2. 11 Financial Forces International Business by Ball, McCulloch, Frantz,
This chapter covers:
The foreign exchange markets
Foreign exchange quotations
Currency exchange risks
Currency exchange controls
How financial forces affect business
Sovereign debt
Small business in a developing country
Financial Forces
International Business
by Ball, McCulloch, Frantz,
Geringer, and Minor
McGraw-Hill/Irwin
Copyright © The McGraw-Hill Companies, Inc. All rights reserved.

3. Chapter Objectives
Realize that money is made, and lost, in the foreign exchange markets
Understand foreign exchange quotations, including cross rates
Recognize currency exchange risks
Understand currency exchange controls
Understand financial forces that affect business
Explain sovereign debt, its causes, and its solutions
Recognize the role of small business in a developing country
11-2

4. Uncontrollable Financial Forces
Foreign Currency Exchange Risks
National Balances of Payment
Taxation
Tariffs
National monetary and fiscal policies
Inflation
National business accounting rules
11-4

5. Fluctuating Currency Values
Most currencies in the world are free to fluctuate against each other
Fluctuations may be quite large
Financial managers must understand how to protect against losses or optimize gains
Another risk is encountered when a national suspends or limits convertibility of its currency
International currency exchange quotes can be found in business publications
11-5

6. Foreign Exchange Quotations
In the world’s currency exchange markets
the U.S. dollar is the common unit being exchanged for other currencies
Reasons for the continued central position of the U.S. dollar include that the U.S. dollar
is the main central reserve asset of many countries
is the most used vehicle currency and intervention currency
is in great demand worldwide as a result of its safe haven aspect and its universal acceptance
11-6

7. Foreign Exchange Quotations
Exchange Rates
By using the reciprocal of the US$ equivalent rate, the currency per US$ rate can be reached and vice versa. 1
US$ equivalent rate = currency per US$ rate
currency per US$ rate = US$ equivalent rate
11-7

8. Exchange Rates Spot rates Forward rate
The exchange rate between two currencies for delivery within two business days
Forward rate
The exchange rate between two currencies for delivery in the future.
Commonly 30, 60, 90, or 180 days
11-8

9. Exchange Rates Trading at a premium
When a currency’s forward rate quotes are stronger than spot
Trading at a discount
When a currency’s forward rate quotes are weaker than spot
Premium or a discount depends on the expectations of the world financial community, businesses, individuals, and governments about what the future will bring
11-9

10. Exchange Rates Cross Rates
Currency exchange rates directly between non-U.S. dollar currencies
Use of the Japanese yen and European euro is increasing
11-10

11. 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
11-11
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 a multinational business

12. Balance of Payments (BOP)
The state of a nation’s BOP can tell about 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
11-12

13. BOP If BOP slipping into deficit
Companies may want to start shopping for export incentives
Export incentives include
tax breaks, lower-cost financing, foreign aid, and other government related incentives to make exporting easier and more profitable
11-13

14. Taxation Tariffs and duties used interchangeably
Taxes on imported goods
Important for business to minimize them
Many tariffs have been lowered or abolished world wide
If a business can lower taxes, it can lower prices to customers
11-14
Taxation in different countries
Income tax is generally the biggest revenue earner for governments
Other types of taxes include
sales or value-added taxes on goods or services
capital gains taxes, property taxes, and social security

15. Inflation Inflation’s Effects on Interest Rates
The inflation rate determines the real cost of borrowing
Real interest rates are found by subtracting inflation from the nominal interest rates
When borrowed money is repaid in the future after inflation, it is worth that much less to the lender
11-15

16. Inflation Monetary and Fiscal Policies Affect Inflation
Monetary policies
control the amount of money in circulation, whether it is growing, and, if so, at what pace
Fiscal policies
address the collecting and spending on money by governments
11-16

17. Inflation and the International Company
High inflation rates
Encourage borrowing because the loan will be repaid with cheaper money
Bring high interest rates
Discourage lending
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
11-17

18. Accounting Practices Vary widely from country to country
Must use host country’s practices then translate into home country practices
U.S. uses Financial Accounting Standards Board
Establishes GAAP
Rule based
Rest of the world follows International Accounting Standards Board
Principle based
11-18

19. Countries Went Bust
The sovereign debt crisis surfaced during the 1980s
Poland’s sovereign debt crisis occurred in 1981
The sovereign debt crisis for Mexico, Brazil, Argentina, and others occurred in 1982 and later
IMF took lead in resolving these crises, BIS made bridge loans in the interim
The immediate causes of the growing country debts were the jumps in oil prices
11-19

20. Debt Problem Solutions
Short-Term Solutions
Rescheduling of debts that countries were unable to pay as they came due
Renegotiations are becoming more difficult
BIS, commercial banks, and central banks are reluctant to come up with more money
IMF’s resources are limited
11-20
Long-Term Solutions
The Baker Plan
Market-oriented strategies to encourage growth and bring inflation under control
The Brady Plan
Private banks with money backed by funds from IMF, World Bank, and developed country governments

21. Debt Problem Solutions
The three mechanisms of the Brady debt relief
The exchange of old debt for new at a discount
The exchange of old debt for new at a lower interest rate
The buying back of debt from creditor banks at a discount
This mechanism has resulted in debtor countries buying their own debt and retiring it
11-21

22. Debt Problem Solutions
The Paris Club, which is a group of Western creditor governments
forgave half of Poland’s debt ($17.5 billion)
The U.S. forgave the Egyptian debt
as an expression of thanks for Egypt’s support in the war against Iraq
11-22
The World Bank, the IMF, and the Paris Club
approved a plan to relieve the massive debt load of some of the world’s most heavily indebted poor countries (HIPC)
Assistance can be defended on a humanitarian basis
Most of these countries are in sub-Saharan Africa

23. United States in Debt Net negative international investment position
is the difference between the value of overseas assets owned by Americans and the value of U.S. assets owned by foreigners
Differences in U.S. debt
First, over $300 billion of the U.S. foreign-owned assets are obligations of the U.S. Treasury or U.S. corporations traded daily in world financial markets
Second, U.S. foreign assets are often measured at book value which results in an estimated undervaluation of up to $200 billion
Third U.S. assets abroad reportedly earn more in interest and dividend per dollar of investment than foreign holdings earn in America
Fourth, It is denominated in U.S. dollars
11-23

24. Sample Rates Bid vs. Offer
AUD/USD
BID
0.6979
OFFER
0.6989
EUR/CHF
1.5447
1.5457
EUR/CZK
EUR/DKK
7.4375
7.4395
EUR/GBP
EUR/JPY
133.68
133.78
EUR/USD
GBP/CHF
GBP/JPY
196.57
196.77
11-24

25. Australian Currency
11-25

26. BOP Data -- 2000 ($millions)
U.S. BOP 2002
Category
Receipts
Payments
Net 
I. Current Account
A. Merchandise Account (Exports/Imports)
848,678
-1,224,417
-375,739
B. Income Account (Rents, Interest, Profits)
352,866
-367,658
-14,792
C. Transfers
-54,136
Current Account Balance
-444,667
II. Capital Account
A. Foreign Investment in the U.S.
1,024,218
B. U.S. Investment Abroad
-580,952
C. Statistical Discrepancy
1,401
Capital Account Balance
444,667
III. Balancing Account (Official Reserve Transfers)
Source: Economic Report of the President 2002

27. U.S. Inflation Rates per CPI & RPI
Retail Price Index
Consumer Price Index
11-27

28. List of 41 highly indebted poor countries
Angola Benin Bolivia Burkina Faso Burundi Cameroon Central African Republic Chad Congo Congo, Dem Rep. Côte d'Ivoire Ethiopia The Gambia Ghana Guinea Guinea-Bissau Guyana Honduras Kenya Lao PDR Liberia
Madagascar Malawi Mali Mauritania Mozambique Myanmar Nicaragua Niger Rwanda Sierra Leone São Tomé Principe Senegal Somalia Sudan Tanzania Togo Uganda Vietnam Yemen, Rep. of Zambia