1. Chapter 10 The International Monetary and Financial Environment
International Business Strategy, Management & the New Realities by Cavusgil, Knight and Riesenberger
International Business: Strategy, Management, and the New Realities

2. 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
International Business: Strategy, Management, and the New Realities

4. International Business: Strategy, Management, and the New Realities
Currency Risk
Currency risk arises from changes in the price of one
currency relative to another, complicating international
transactions. Issues:
● Currency exposure
● Asset valuation
● Foreign taxation
● Inflationary and transfer pricing
For example,
If a supplier’s currency appreciates, you pay a larger amount of your currency for your purchase.
If a foreign buyer’s currency depreciates, you receive a smaller payment amount in your currency
International Business: Strategy, Management, and the New Realities

5. The Four Risks of International Business

6. 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
International Business: Strategy, Management, and the New Realities

7. International Business: Strategy, Management, and the New Realities
Capital Flight
Capital flight: The (often rapid) sale of holdings in a nation’s 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 country’s ability to service debt/ pay for imports.
In , some $90 billion left Mexico when foreign lenders lost confidence in the Mexican economy and investors withdrew their investments
International Business: Strategy, Management, and the New Realities

8. Foreign Exchange Markets
Foreign exchange: all forms of internationally-traded
monies including currency, bank deposits, checks, and
electronic transfers.
Foreign exchange market: the global marketplace for
buying and selling national currencies
Exchange rates fluctuate constantly. E.g., yen-dollar
exchange rate:
yen to the U.S. dollar.
yen to the dollar (nearly 50% appreciation).
Result: Decrease in Japanese exports to U.S.; Increase in
U.S. exports to Japan
International Business: Strategy, Management, and the New Realities

10. 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
International Business: Strategy, Management, and the New Realities

11. 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
International Business: Strategy, Management, and the New Realities

12. Factors That Influence the Supply and Demand of a Currency
Economic growth
Interest rates and inflation
Market psychology
Government action
International Business: Strategy, Management, and the New Realities

13. International Business: Strategy, Management, and the New Realities
1. Economic Growth
The increase in value of the goods and services
produced by an economy.
Typically measured as the annual increase in real GDP.
Innovation and entrepreneurship drive business activity and demand.
International Business: Strategy, Management, and the New Realities

14. 2. Interest Rates and Inflation
Inflation: a rise in the prices of goods and services.
Reduces the purchasing power of the affected currency
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
International Business: Strategy, Management, and the New Realities

16. International Business: Strategy, Management, and the New Realities
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.
International Business: Strategy, Management, and the New Realities

17. International Business: Strategy, Management, and the New Realities
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 nation’s Central Bank, by buying and selling currency in the foreign exchange market
International Business: Strategy, Management, and the New Realities

18. Valuation of Currency Affects Trade Surplus or Deficit
Trade surplus: country’s exports exceed its imports; may result when currency is undervalued.
Trade deficit: nation's imports exceed its exports, causing net outflow of foreign exchange.
Balance of trade: difference between the value of a nation’s exports and its imports.
International Business: Strategy, Management, and the New Realities

19. 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
International Business: Strategy, Management, and the New Realities

20. 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.
International Business: Strategy, Management, and the New Realities

21. 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.
International Business: Strategy, Management, and the New Realities

22. Monetary and Financial Systems
International monetary system: the institutional framework, rules, and procedures by which national currencies are exchanged for one another.
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
International Business: Strategy, Management, and the New Realities

23. 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., euro
International Business: Strategy, Management, and the New Realities

24. 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 sectors.
International Business: Strategy, Management, and the New Realities