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International Business Strategy, Management


Chapter 10 The International Monetary and Financial Environment International Business Strategy, Management & the New Realities by Cavusgil, Knight and Riesenberger – PowerPoint PPT presentation

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Title: International Business Strategy, Management

International BusinessStrategy, Management the
New Realities by Cavusgil, Knight and
  • Chapter 10
  • The International Monetary and Financial

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
  • currency relative to another, complicating
  • 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

The Four Risks of International Business
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

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
  • In 1979-1983, some 90 billion left Mexico when
    foreign lenders lost confidence in the Mexican
    economy and investors withdrew their investments

Foreign Exchange Markets
  • Foreign exchange all forms of internationally-tra
  • monies including currency, bank deposits, checks,
  • electronic transfers.
  • Foreign exchange market the global marketplace
  • buying and selling national currencies
  • Exchange rates fluctuate constantly. E.g.,
  • exchange rate
  • 1985 - 240 yen to the U.S. dollar.
  • 1988 - 125 yen to the dollar (nearly 50
  • 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

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

Factors That Influence the Supply and Demand of
a Currency
  • Economic growth
  • Interest rates and inflation
  • Market psychology
  • Government action

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

2. Interest Rates and Inflation
  • Inflation a rise in the prices of goods and
  • Reduces the purchasing power of the affected
  • 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.

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

Valuation of Currency Affects Trade Surplus or
  • Trade surplus countrys exports exceed its
    imports may result when currency is
  • 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.

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

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.

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.

Monetary and Financial Systems
  • International monetary system the institutional
    framework, rules, and procedures by which
    national currencies are exchanged for one
  • 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

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.,

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

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