1. MS34B, UWI Mona, Department of Management Studies International Business Management (MS34B) Foreign Exchange Systems and Management Facilitator: Densil A. Williams

2. MS34B, UWI Mona, Department of Management Studies Contents Introduction Exchange Rate Concepts Determinants of Exchange Rate Theories of Exchange Rate Exchange Rate and Economic Growth

3. MS34B, UWI Mona, Department of Management Studies Introduction In international transactions, companies need a mechanism to exchange one currency for another. This mechanism is called the foreign exchange market. Currencies are bought and sold in this market. Institutions exchange one currency for another at a specific exchange rate. This rate depends on a number of factors : size of the transaction, the trader conducting the transaction, general economic conditions and sometimes government mandate.

4. MS34B, UWI Mona, Department of Management Studies Introduction Functions of the Foreign Exchange Market Currency Conversion In international trade, the seller normally wants to have payments in his/her local currency while the buyer wants to pay in his/her local currency which are both different To solve this problem, the buyer goes to the foreign exchange market and exchange his currency for that of the seller so that s/he can pay in the sellers local currency Companies that invest in FDI and want to repatriate profits must convert local currency to the currency of the host country. This is done on the foreign exchange market.

5. MS34B, UWI Mona, Department of Management Studies Introduction Functions of the Foreign Exchange Market Currency Hedging International business traders normally try to insure against potential losses that result from adverse changes in the exchange rate. This is called Hedging. Hedging serves two purposes: A) to reduce the risks associated with international transfer of funds. B) to protect the trades interest in transactions where there is a time lag between billing and receipt of payment.

6. MS34B, UWI Mona, Department of Management Studies Exchange Rate Determination Like other commodities, the exchange rate is determined by interaction of supply and demand for currency. Demand and Supply are influenced by: - Trade (imports/exports of goods and services), - Investment (portfolio and foreign direct initial investment - repatriation of capital and remittance of dividends) - Monetary factors – changes in supply of domestic currency.

7. MS34B, UWI Mona, Department of Management Studies Theories of Exchange Rate Determination Purchasing Power Parity: Spot Exchange Rates Change in Proportion to the Differential Inflation between Two Economies. It tells us how much of one currency a consumer in one country needs in order to buy the same amount of products as a consumer in another country. In other words, it is the relative ability of two countries currencies to buy the same basket of goods in those two countries.

8. MS34B, UWI Mona, Department of Management Studies Theories of Exchange Rate Determination Inflation and Exchange Rate Inflation erodes purchasing power. As a result, governments try to control by managing the supply and demand of their currency. Factors affecting money supply change include: Public Sector Credit, Private Sector Credit, Changes in Monetary Base (currency issue, cash reserves, current accounts), changes in net international reserves, open market operations of central bank.

9. MS34B, UWI Mona, Department of Management Studies Exchange Rate and Economic Growth Countries in the Caribbean that adopt a fixed regime have seen higher growth rates while those with a flexible regime except for a few (Trinidad & Tobago) have seen lower growth rates. The verdict is still out as to which regime is most suitable in small, open developing economies.

10. MS34B, UWI Mona, Department of Management Studies Concluding Remarks In this discourse, we have shown how the foreign exchange market works and the impact of the exchange rate on the economic growth in developing economies. The exchange rate is a critical price in the economy and improper management can have serious negative implications for the competitiveness of the economy. It is therefore critical that managers and policy makers fully understand the factors that drive exchange rate determination and manage these effectively.