Original Work, NO PLAGERIESM, Cite Reference, 3 slides per topic w.docx

Original Work, NO PLAGERIESM, Cite Reference, 3 slides per
topic w/SPEAKER NOTES
All 3 topics are regarding Guatemala and people who live there
with Upper Respiratory Infections
1. Locate and explain, available Internet resources that address
this issue.
2. Name an organization that is involved in addressing this
issue.
3. What are the ethical issues involved in resolving this global
health problem?
International Business
10e
By Charles W.L. Hill
Copyright © 2015 McGraw-Hill Education. All rights reserved.
No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
*
Chapter 12
The Global Capital Market

*
12-*
Why Do
Capital Markets Exist?Capital markets bring together investors
and borrowersinvestors - corporations with surplus cash,
individuals, and non-bank financial institutionsborrowers -
individuals, companies, and governmentsmarkets makers - the
financial service companies that connect investors and
borrowers, either directly (investment banks) or indirectly
(commercial banks)capital market loans can be equity or debt
*
LO 1: Describe the benefits of the global capital market.
12-*
Who Are the Main Players
in Capital Markets?
The Main Players in the Generic Capital Market
*
The Opening Case: Declining Cross-Border Capital Flows:
Retreat or Reset? explores the challenges that today’s highly

integrated capital markets present. The financial crisis that
began in the United States in 2008, quickly spread to other
nations resulting in worldwide recession. Five years after the
global crisis, the global capital market has not reached its 2007
peak. Is that a sign of permanent retreat or a global reset?
12-*
What Makes the Global
Capital Market Attractive? Today’s capital markets are highly
interconnected and facilitate the free flow of money around the
worldBorrowers benefit from the additional supply of funds
global capital markets providelowers the cost of capital the
price of borrowing money or the rate of
return that borrowers pay investors
*
Capital market loans includeEquity loans- when corporations
sell stock to investorsDebt loans - when a corporation borrows
money and agrees to repay a predetermined portion of the loan
amount at regular intervals regardless of how much profit it is
making
In a purely domestic capital market the pool of investors is
limited to residents of the country.
Thisplaces an upper limit on the supply of funds
availableincreases the cost of capital
12-*

Capital Market Attractive?
Market Liquidity and the Cost of Capital
*
Management Focus: Deutsche Telekom Taps the Global Capital
Market examines Deutsche Telekom’s privatization strategy.
Deutsche Telekom, one of the world’s largest telephone
companies was state-owned until 1996 when the decision was
made to privatize the company in order to increase efficiency
and be in a better position to face the greater competition the
deregulation of the European Union’s telecommunications
sector was expected to create.
12-*
Capital Market Attractive? Investors benefit from the wider
range of investment opportunities diversify portfolios and lower
risk But, volatile exchange rates can make what would
otherwise be profitable investments, unprofitable
*
A fully diversified portfolio that contains stocks from many
countries is less than half as risky as a fully diversified
portfolio that contains only U.S. stocks.
12-*

Capital Market Attractive?
Risk Reduction through Portfolio Diversification
*
Source: B. Solnik, “Why Not Diversify Internationally Rather
than Domestically?” Adapted with permission from Financial
Analysts Journal, July-August 1974, p. 17. Copyright 1974.
Financial Analysts Federation, Charlottesville, VA. All rights
reserved.
12-*
How Have Global Capital Markets Changed Since 1990?Global
capital markets have grown rapidlythe stock of cross-border
bank loans was just $3,600 billion in 1990, $7,859 billion in
2000, $33,913 billion in 2012the international bond market has
grown from $3,515 billion in 1997, $5,908 billion in 2000,
$21,979 billion in 2012
*
LO 2: Identify why the global capital market has grown so
rapidly.
12-*
Why Is the Global Capital Market Growing?Two factors are
responsible for the growth of capital markets

Advances in information technologythe growth of international
communications technology and advances in data processing
capabilities 24-hour-a-day trading so, shocks that occur in one
financial market spread around the globe very quickly
*
12-*
Why Is the Global Capital Market Growing?
Deregulation by governments has facilitated growth in
international capital marketsgovernments have traditionally
limited foreign investment in domestic companies, and the
amount of foreign investment citizens could makesince the
1980s, these restrictions have been falling
*
12-*
Why Is the Global Capital Market Growing?Deregulation began
in the U.S., then moved to
Great Britain, Japan, and FranceMany countries have
dismantled capital controls making it easier for both inward and
outward investment to occurThe 2008-2009 global financial
crisis raised questions as to whether deregulation had gone too
farQuestion: Are new regulations for the financial services
industry needed?

*
12-*
What Are the Risks of the Global Capital Markets?Question:
Could deregulation of capital markets and fewer controls on
cross-border capital flows make nations more vulnerable to the
effects of speculative capital flows?can have a destabilizing
effect on economiesSpeculative capital flows may be the result
of inaccurate information about investment opportunitiesif
global capital markets continue to grow, better quality
information is likely to be available from financial
intermediaries
*
LO 3: Understand the risks associated with the globalization of
capital markets.
Country Focus: Did the Global Capital Markets Fail Mexico?
explores Mexico’s economic problems in the mid-1990s.
Mexico went from being a strong developing country with a
good future to a country facing a financial crisis.
12-*
What Is a Eurocurrency?A Eurocurrency is any currency banked
outside its country of originAbout two-thirds of all
Eurocurrencies are Eurodollars dollars banked outside the
U.S.Other important Eurocurrencies are the euro-yen, the euro-
pound, and the euro-euroThe Eurocurrency market is an
important source of low-cost funds for international companies

*
LO 4: Compare and contrast the benefits and risks associated
with the Eurocurrency market, the global bond market, and the
global equity markets.
12-*
Why Has the Eurocurrency Market Grown?The eurocurrency
market began in the 1950s when the Eastern bloc countries
feared that the United States might seize their dollarsso, they
deposited them in Europeadditional dollar deposits came from
Western European central banks and companies that exported to
the U.S. could earn a higher rate of interest in London
*
12-*
Why Has the Eurocurrency Market Grown?In 1957, the market
surged again after changes in British lawsunder the new laws,
British banks had to attract dollar deposits and loan dollars
rather pounds to finance non-British trade London became the
leading center of the eurocurrency marketcontinues to hold this
position today
*
12-*

Why Has the Eurocurrency Market Grown?In the 1960s, the
market grew once again Changes in U.S. regulations
discouraged U.S. banks from lending to non-U.S.
residentswould-be borrowers of dollars outside the U.S. turned
to the Euromarket as a source of dollars
*
12-*
Why Has the Eurocurrency Market Grown?The next big increase
came after the 1973-74 and 1979-80 oil price increasesArab
members of OPEC accumulated huge amounts of dollarsavoided
potential confiscation of their dollars by the U.S. by depositing
them in banks in London
*
12-*
What Makes the Eurocurrency Market Attractive?The
Eurocurrency market is attractive because it is not regulated by
the governmentbanks can offer higher interest rates on
Eurocurrency deposits than on deposits made in the home
currencybanks can charge lower interest rates to Eurocurrency
borrowers than to those who borrow the home currency
*

12-*
What Makes the Eurocurrency Market Attractive?The spread
between the Eurocurrency deposit and lending rates is less than
the spread between the domestic deposit and lending rates Gives
Eurocurrency banks a competitive edge over domestic banks
*
12-*
What Makes the Eurocurrency Market Attractive?
Interest Rate Spreads in Domestic and Eurocurrency Markets
*
12-*
What Makes the Eurocurrency Market Unattractive?The
Eurocurrency market has two significant drawbacks:
Because the Eurocurrency market is unregulated, there is a
higher risk that bank failure could cause depositors to lose
fundscan avoid this risk by accepting a lower return on a home-
country deposit
Companies borrowing Eurocurrencies can be exposed to foreign
exchange risk can minimize this risk through forward market

hedges
*
12-*
What Is the
Global Bond Market?Bonds are an important means of financing
for many companies the most common bond is a fixed rate
which gives investors fixed cash payoffsThe global bond market
grew rapidly during the 1980s and 1990s and continues to do in
the new century
*
Foreign bonds sold in the United States are called Yankee
bonds.
Foreign bonds sold in Japan are Samurai bonds.
Foreign bonds sold in Great Britain are bulldogs.
12-*
What Is the
Global Bond Market?There are two types of international bonds
Foreign bonds are sold outside the borrower’s country and are
denominated in the currency of the country in which they are
issuedused by companies when they think it will reduce the cost
of capital
Eurobonds are underwritten by a syndicate of banks and placed

in countries other than the one in whose currency the bond is
denominated
*
12-*
What Makes the Eurobond Market Attractive?The Eurobond
market is attractive because
It lacks regulatory interference since companies do not have to
adhere to strict regulations, the cost of issuing bonds is lower
It has less stringent disclosure requirements than domestic bond
markets it can be cheaper and less time consuming to offer
Eurobonds than dollar-denominated bonds
It is more favorable from a tax perspective Eurobonds can be
sold directly to foreign investors
*
12-*
What Is the
Global Equity Market?The global equity market allows firms to
Attract capital from international investors many investors buy
foreign equities to diversify their portfolios
List their stock on multiple exchanges this type of trend may
result in an internationalization of corporate ownership

*
12-*
What Is the
Global Equity Market?
Raise funds by issuing debt or equity around the worldby
issuing stock in other countries, firms open the door to raising
capital in the foreign marketgives the firm the option of
compensating local managers and employees with stock
provides for local ownershipincreases visibility with local
stakeholders
*
12-*
How Do Exchange Rates
Affect the Cost of Capital?Adverse exchange rates can increase
the cost of foreign currency loansWhile it may initially seem
attractive to borrow foreign currencies, when exchange rate risk
is factored in, that can changefirms can hedge their risk by
entering into forward contracts but this will also raise
costsFirms must weigh the benefits of a lower interest rate
against the risk of an increase in the real cost of capital

*
LO 5: Understand how foreign exchange risks affect the cost of
capital.
12-*
What Do Global Capital Markets Mean for Managers? Growth
in global capital markets has created opportunities for firms to
borrow or invest internationallyfirms can often borrow at a
lower cost than in the domestic capital marketfirms must
balance the foreign exchange risk associated with borrowing in
foreign currencies against the costs savings
*
12-*
What Do Global Capital Markets Mean for Managers? Growth
in capital markets offers opportunities for firms, institutions,
and individuals to diversify their investments and reduce
riskagain though, investors must consider foreign exchange rate
riskCapital markets are likely to continue to integrate providing
more opportunities for business
International Business 10e

*
Chapter 11
The International Monetary System
*
11-*
What Is The International Monetary System?The international
monetary system refers to the institutional arrangements that
countries adopt to govern exchange ratesA floating exchange
rate system exists when a country allows the foreign exchange
market to determine the relative value of a currencythe U.S.
dollar, the EU euro, the Japanese yen, and the British pound all
float freely against each othertheir values are determined by
market forces and fluctuate day to day
*
The world’s four major currencies – dollar, euro, yen, and
pound – are all free to float against each other.
11-*

What Is The International Monetary System?A pegged exchange
rate system exists when a country fixes the value of its currency
relative to a reference currencyMany Gulf states peg their
currencies to the U.S. dollarA dirty float exists when a country
tries to hold the value of its currency within some range of a
reference currency such as the U.S. dollarChina pegs the yuan
to a basket of other currencies
*
Pegged exchange rates, dirty floats, and fixed exchange rates all
require some degree of government intervention.
11-*
What Is The International Monetary System?A fixed exchange
rate system exists when countries fix their currencies against
each other at some mutually agreed on exchange rateEuropean
Monetary System (EMS) prior to 1999
*
11-*
What Was The Gold Standard?The gold standard refers to a

system in which countries peg currencies to gold and guarantee
their convertibilitythe gold standard dates back to ancient times
when gold coins were a medium of exchange, unit of account,
and store of valuepayment for imports was made in gold or
silver
*
LO 1: Describe the historical development of the modern global
monetary system.
11-*
What Was The Gold Standard?later, payment was made in paper
currency which was linked to gold at a fixed rate in the 1880s,
most nations followed the gold standard$1 = 23.22 grains of
“fine” (pure) goldthe gold par value refers to the amount of a
currency needed to purchase one ounce of gold
*
11-*
Why Did The
Gold Standard Make Sense? The great strength of the gold
standard was that it contained a powerful mechanism for
achieving balance-of-trade equilibrium by all countrieswhen the
income a country’s residents earn from its exports is equal to
the money its residents pay for importsIt is this feature that
continues to prompt calls to return to a gold standard

*
11-*
Why Did The
Gold Standard Make Sense? The gold standard worked well
from the 1870s until 1914 but, many governments financed their
World War I expenditures by printing money and so, created
inflationPeople lost confidence in the system demanded gold for
their currency putting pressure on countries' gold reserves, and
forcing them to suspend gold convertibilityBy 1939, the gold
standard was dead
*
Post WWI, war heavy expenditures affected the value of dollars
against gold.
U.S. raised dollars to gold from $20.67 to $35 per ounce.
Other countries followed suit and devalued their currencies.
11-*
What Was The

Bretton Woods System?In 1944, representatives from 44
countries met at Bretton Woods, New Hampshire, to design a
new international monetary system that would facilitate postwar
economic growth Under the new agreement a fixed exchange
rate system was establishedall currencies were fixed to gold, but
only the U.S. dollar was directly convertible to
golddevaluations could not to be used for competitive purposesa
country could not devalue its currency by more than 10%
without IMF approval
*
monetary system.
A key problem with the gold standard was that there was no
multinational institution that could stop countries from
engaging in competitive devaluations.
11-*
What Institutions Were Established At Bretton Woods?The
Bretton Woods agreement also established two multinational
institutions
The International Monetary Fund (IMF) to maintain order in the
international monetary system through a combination of
discipline and flexibility
The World Bank to promote general economic development also
called the International Bank for Reconstruction and
Development (IBRD)
*
LO 2: Explain the role played by the World Bank and the IMF
in the international monetary system.

11-*
What Institutions Were Established At Bretton Woods?
The International Monetary Fund (IMF) fixed exchange rates
stopped competitive devaluations and brought stability to the
world trade environment fixed exchange rates imposed
monetary discipline on countries, limiting price inflationin
cases of fundamental disequilibrium, devaluations were
permitted the IMF lent foreign currencies to members during
short periods of balance-of-payments deficit, when a rapid
tightening of monetary or fiscal policy would hurt domestic
employment
*
The International Monetary Fund (IMF) Articles of Agreement
were heavily influenced by the worldwide financial collapse,
competitive devaluations, trade wars, high unemployment,
hyperinflation in Germany and elsewhere, and general economic
disintegration that occurred between the two world wars.
The aim of the IMF was to try to avoid a repetition of that chaos
through a combination of discipline and flexibility.
11-*
What Institutions Were Established At Bretton Woods?
The World Bank Countries can borrow from the World Bank in
two ways
Under the IBRD scheme, money is raised through bond sales in
the international capital marketborrowers pay a market rate of
interest - the bank's cost of funds plus a margin for expenses.
Through the International Development Agency, an arm of the

bank created in 1960IDA loans go only to the poorest countries
*
11-*
Why Did The Fixed Exchange Rate System Collapse?Bretton
Woods worked well until the late 1960sIt collapsed when huge
increases in welfare programs and the Vietnam War were
financed by increasing the money supply and causing significant
inflation other countries increased the value of their currencies
relative to the U.S. dollar in response to speculation the dollar
would be devaluedHowever, because the system relied on an
economically well managed U.S., when the U.S. began to print
money, run high trade deficits, and experience high inflation,
the system was strained to the breaking point the U.S. dollar
came under speculative attack
*
monetary system.
The system of fixed exchange rates established at Bretton
Woods worked well until the late 1960s.The U.S. dollar was the
only currency that could be converted into goldThe U.S. dollar
served as the reference point for all other currenciesAny
pressure to devalue the dollar would cause problems through out
the world
Factors that led to the collapse of the fixed exchange system
include:President Johnson financed both the Great Society and
Vietnam by printing moneyHigh inflation and high spending on
importsOn August 8, 1971, President Nixon announced the

dollar was no longer convertible to goldCountries agreed to
revalue their currencies against the dollarOn March 19, 1972,
Japan and most of Europe floated their currenciesIn 1973,
Bretton Woods failed because the key currency (dollar) was
under speculative attack
11-*
What Was The
Jamaica Agreement?A new exchange rate system was
established in 1976 at a meeting in Jamaica The rules that were
agreed on then are still in place todayUnder the Jamaican
agreementfloating rates were declared acceptablegold was
abandoned as a reserve assettotal annual IMF quotas - the
amount member countries contribute to the IMF - were
increased to $41 billion – today they are about $767 billion
*
monetary system.
11-*
What Has Happened To Exchange Rates Since 1973?Since 1973,
exchange rates have been more volatile and less predictable
than they were between 1945 and 1973 because ofthe 1971 and
1979 oil crisesthe loss of confidence in the dollar after U.S.
inflation in 1977-78the rise in the dollar between 1980 and
1985the partial collapse of the EMS in 1992the 1997 Asian
currency crisisthe global financial crisis of 2008–2010;
sovereign debt crisis of 2010–2011

*
monetary system.
11-*
What Has Happened To
Exchange Rates Since 1973?
Major Currencies Dollar Index, 1973-2013
*
Source: From data at
http://www.federalreserve.gov/releases/H10/summary/indexn_m
.htm.
monetary system.
Country Focus: The U.S. Dollar, Oil Prices, and Recycling
Petrodollars explores what oil producing nations are likely to do
with the dollars they have earned. Recently, oil prices have
surged as a result of higher than expected demand, tight
supplies, and perceived geopolitical risks. Since oil is priced in
dollars, oil producers have seen their dollar reserves increase.
11-*
Which Is Better – Fixed
Rates Or Floating Rates?Floating exchange rates provide
Monetary policy autonomyremoving the obligation to maintain

exchange rate parity restores monetary control to a government
Automatic trade balance adjustmentsunder Bretton Woods, if a
country developed a permanent deficit in its balance of trade
that could not be corrected by domestic policy, the IMF would
have to agree to a currency devaluation
Help countries recover from financial crises
*
LO 3: Compare and contrast the differences between a fixed
and floating exchange rate system.
11-*
Which Is Better – Fixed Rates Or Floating Rates?But, a fixed
exchange rate system
Provides monetary disciplineensures that governments do not
expand their money supplies at inflationary rates
Minimizes speculationcauses uncertainty
Reduces uncertaintypromotes growth of international trade and
investment
*
11-*
Who Is Right?There is no real agreement as to which system is
better We know that a Bretton Woods-style fixed exchange rate
regime will not workBut a different kind of fixed exchange rate
system might be more enduringcould encourage stability that
would facilitate more rapid growth in international trade and
investment

*
11-*
What Type of Exchange Rate System Is In Practice
Today?Various exchange rate regimes are followed today21% of
IMF members follow a free float policy23% of IMF members
follow a managed float system5% of IMF members have no
legal tender of their ownexcludes Euro Zone countriesthe
remaining countries use less flexible systems such as pegged
arrangements, or adjustable pegs
*
LO 4: Identify exchange rate regimes used in the world today
and why countries adopt different exchange rate regimes.
11-*
What Type of Exchange Rate System Is In Practice Today?
Exchange Rate Policies of IMF Members
*
Chart1Free Float 21%Managed Float 23%No Separate Tender
5%Fixed Peg 43%Adjustable Peg 8%
Percentage
21
23

5
43
8
Sheet1PercentageFree Float 21%21Managed Float 23%23No
Separate Tender 5%5Fixed Peg 43%43Adjustable Peg 8%8To
resize chart data range, drag lower right corner of range.
11-*
What Is A Pegged Rate System?A country following a pegged
exchange rate system pegs the value of its currency to that of
another major currencypopular among the world’s smaller
nations imposes monetary discipline and leads to low
inflationadopting a pegged exchange rate regime can moderate
inflationary pressures in a country
*
11-*
What Is A Currency Board?Countries using a currency board
commit to converting their domestic currency on demand into
another currency at a fixed exchange ratethe currency board
holds reserves of foreign currency equal at the fixed exchange
rate to at least 100% of the domestic currency issued the
currency board can issue additional domestic notes and coins
only when there are foreign exchange reserves to back them
*

11-*
What Is The Role
Of The IMF Today?Today, the IMF focuses on lending money
to countries in financial crisisThere are three main types of
financial crises:
Currency crisis
Banking crisis
Foreign debt crisis
*
LO 5: Understand the debate surrounding the role of the IMF in
the management of financial crises.
11-*
What Is The Role
Of The IMF Today?A currency crisis occurs when a speculative
attack on the exchange value of a currency results in a sharp
depreciation in the value of the currency, or forces authorities
to expend large volumes of international currency reserves and
sharply increase interest rates in order to defend prevailing
exchange ratesBrazil 2002
*

11-*
What Is The Role
Of The IMF Today?A banking crisis refers to a situation in
which a loss of confidence in the banking system leads to a run
on the banks, as individuals and companies withdraw their
depositsA foreign debt crisis is a situation in which a country
cannot service its foreign debt obligations, whether private
sector or government debtGreece and Ireland 2010
*
11-*
What Was The Mexican Currency Crisis Of 1995? The Mexican
currency crisis of 1995 was a result ofhigh Mexican debtsa
pegged exchange rate that did not allow for a natural adjustment
of pricesTo keep Mexico from defaulting on its debt, the IMF
created a $50 billion aid package required tight monetary policy
and cuts in public spending
*
Country Focus: The Mexican Currency Crisis of 1995 details
the IMF’s role in the Mexican currency crisis.

11-*
What Was The
Asian Currency Crisis?The 1997 Southeast Asian financial
crisis was caused by events that took place in the previous
decade including
An investment boom - fueled by huge increases in exports
Excess capacity - investments were based on projections of
future demand conditions
High debt - investments were supported by dollar-based debts
Expanding imports – caused current account deficits
*
11-*
What Was The
Asian Currency Crisis?By mid-1997, several key Thai financial
institutions were on the verge of defaultspeculation against the
bahtThailand abandoned the baht peg and allowed the currency
to floatThe IMF provided a $17 billion bailout loan package
required higher taxes, public spending cuts, privatization of
state-owned businesses, and higher interest rates
*

11-*
What Was The
Asian Currency Crisis?Speculation caused other Asian
currencies including the Malaysian Ringgit, the Indonesian
Rupaih and the Singapore Dollar to fallThese devaluations were
mainly driven by excess investment and high borrowings, much
of it in dollar denominated debta deteriorating balance of
payments position
*
11-*
What Was The
Asian Currency Crisis?The IMF provided a $37 billion aid
package for Indonesiarequired public spending cuts, closure of
troubled banks, a balanced budget, and an end to crony
capitalismThe IMF provided a $55 billion aid package to South
Korearequired a more open banking system and economy, and
restraint by chaebol
*
11-*

How Has The IMF Done?By 2012, the IMF was committing
loans to 52 countries in economic and currency crisisAll IMF
loan packages require tight macroeconomic and monetary policy
However, critics worrythe “one-size-fits-all” approach to
macroeconomic policy is inappropriate for many countriesthe
IMF is exacerbating moral hazard - when people behave
recklessly because they know they will be saved if things go
wrong the IMF has become too powerful for an institution
without any real mechanism for accountability
*
11-*
How Has The IMF Done?But, as with many debates about
international economics, it is not clear who is right However, in
recent years, the IMF has started to change its policies and be
more flexibleurged countries to adopt fiscal stimulus and
monetary easing policies in response to the 2008-2010 global
financial crisis
*
11-*
What Does The Monetary System Mean For
Managers?Managers need to understand how the international

monetary system affects
Currency management - the current system is a managed float -
government intervention can influence exchange
ratesspeculation can also create volatile movements in exchange
rates
*
LO 6: Explain the implications of the global monetary system
for currency management and business strategy.
11-*
What Does The Monetary System Mean For Managers?
Business strategy - exchange rate movements can have a major
impact on the competitive position of businessesneed strategic
flexibility
Corporate-government relations - businesses can influence
government policy towards the international monetary
systemcompanies should promote a system that facilitates
international growth and development
*
Management Focus: Airbus and the Euro describes how Airbus
is protecting itself from exchange rate fluctuations. French
aircraft maker Airbus prices its planes in dollars. However,
because over half the company’s costs are in euros, the
company has the potential to see significant fluctuations in its
earnings if it does not hedge its foreign exchange exposure.

International Business 10e
*
Chapter 10
The Foreign Exchange Market
*
10-*
Why Is The Foreign
Exchange Market Important?The foreign exchange market
is used to convert the currency of one country into the currency
of another
provides some insurance against foreign exchange risk - the
adverse consequences of unpredictable changes in exchange
ratesThe exchange rate is the rate at which one currency is
converted into anotherevents in the foreign exchange market
affect firm sales, profits, and strategy

*
LO 1: Describe the functions of the foreign exchange market.
The foreign exchange market is the market where currencies are
bought and sold and in which currency prices are determined. It
is a network of banks, brokers and dealers that exchange
currencies 24 hours a day.
The Opening Case: The Rise (and Fall) of the Japanese Yen
illustrates the dramatic fluctuation in the value of Japanese
currency over the last two decades and the impact on Japanese
exports.
10-*
When Do Firms Use The Foreign Exchange
Market?International companies use the foreign exchange
market when the payments they receive for exports, the income
they receive from foreign investments, or the income they
receive from licensing agreements with foreign firms are in
foreign currenciesthey must pay a foreign company for its
products or services in its country’s currencythey have spare
cash that they wish to invest for short terms in money
marketsthey are involved in currency speculation - the short-
term movement of funds from one currency to another in the
hopes of profiting from shifts in exchange rates
*
10-*
How Can Firms Hedge Against Foreign Exchange Risk?The
foreign exchange market provides insurance to protect against
foreign exchange risk the possibility that unpredicted changes

in future exchange rates will have adverse consequences for the
firmA firm that insures itself against foreign exchange risk is
hedging
*
10-*
What Is The Difference Between Spot Rates And Forward
Rates?The spot exchange rate is the rate at which a foreign
exchange dealer converts one currency into another currency on
a particular dayspot rates change continually depending on the
supply and demand for that currency and other currencies Spot
exchange rates can be quoted as the amount of foreign currency
one U.S. dollar can buy, or as the value of a dollar for one unit
of foreign currency
*
LO 2: Understand what is meant by spot exchange rates.
10-*
Rates?
Value of the U.S. Dollar Against Other Currencies 2/12/11
*

10-*
Rates?To insure or hedge against a possible adverse foreign
exchange rate movement, firms engage in forward exchanges
two parties agree to exchange currency and execute the deal at
some specific date in the future A forward exchange rate is the
rate used for these transactionsrates for currency exchange are
typically quoted for 30, 90, or 180 days into the future
*
LO 3: Recognize the role that forward exchange rates play in
insuring against foreign exchange risk.
Management Focus: Volkswagen’s Hedging Strategy examines
Volkswagen’s hedging strategy and why Volkswagen lost over
€1 billion in 2003.
10-*
What Is A Currency Swap?A currency swap is the simultaneous
purchase and sale of a given amount of foreign exchange for
two different value datesSwaps are transacted between
international businesses and their banksbetween banksbetween
governments when it is desirable to move out of one currency
into another for a limited period without incurring foreign
exchange rate risk
*

10-*
What Is The Nature Of The
Foreign Exchange Market?The foreign exchange market is a
global network of banks, brokers, and foreign exchange dealers
connected by electronic communications systemsthe average
total value of global foreign exchange trading in March, 1986
was just $200 billion, in April, 2010 it hit $4 trillion per day
the most important trading centers are London, New York,
Zurich, Tokyo, and Singaporethe market is always open
somewhere in the world—it never sleeps
*
10-*
Do Exchange Rates Differ Between Markets?High-speed
computer linkages between trading centers mean there is no
significant difference between exchange rates in the differing
trading centersIf exchange rates quoted in different markets
were not essentially the same, there would be an opportunity for
arbitrage the process of buying a currency low and selling it
high
*
10-*

Do Exchange Rates Differ Between Markets?Most transactions
involve dollars on one side—it is a vehicle currency 85% of all
foreign exchange transactions involve the U.S. dollar other
vehicle currencies are the euro, the Japanese yen, and the
British poundChina’s renminbi is still only used for about 0.3%
of foreign exchange transactions
*
10-*
How Are Exchange Rates Determined?Exchange rates are
determined by the demand and supply for different
currenciesThree factors impact future exchange rate movements
A country’s price inflation
A country’s interest rate
Market psychology
*
LO 4: Understand the different theories explaining how
currency exchange rates are determined and their relative
merits.
10-*
How Do Prices
Influence Exchange Rates?The law of one price states that in
competitive markets free of transportation costs and barriers to
trade, identical products sold in different countries must sell for

the same price when their price is expressed in terms of the
same currencyotherwise there is an opportunity for arbitrage
until prices equalize between the two markets
*
In competitive markets free of transportation costs and trade
barriers, identical products sold in different countries must sell
for the same price when their price is expressed in terms of the
same currency
Example: U.S./Euro exchange rate: $1 = € .78
A jacket selling for $50 in New York should retail for € 39.24
in Paris (50 x.78)
10-*
How Do Prices
Influence Exchange Rates?Purchasing power parity theory
(PPP) argues that given relatively efficient markets (a market
with no impediments to the free flow of goods and services) the
price of a “basket of goods” should be roughly equivalent in
each countrypredicts that changes in relative prices will result
in a change in exchange rates
*
10-*
How Do Prices

Influence Exchange Rates?A positive relationship exists
between the inflation rate and the level of money supply when
the growth in the money supply is greater than the growth in
output, inflation will occur PPP theory suggests that changes in
relative prices between countries will lead to exchange rate
changes, at least in the short runa country with high inflation
should see its currency depreciate relative to others
*
Country Focus: Quantitative Easing, Inflation, and the Value of
the U.S. Dollar explores the notion of quantitative easing. The
technique was used by the U.S. government to expand the
money supply in 2010. The Fed pursued other rounds of
quantitative easing in 2011, 2012, and possibly through 2014.
Critics worried that the policy would lead to a decline in the
value of the dollar—which hasn’t yet happened.
10-*
How Do Prices
Influence Exchange Rates?Question: How well does PPP
work?Empirical testing of PPP theory suggests that it is most
accurate in the long run, and for countries with high inflation
and underdeveloped capital marketsit is less useful for
predicting short term exchange rate movements between the
currencies of advanced industrialized nations that have
relatively small differentials in inflation rates
*

10-*
How Do Interest Rates
Influence Exchange Rates?The International Fisher Effect states
that for any two countries the spot exchange rate should change
in an equal amount but in the opposite direction to the
difference in nominal interest rates between two countries In
other words:
[(S1 - S2) / S2 ] x 100 = i $ - i ¥ where i$ and i¥
are the respective nominal interest rates in two countries (in this
case the U.S. and Japan), S1 is the spot exchange rate at the
beginning of the period and S2 is the spot exchange rate at the
end of the period
*
10-*
How Does Investor Psychology
Influence Exchange Rates?The bandwagon effect occurs when
expectations on the part of traders turn into self-fulfilling
prophecies - traders can join the bandwagon and move exchange
rates based on group expectationsinvestor psychology and
bandwagon effects greatly influence short term exchange rate
movements government intervention can prevent the bandwagon
from starting, but is not always effective
*
Government restrictions can include:A restriction on residents’
ability to convert the domestic currency into a foreign

currencyRestricting domestic businesses’ ability to take foreign
currency out of the country
Governments will limit or restrict convertibility for a number of
reasons that include:Preserving foreign exchange reservesA fear
that free convertibility will lead to a run on their foreign
exchange reserves – known as capital flight
10-*
Should Companies Use Exchange Rate Forecasting
Services?There are two schools of thought
The efficient market school - forward exchange rates do the best
possible job of forecasting future spot exchange rates, and,
therefore, investing in forecasting services would be a waste of
money
The inefficient market school - companies can improve the
foreign exchange market’s estimate of future exchange rates by
investing in forecasting services
*
LO 5: Identify the merits of different approaches toward
exchange rate forecasting.
10-*
Should Companies Use Exchange Rate Forecasting Services?
An efficient market is one in which prices reflect all available
information if the foreign exchange market is efficient, then
forward exchange rates should be unbiased predictors of future
spot ratesMost empirical tests confirm the efficient market
hypothesis suggesting that companies should not waste their
money on forecasting services

*
10-*
Should Companies Use Exchange Rate Forecasting Services?
An inefficient market is one in which prices do not reflect all
available informationin an inefficient market, forward exchange
rates will not be the best possible predictors of future spot
exchange rates and it may be worthwhile for international
businesses to invest in forecasting services However, the track
record of forecasting services is not good
*
10-*
How Are Exchange
Rates Predicted?Two schools of thought on forecasting:
Fundamental analysis draws upon economic factors like interest
rates, monetary policy, inflation rates, or balance of payments
information to predict exchange rates
Technical analysis charts trends with the assumption that past
trends and waves are reasonable predictors of future trends and
waves
*

10-*
Are All Currencies
Freely Convertible?A currency is freely convertible when a
government of a country allows both residents and non-residents
to purchase unlimited amounts of foreign currency with the
domestic currency A currency is externally convertible when
non-residents can convert their holdings of domestic currency
into a foreign currency, but when the ability of residents to
convert currency is limited in some way A currency is
nonconvertible when both residents and non-residents are
prohibited from converting their holdings of domestic currency
into a foreign currency
*
10-*
Are All Currencies
Freely Convertible?Most countries today practice free
convertibilitybut many countries impose restrictions on the
amount of money that can be convertedCountries limit
convertibility to preserve foreign exchange reserves and prevent
capital flight when residents and nonresidents rush to convert
their holdings of domestic currency into a foreign currencymost
likely to occur in times of hyperinflation or economic crisis

*
10-*
Are All Currencies
Freely Convertible?When a currency is nonconvertible, firms
may turn to countertrade barter-like agreements where goods
and services are traded for other goods and serviceswas more
common in the past when more currencies were nonconvertible,
but today involves less than 10% of world trade
*
10-*
What Do Exchange Rates
Mean For Managers?Managers need to consider three types of
foreign exchange risk
Transaction exposure - the extent to which the income from
individual transactions is affected by fluctuations in foreign
exchange valuesincludes obligations for the purchase or sale of
goods and services at previously agreed prices and the
borrowing or lending of funds in foreign currencies
*
LO 6: Compare and contrast the differences among translation,
transaction, and economic exposure, and what managers can do
to manage each type of exposure.

10-*
Mean For Managers?
Translation exposure - the impact of currency exchange rate
changes on the reported financial statements of a
companyconcerned with the present measurement of past
eventsgains or losses are “paper losses” they are unrealized
*
10-*
Mean For Managers?
Economic exposure - the extent to which a firm’s future
international earning power is affected by changes in exchange
ratesconcerned with the long-term effect of changes in exchange
rates on future prices, sales, and costs
*
10-*
How Can Managers

Minimize Exchange Rate Risk?To minimize transaction and
translation exposure, managers should
Buy forward
Use swaps
Lead and lag payables and receivableslead and lag strategies
can be difficult to implement
*
10-*
How Can Managers
Minimize Exchange Rate Risk?Lead strategy - attempt to collect
foreign currency receivables early when a foreign currency is
expected to depreciate and pay foreign currency payables before
they are due when a currency is expected to appreciateLag
strategy - delay collection of foreign currency receivables if
that currency is expected to appreciate and delay payables if the
currency is expected to depreciate
*
10-*
How Can Managers
Minimize Exchange Rate Risk?To reduce economic exposure,
managers should

Distribute productive assets to various locations so the firm’s
long-term financial well-being is not severely affected by
changes in exchange rates
Ensure assets are not too concentrated in countries where likely
rises in currency values will lead to increases in the foreign
prices of the goods and services the firm produces
*
Management Focus: Dealing with the Rising Euro describes the
exchange rate exposure faced by two German companies, SMS
Elotherm and Keiper.
10-*
How Can Managers
Minimize Exchange Rate Risk?In general, managers should
Have central control of exposure to protect resources efficiently
and ensure that each subunit adopts the correct mix of tactics
and strategies
Distinguish between transaction and translation exposure on the
one hand, and economic exposure on the other hand
Attempt to forecast future exchange rates
Establish good reporting systems so the central finance function
can regularly monitor the firm’s exposure position
Produce monthly foreign exchange exposure reports
*

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