1. © 2013 Cengage Learning. All rights reserved. CHAPTER 7 GLOBAL2  PENG © J Marshall—Tribaleye Images/Alamy

2. © 2013 Cengage Learning. All rights reserved. CHAPTER 7 LEARNING OBJECTIVES After studying this chapter, you should be able to: 1.List the factors that determine foreign exchange rates. 2.Articulate and explain the steps in the evolution of the international monetary system. 3.Identify strategic responses firms can take to deal with foreign exchange movements. 4.Identify three things you need to know about currency when doing business internationally.

3. © 2013 Cengage Learning. All rights reserved. LO1: EXAMPLE OF KEY EXCHANGE RATES (4/6/11) Source: These examples are from April 6, 2011. Adapted from “Key currency cross rates,” Wall Street Journal, 6 April 2011, available at http://www.wsj.com [accessed 6 April 2011]. Copyright © 2011 Dow Jones & Company, Inc. All Rights Reserved. Reading vertically, the first column means US$1 = C$0.96 = ¥85 = Mexican Peso 11.81 = SFr 0.92 = £0.61 = €0.70. Reading horizontally, the last row means €1 = US$1.43; £1 = US$1.63; SFr 1 = US$1.09; Mexican Peso 1 = US$0.08; ¥1 = US$0.01; C$1 = US$1.04.

4. © 2013 Cengage Learning. All rights reserved. LO1: WHAT DETERMINES FOREIGN EXCHANGE RATES?

5. © 2013 Cengage Learning. All rights reserved. LO1: PURCHASING POWER PARITY A conversion that determines the equivalent amount of goods and services different currencies can purchase. The Big Mac Index

6. © 2013 Cengage Learning. All rights reserved. LO1: INTEREST RATES AND MONEY SUPPLY If one country’s interest rates are high relative to the interest rates of other countries, it will attract foreign funds. Inflation causes currency to depreciate.

7. © 2013 Cengage Learning. All rights reserved. LO1: PRODUCTIVITY Rise in a country’s productivity brings increase of FDI, fueling demand for its home currency.

8. © 2013 Cengage Learning. All rights reserved. LO1: BALANCE OF PAYMENTS A country’s international transaction statement.

9. © 2013 Cengage Learning. All rights reserved. LO1: BALANCE OF PAYMENTS

10. © 2013 Cengage Learning. All rights reserved. LO1: EXCHANGE RATE POLICIES Floating (flexible) exchange rate policy – willingness to let demand and supply conditions determine exchange rates.  Clean float  Dirty float Fixed rate policy – fixes exchange rate relative to other currencies.

11. © 2013 Cengage Learning. All rights reserved. LO1: INVESTOR PSYCHOLOGY Primary factor in short-run movements Bandwagon effect Capital flight

12. © 2013 Cengage Learning. All rights reserved. LO2: THE EVOLUTION OF THE INTERNATIONAL MONETARY SYSTEM  The Gold Standard (1870-1914) Gold used as common denominator © iStockphoto.com/Talaj

13. © 2013 Cengage Learning. All rights reserved. LO2: THE EVOLUTION OF THE INTERNATIONAL MONETARY SYSTEM  The Bretton Woods System (1944-1973) US dollar as common denominator © iStockphoto.com/Anton Vakhlachev

14. © 2013 Cengage Learning. All rights reserved. LO2: THE EVOLUTION OF THE INTERNATIONAL MONETARY SYSTEM  The Post-Bretton Woods System (1973- present) No common denominator; diversity of exchange rates.

15. © 2013 Cengage Learning. All rights reserved. LO2: INTERNATIONAL MONETARY FUND (IMF)  Legacy of Bretton Woods system.  Lender of last resort for countries experiencing balance of payments problems.  Each member country assigned a quota that determines required contribution.  Loans typically require long-term policy reforms.

16. © 2013 Cengage Learning. All rights reserved. LO3: STRATEGIC RESPONSES TO FOREIGN EXCHANGE MOVEMENTS Strategies for Financial Companies Main goal – to profit from foreign exchange market.  Spot transactions – single-shot exchange of one currency for another.  Forward transactions –purchase or sale of currencies for future delivery.  Currency hedging – a transaction that protects trades and investors from exposure to the fluctuations of the spot (daily) exchange rate.  Currency swap – conversion of one currency into another at Time 1, with agreement to revert it back to original currency at Time 2 in the future.

17. © 2013 Cengage Learning. All rights reserved. LO3: STRATEGIC RESPONSES TO FOREIGN EXCHANGE MOVEMENTS  Typically three outcomes: A razor-thin spread Quick decisions on buying and selling Ever-increasing volume in order to make more profits

18. © 2013 Cengage Learning. All rights reserved. LO3: STRATEGIC RESPONSES TO FOREIGN EXCHANGE MOVEMENTS Strategies for Non-Financial Companies  Invoicing in their own currencies  Currency hedging  Strategic hedging

19. © 2013 Cengage Learning. All rights reserved. LO4: THREE THINGS TO KNOW ABOUT CURRENCIES Fostering foreign exchange literacy is a must. Risk analysis of any country must include an analysis of its currency risks. A currency risk-management strategy is necessary—via invoicing in one’s own currency, currency hedging, or strategic hedging.

20. © 2013 Cengage Learning. All rights reserved. DEBATE: IMF’S ACTIONS, CRITICISMS, AND REFORMS