ch 10

International Business : 

International Business Foreign Exchange: Dealing with Currencies with a basic introduction to the International Monetary System International Business 10e Daniels/Radebaugh/Sullivan 9-1 2004 Prentice Hall, Inc

Foreign Exchange Terms : 

Foreign Exchange Terms Foreign exchange: money denominated in the currency of another nation or group of nations Cash Credit Bank deposits Other short-term claims (e.g., bonds) Exchange rate: the price of a particular currency relative to another

What you need to know … : 

What you need to know … What is money? Why and when do businesspeople deal with foreign money? How should you convert money from one currency into another? How are the values of currencies set? How can you predict when currency values will change?

What is money? : 

What is money? The “medium of exchange” that is, something widely accepted as means of payment Usually, governments declare certain pieces of paper to be money But people must accept them Alternatives are inconvenient, but possible Tobacco in early American colonies U.S. dollar in Russia when ruble collapsed

Why and when do businesspeople deal with foreign money? : 

Why and when do businesspeople deal with foreign money? Sell abroad, and you may receive payment in foreign currency Buy abroad, and you may have to pay in foreign currency Travel abroad, you must spend foreign currency A foreign direct investment will have to pay expenses in foreign currency

How should you convert money from one currency into another? : 

How should you convert money from one currency into another? Current values of major foreign currencies are available on the Web Most businesspeople normally buy from or sell to a bank The bank often gives less than the rates offered on the Web, but handles all details Banks may vary a lot in how good a deal they give

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A business with significant foreign activity creates a stable relationship with one or a few banks Negotiating with the bank, it can get good rates on foreign exchange Nowadays, you can do your own currency trading You get the rates shown on the Web if you buy/sell $1 million or so

How are the values of currencies set? : 

How are the values of currencies set? There are two basic ways “Fixed” or “Pegged” exchange rates Governments decide the value of currency Example: Hong Kong’s government keeps the value of its dollar at roughly US$0.128 (US$1=HK$7.80) “Floating” exchange rates Supply and demand sets values The value of most major currencies “floats” Euro, Japanese yen, British pound, etc.

Fixed exchange rates have important benefits : 

Fixed exchange rates have important benefits They make business predictable In some very prosperous periods, most major exchange rates have been fixed The late 19th century 1945-1971

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But a fixed exchange rate requires discipline in the government – and a willingness to create pain Example: Suppose your nation’s economy is very prosperous Your people will have money to buy imports Their demand for foreign currencies will put upward pressure on their exchange rates Government has to slow the domestic economy to prevent change in exchange rate Higher taxes, higher interest rates, lower spending

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Many economists say if a country is having difficulty maintaining a fixed exchange rate, the economy is overheated They say higher interest rates or higher taxes might be better for the economy in the long run in those circumstances But politicians don’t like to take pain U.S. abandoned fixed exchange rates when the Vietnam War created strong inflation

Slide 13: 

It seems that the more complicated an economy, the more difficult it is to maintain fixed exchange rates Many small countries succeed Hong Kong, Bangladesh, Fiji Few propose them for the largest developed countries today

Slide 14: 

But China maintains a fixed exchange rate Its government buys all surplus dollars in the country In Sept. 2006 China had $987.9 billion US dollars

Most international business involves currencies with floating rates : 

Most international business involves currencies with floating rates Buyers and sellers establish prices in markets like those for tea and wheat $1,200,000,000,000 in foreign exchange is traded every day US dollar is most widely traded involved in 90% of all transactions London is the main foreign-exchange market

Key Foreign-Exchange Terms : 

Key Foreign-Exchange Terms Bid: the rate at which traders buy foreign currency Offer: the rate at which traders sell foreign currency Spread: the difference between bid and offer rates; the profit margin for the trader 9-6

Market Rhythms : 

Market Rhythms 9-13

How can you predict when currency values will change? : 

How can you predict when currency values will change? Business decisions demand you look far ahead If exchange rates will change, your whole calculation will be off Some foreign currencies have lost 90% or more of their value in a year

‘Fundamental analysis’ involves examining basic economic data : 

‘Fundamental analysis’ involves examining basic economic data How fast are prices rising in the country? Is there a trade surplus or deficit? Is the government running budget deficits? How much? How do interest rates in the countries compare? How has the government been managing the currency?

Technical analysis involves examining trends in exchange rates : 

Technical analysis involves examining trends in exchange rates One principle: Trends once established often tend to continue ‘The trend is your friend’ But if “everyone” agrees something will happen, it may not happen When ‘everyone’ thinks the dollar will go down, ‘everyone’ has already sold dollars If the news changes, many may quickly change their minds and want to buy

Foreign exchange can be the difference between profit and loss : 

Foreign exchange can be the difference between profit and loss HSBC Bank in Argentina They entered Argentina at a time when it appeared the government was starting to manage the economy effectively But they continued investing as government became more irresponsible They lost big

Foreign-Exchange Instruments : 

Foreign-Exchange Instruments Spot transactions: involve the exchange of currency the second day after the date on which the two foreign-exchange traders agree Outright forward transactions: involve the exchange of currency 3 or more days after the date the traders agree FX swap: involves a swap of one currency for another and then swapped back on a future date 9-5

Choosing a Foreign-Exchange Trader : 

Choosing a Foreign-Exchange Trader Capability to handle major currencies Capability to handle major cross-trades Capability to handle specific currencies Capability to handle derivatives (forwards, swaps, and options) Capability to engage in research Ranking in specific locations Large international banks will use multiple foreign-exchange traders depending upon their expertise in particular areas 9-15

Foreign-Exchange Convertibility : 

Foreign-Exchange Convertibility Fully convertible currencies are those that the government allows both residents and nonresidents to purchase in unlimited amounts “Hard currencies” are fully convertible “Soft currencies” (or weak currencies) are not fully convertible Typically from developing countries Known as “exotic currencies” 9-10