demand of the currency

Interest rates

Inflation

Expectations

Exchange Rate Fluctuation…

Monetary policies Government policies that control the amount of money in circulation and its

growth rate Fiscal policies

Policies that address the collecting and spending of money by the government

Law of one price Concept that in an efficient market, like products will have like prices

Arbitrage The process of buying and selling instantaneously to make profit with no risk

Exchange Rate Fluctuation Fisher effect

The relationship between real and nominal interest rates: the real interest rate will be the nominal interest rate minus the expected rate of inflation

International Fisher effect Concept that the interest rate differentials for any two currencies will

reflect the expected change in their exchange rates Purchasing Power Parity (PPP)

Theory that predicts that currency exchange rates between two countries should equal the ratio of the price levels of their commodity baskets

Exchange Rate Forecasting…

Efficient market approach Assumption that current market prices fully reflect all available

relevant information

Random walk hypothesis Assumption that the unpredictability of factors suggests that

the best predictor of tomorrow’s prices is today’s prices

Exchange Rate Forecasting

Fundamental approach Exchange rate prediction based on econometric models

that attempt to capture the variables and their correct relationships

Technical analysis An approach that analyzes data for trends and then

projects these trends forward

Currency Exchange Controls…

Government controls that limit the legal uses of a currency in international transactions

Value of currency is arbitrarily fixed at a rate higher than its market value

If you see “official rate” next to a currency rate quotation, that country has currency exchange controls in place

Currency Exchange Controls

A black market typically surfaces as a result of currency exchange controls

However, this type of currency exchange transaction is illegal

The black market is rarely able to accommodate transactions of the size involved in international business

Tariffs

Tariffs

Taxes, usually on imported goods

May be ad valorem, specific, compound, or variable

Taxation

Income tax• Direct tax on personal and corporate income

Value-added tax (VAT)• A tax charged on the value added to a good as it moves

through production from raw materials to final purchaser Withholding tax

• Indirect tax levied on passive income that the corporation would pay out to non residents

Corporate Tax Rates

Inflation A trend of rising prices

May be caused by demand exceeding supply May be caused by an increase in the money supply

Measured by consumer price index (CPI) Basket of consumer goods

Gross domestic product deflator--OECD Takes into account the prices of intermediate goods and services

Inflation and the International Company.. High inflation rates Make capital expenditure planning more difficult Cause the cost of goods and services to rise Tend to cause BOP deficits Could lead to more restrictive fiscal or monetary policies, currency controls,

export incentives, and import obstacles Encourage borrowing because the loan will be repaid with cheaper money Bring high interest rates Discourage lending Make capital expenditure planning more difficult

Balance of Payments (BOP)

The state of a nation’s BOP reveals the state of that country’s economy

If the BOP is slipping into deficit

the government is probably considering one or more market or nonmarket measures to correct or suppress that deficit Currency devaluation or restrictive monetary or fiscal

policies to induce deflation are likely

Currency or trade controls may be near