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1 International Monetary System - History ü Fixed Exchange Rates & Gold Standard, WWII - 1971 ü Floating Exchange Rates, 1971 - Present.

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Presentation on theme: "1 International Monetary System - History ü Fixed Exchange Rates & Gold Standard, WWII - 1971 ü Floating Exchange Rates, 1971 - Present."— Presentation transcript:

1 1 International Monetary System - History ü Fixed Exchange Rates & Gold Standard, WWII - 1971 ü Floating Exchange Rates, 1971 - Present

2 2 Floating Exchange Rates, 1971 - Present ü Supply of $’s in International Markets: –Imports –American Travel Abroad –U.S. Government Aid –Payment of Interest, Dividend & Profits abroad –Speculation

3 3 Floating Exchange Rates, 1971 - Present ü Demand for $’s in International Markets –Exports –Foreign Travel to U.S. –Foreign Investment in U.S. –Receipt of Interest, Dividends & Profit –Speculation

4 4 Floating Exchange Rates, 1971 - Present ü Key Determinants –Relative Interest Rates –Relative Inflation Rates –Relative Economic Growth Rates

5 5 Key Currency Cross Rates Late New York Trading Monday, January 6, 2003 DollarEuroPoundSFrancPesoYenCdnDlr Canada1.55961.63262.50811.1206.14991.01309… Japan119.16124.74191.6385.61711.454…76.406 Mexico10.403710.890616.7317.4750….087316.6708 Switzerland1.39181.45692.2383….13378.01168.8924 U.K..62180.6509….4468.05977.00522.39871 Euro.95530…1.5363.68638.09182.00802.61253 U.S.…1.04681.6082.71850.09612.00839.64120 Source: Reuters

6 6 Exchange Rates The foreign exchange mid-range rates below apply to trading among banks in amounts of $1 million and more, as quoted at 4 p.m. Eastern time by Reuters and other sources. Retail transactions provide fewer units of foreign currency per dollar. U.S. $ Equivalent Currency Per U.S. $ CountryMonFriMonFri Argentina (Peso)-y.3008.30033.32453.3300 Canada (Dollar).6412.63911.55961.5647 1-month forward.6405.63831.56131.5667 3-month forward.6389.63671.56521.5706 6-month forward.6364.63431.57131.5765

7 7 Exchange Rates U.S. $ Equivalent Currency Per U.S. $ CountryMonFriMonFri Chile (Peso).001403.001401712.76713.78 Ecuador (US Dollar)1.0000 Japan (Yen).008392.008352119.16119.73 1-month forward.008402.008362119.02119.59 3-month forward.008420.008380118.76119.33 6-month forward.008449.008409118.36118.92 Mexico (Peso) Floating rate.0961.096210.403710.3928 Switzerland (Franc).7185.71481.39181.3990

8 8 Exchange Rates U.S. $ Equivalent Currency Per U.S. $ CountryMonFriMonFri U.K. (Pound)1.60821.6094.6218.6213 1-month forward1.60441.6058.6233.6227 3-month forward1.59811.5993.6257.6253 6-month forward1.58831.5895.6296.6291

9 9 Exposures To Foreign Currency Risk ü Economic Exposure ü Transactions Exposure ü Translation Exposure

10 10 Economic Exposure Original Impact of Exchange Rate Movements on Earnings: Madison Inc. (in millions) C$ = $.75C$ = $.80C$ = $.85 Sales (1) U.S. $300 $304 $307 (2) CanadianC$4 = $ 3C$4 = $ 3.2C$4 = $ 3.4 (3) Total $303 $307.2 $310.4 Cost of goods sold (4) U.S. $ 50 (5) CanadianC$200 = $150C$200 = $160C$200 = $170 (6) Total $200 $210 $220 (7) Gross profit $103 $ 97.2 90.4

11 11 Economic Exposure Original Impact of Exchange Rate Movements on Earnings: Madison Inc. (in millions) Source: J. Madura, International Financial Management Operating expenses (8) U.S.: Fixed $ 30 (9) U.S.: Variable (10% of total sales) $ 30.3 $ 30.72 $ 31.04 (10) Total $ 60.3 $ 60.72 $ 61.04 (11) Earnings before interest and taxes $ 42.7 $ 36.48 $ 29.36 Interest expense (12) U.S. $ 3 (13) CanadianC$10 = $ 7.5C$10 = $ 8C$10 = $ 8.5 (14) Total $ 10.5 $ 11 $ 11.5 (15) Earnings before taxes $ 32.2 $ 25.48 $ 17.86

12 12 Transactions Exposure Methods to Deal with Foreign Exchange Risk POSITION in FOREIGN CURRENCY (FX) EXPECTED FOREIGN CURRENCY (FX) CHANGE DEPRECIATIONAPPRECIATION “LONG” EXPECTED RECEIPTS (e.g. AR) NET ASSET POSITION Invoice Policy Accelerate Collections Sell Forward or Futures contract to deliver FX for $s at forward/future rate and time Borrow FX from foreign bank, convert to $s, invest in U.S. Buy Currency Put Options “SHORT” OBLIGATIONS (e.g. AP) NET LIABILITY POSITION Invoice Policy Accelerate Payments Buy a Forward or Futures contract to purchase FX for $s at the forward/futures rate and time. Use case or borrow U.S. $s, convert and buy foreign securities. Buy Currency Call Option

13 13 International Capital Budgeting K=20% YEAR0 1 2 3 CF’S (FCU’S) (390 FCU’S) 80 FCU’S 300 FCU’S 225 FCU’S PRESENT VALUE FACTOR1.0.8333.6944.5790 ----------------------------------------------------------------------------------------------------------- PRESENT VALUE (390) 66.66 208.32 130.275 NET PRESENT VALUE (FCU’S)15.255YES, ACCEPT ------------------------------------------------------------------------------------------------------------------------------------------------------- SCENARIO I Foreign currency Converted to U.S. Dollars (Depreciation of FCU, APPRECIATION OF $) Exchange Rate1.0 FCU’S/$ 1.1 1.25 1.35 CF’S ($) (390) $72.72 $240.00 $166.67 PV of CF’S ($) (390)60.60 166.66 96.50 ---------------------------------------------------------------------------------------------------------- NET PRESENT VALUE ($)(66.24)NO, REJECT SCENARIO II Appreciation of FCU, Depreciation of $ Exchange Rate1.0 FCU’S/$.9.85.8 PV OF CF’S ($)(390)$74.07 $245.08 $162.84 ---------------------------------------------------------------------------------------------------------- NET PRESENT VALUE ($)91.99YES, ACCEPT

14 14 Translation Exposure Translation of Subsidiary’s Financial Statements under FASB-52 Rules (figures in thousands) Assets Value in Functional Currency FASB-52 Translation Rates Translation To U.S. Dollars Under FASB-52 Cash4,000Current, $1.50$6,000 Inventory6,000Current; $1.509,000 Fixed assets10,000Current; $1.5015,000 Total Assets 20,000$30,000

15 15 Translation Exposure Translation of Subsidiary’s Financial Statements under FASB-52 Rules (figures in thousands) Liabilities and equity Accounts payable2,000Current; $1.503,000 Long-term debt10,000Current; $1.5015,000 Common Stock5,000Historical; $2.0010,000 Retained earnings3,000Forced2,000 Total liabilities and equity 20,000$30,000 -3,100 (Cumulative Translation Account) +5,100 (Accumulated Earnings)

16 16 Translation Exposure Translation of Subsidiary’s Financial Statements under FASB-52 Rules (figures in thousands) Income Statement Sales12,000Weighted avg.; $1.7020,400 - Cost of Sales8,000Weighted avg.; $1.70 13,600 Gross profit4,000 6,800 - Operating expenses1,000Weighted avg.; $1.70 1,700 Operating profit3,000 5,100 Gain on translation Net income 3,000 5,100 Source: J. Madura, International Financial Management

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