1. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three chapter six Concept Preview After reading this chapter, you should be able to: 1. realize that much money is made and lost in the foreign currency exchange (Fx). 2. understand Fx quotations including cross rates. 3. recognize currency exchange risks. 4. expect currency exchange controls. 5. anticipate financial forces such as balance of payments, tariffs, taxes, inflation, fiscal and Monterey policies, and differing accounting practices that affect business. Financial Forces

2. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three chapter six Concept Preview continued After reading this chapter, you should be able to: 6. understand sovereign debt, its causes, and its solutions. 7. know that a Third World vegetable stand might be a better credit risk than a Third World government. 8. know that the U.S. has a net negative international investment position. Financial Forces

3. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three 6-3 Financial Forces  Tariffs, customs or import duties  Taxation  Inflation  Accounting practices  Debt  Fluctuating currency values  Foreign exchange quotations  Exchange rate risks  Currency exchange controls  Balance of payments

4. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three Financial Forces  Fluctuating currency values  values change  Foreign exchange quotations  use of US$  forward rates for Britain, Canada, France, Japan, Switzerland, Germany  premium trade vs. discount 6-4

5. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three Key Currency Cross Rates late New York trading June 4, 1997 CountryDollarPoundSfrancGuilderPesoYenLiraD-MarkFfrancCdnDlr Canada1.37632.2478.95246.70768.17378.01184.01184.79670.23609— France5.82959.52074.03432.9975.72605.05015.003443.3745—4.2356 Germany1.72752.82141.1955.88827.21812.01486.00102—.296341.2552 Italy1697.02771.51174.4872.58214.2714.598—982.34291.111233.0 Japan116.25189.86 80.4559.77514.678—.0685067.29419.94284.466 Mexico7.920012.9355.48104.0724—.06813.004674.58471.35865.7546 Netherlands1.94483.17621.3459—.24556.01673.001151.1258.333611.4131 Switzerland1.44502.3600—.42373.31484.07731.00527.00036.35444.10503 UK.61229—.42373.31484.07731.00527.00036.35444.10503.44488 US—1.6332.69204.51419.12626.00860.00059.57887.17154.72659 Source: Dow Jones Source: The Wall Street Journal, June 5, 1997, p. C24 6-5 Table 6.1

6. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three Exchange Rates Tuesday, June 4, 1997 — Sample data U.S. $ equiv.Currency per U.S. $ CountryWedTueWedTue Argentina (peso)1.00141.0014.9986.9986 Britain (pound)1.63321.6347.6123.6117 1-month forward1.63211.6336.6127.61223- months forward1.62981.6314.6136.61306- months forward1.62681.6285.6147.6141 China (renminb).1202.12028.32158.3219 Commercial rate.03040.0303132.90032.991 Ecuador (sucre) — ——— Floating rate.0002556.00025623,912.503,902.50 Israel (shekel).2934.29363.40783.4058 Kuwait (dinar)3.30143.3025.3029.3028 Netherlands (guilder).5142.51451.94481.9435 Singapore (dollar).6989.69881.43081.4310 South Africa (rand).2236.22364.47304.4715 Spain (peseta).006853.006856145.93145.85 SDR1.38371.3876.7227.7207 ECU1.12931.1299—— Source: The Wall Street Journal, June 5, 1997, p. C24. 6-6 Figure 6.2

7. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three 6-7 Exchange Rates and Risks  Spot rate  exchange rate between two currencies for delivery within two business days  Forward rate  exchange rate between two currencies for delivery in the future, commonly 30, 60, 90, or 180 days  Transaction—risk of value change  Translation risk

8. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three 6-8 Currency Exchange Controls  Government controls that limit the legal uses of a currency in international transactions  Government sets value regardless of market  Government has to approve foreign currency purchases  Retains funds in the country

9. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three Balance of Payments  If BOP is slipping into deficit, the government is probably considering market or non-market measures to correct or suppress the deficit  Management should be alert for efforts to devalue the currency or deflate the economy  Currency or trade controls may be coming 6-9

10. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three 6-10 Financial Forces  Tariffs, Customs or Import Duties  amount paid depends on classification of goods  Harmonized Code System  Taxation  income, sales, VAT and capital gains  rates, enforcement and compliance differs by country  Inflation  monetary policies deal with the amount of money in circulation and growth  increase savings—decrease velocity—lower inflation  spend income—increases velocity—higher inflation  high rates help borrowers replay with cheaper money

11. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three Nominal and Real Interest Rates April 13, 1996 6-11 Figure 6.4 Short-term interest rates April 10th 1996, % Note: Real interest deflated by consumer-price inflation. Source: The Economist, April 13, 1996, p. 101.

12. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three Inflation Rates in OCED Countries 6-12 Figure 6.5 Interest rates Consumer prices, % change on a year earlier Source: The Economist, April 6, 1996, p. 108. 77.5 70.1 49.0

13. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three Financial Forces  Accounting practices  variation by country  translation risk  Debt  US debt is government or corporate bonds  LDC debt often is used to meet current operating expenses  Countries went bust 6-13

14. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three Secondary Market Transactions in debt instruments of developing countries and countries in transition (In billions of U.S. dollars) 6-14 Table 6.2 199319941995 Total turnover1,978.92,766.22,738.8 By country Africa79.8111.4109.2 Asia18.224.731.1 Europe104.5172.3314.0 Western Hemisphere1,621.62,259.32,284.2 Unspecified154.8198.5— By Instrument Loans273.6244.4175.3 Brady bonds1,021.31,684.01,580.3 Corporate and non-Brady sovereign bonds176.6164.9232.8 Local market instruments*361.9518.9572.4 Options and warrants on debt57.4142.4178.0 Unspecified—11.6— *Data for 1993 do not include trading in short-term local-market instruments. Sources: Emerging Markets Traders Association and IMF staff estimates.

15. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three External Debt of Selected HIPCs in 1994 6-15 Table 6.3 Annual Per CapitaDebt GNPDebt asDebt asService as (in U.S.PercentagePercentagePercentage CountryDollars)of GNPof Exportsof Exports Bolivia77089.4390.128.2 Ethiopia100109.8630.011.5 Mali250151.8589.227.5 Mozambique90450.41,388.723.0 Nicaragua340800.62,286.138.0 Tanzania140229.5877.520.5 Uganda19088.11,042.745.6 Zambia350204.3560.131.5 All low- and1,09037.6162.816.6 middle-income countries Source: World Bank, World Development Report 1996.

16. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three Longer Term Solutions 1.Borrowing countries will have to pursue policies ensuring that new money they obtain is used for economic growth rather than consumption, capital flight over-ambitious schemes or armaments 2.Borrowers should build up reserves in good years to withstand the fluctuations in commodity export prices 3. Developed countries must strive for their own economic growth and open their markets to LDC exports 4. IMF and other creditors must not try to enforce too stringent austerity measures on debtors. 5. The IMF, World Bank, and other agencies that aid LDC’s must be assured of sufficient funding so they can take long-term views. 6-16

17. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three Longer Term Solutions 6.Parts of huge LDC external debts must be changed in form to types of equity. 7.LDC’s must relax their restrictions on foreign investments and repatriation of profits from existing investments. 8. Blame for the debt crisis… -LDC’s borrowed more money than they could productively invest -LDC’s wasted borrowed money at home or corruptly sent abroad for personal accounts of leaders - lending banks were encouraged to lend by their governments because the governments were thus relieved to that extent of foreign aid - banks made limited inquires into uses of money - banks failed to get collateral to secure the loans 6-17

18. Irwin/McGraw-Hill © The McGraw-Hill Companies, Inc., 1999 section three 6-18 U.S. Debt net negative investment position  Over $300 billion of U.S. foreign-owned assets are obligations of the U.S. Treasury or U. S. corporations— face value of debt is subject to constant change.  U.S. foreign assets are often measured at book value which results in an estimated undervaluation of up to $200 billion.  U.S. assets abroad reportedly earn more in interest and dividend per dollar of investment than foreign holdings earn in America.  Although current U.S. net liabilities are immense in absolute terms, they are relatively small in terms of other economic indicators—total U.S. debt is 6% of U.S. GDP.  The most distinctive characteristic of the U.S. foreign debt is its denomination in U.S.$.