Module 3 online lectures ( httpsmyclasses.argosy.edud2llecon.docx

Module 3 online lectures (
https://myclasses.argosy.edu/d2l/le/content/17886/viewContent/
740034/View)
Regional Economic Integration (1 of 6)
Graphic depicting levels of regional economic integration.
What is Regional Economic Integration?
Regional economic integration refers to agreements between
countries — usually in the same geographic region — to reduce
and ultimately remove economic barriers to the free flow of
goods, services, and production elements. Applying the theory
of comparative advantage, member nations can expect
substantial gains from regional trade agreements.
The five levels of regional economic integration are:
Free trade areas
Customs unions
Common markets
Economic unions
Political unions
We’ll explore each of these types of trade agreements in greater
detail.
Free Trade Areas
A free trade area eliminates barriers to the trade of goods and
services among member nations. In theory the governments of
member nations do not permit discriminatory tariffs, quotas,
subsidies, or administrative impediments to distort trade among
the member nations. However, each country can determine its
own trade policies with reference to nonmembers.

Of the several free trade agreements, the most notable is the
North American Free Trade Agreement (NAFTA). This is a
regional agreement between the government of Canada, the
government of the United Mexican States, and the government
of the United States of America to implement a free trade area.
Click here to visit the European Union (EU) Web site.
Common Markets
Another example of regional economic integration, common
markets serve to:
Eliminate trade barriers between member nations
Adopt common external policies
Enable factors of production to move freely among member
nations
Common markets usually do not place any restrictions on
immigration, emigration, or cross-border flows of capital. Thus,
labor and capital move freely within the common markets,
unlike in the customs market model. Currently, the European
Union (EU) is a common market although its goal is to become
a full economic union.
The Treaty of Maastricht, signed in 1991, advanced the goals of
the EU by outlining steps for economic union and partial
political union. Additionally, the treaty provided a framework
for a common foreign policy, an economic policy, a defense
policy, citizenship, and currency.
The common currency eliminates exchange costs and reduces
risk, making EU organizations more efficient than they were
before the formation of the EU. By adopting the Euro, the EU
has created the second largest currency zone in the world —
second only to the U.S. dollar.
If the EU is successful in establishing a common market and
currency among all its members, member nations can expect
positive results from the free flow of trade and investment.

Competition among European organizations may also increase.
However, the downside of this integration may be the failure of
inefficient organizations due to lack of protection against high
tariffs, quotas, or administrative trade barriers.
Click here to read an article about the unification of East and
West Germany.
Economic Unions
Economic unions eliminate trade barriers among member
nations, adopt a common external policy, and permit factors of
production to move freely among member nations.
A full economic union mandates:
A common currency
Adoption of the tax rates of member nations
Implementation of a common monetary and fiscal policy
While a true economic union has yet to be formed, certain
regional integration agreements — such as the EU — have this
aim in mind.
You may argue that the EU is an economic union due to the
partial adoption of the Euro. However, until all member nations
accept the common currency, formulate a common fiscal and
monetary policy, and facilitate differences in tax rates, the EU
cannot be classified as a true economic union.
Political Unions
A political union is the coupling of multiple previously separate
nations into one country. All components of an economic union
apply, in addition to the political elements of the countries
involved. Perhaps the best example is the United States, where
previously separate states banded together to form one country.
Another more recent example is the unification of East and
West Germany.

Caption which reads: How can states cooperate without
abandoning what is the characteristic feature of a state, viz its
national sovereignty? The European answer to this question has
not been to erect a new federation but to maintain the nation-
states in Europe while at the same time delegating enough
power to the Union so that it can function as a legal order.
Economic and Political Case for Integration
The rationale for regional integration is both economic and
political. Regional economic integration is viewed by some as
an attempt to achieve additional gains from the free flow of
trade and investment among countries. The realized gains are
beyond those allowed by the World Trade Organization (WTO).
From a political perspective, integration comprises two main
components:
First, by linking them together, political integration makes
countries more dependent on each other, creating an
environment that requires regular interaction. This also has a
positive effect by reducing conflict in the region.
Second, political integration creates a body of nations that is
more influential in the world, thereby establishing a stronger
bond and position of authority relative to other nations.
Drawbacks of Regional Integration
Regional integration has several drawbacks. Although a nation
may benefit significantly from a regional trade agreement, it
may be at a cost to certain groups within that nation. Integration
may also impede national sovereignty.
Current trends favor regional free trade agreements. However,
some economists express concern that the benefits of regional
integration do not outweigh the costs. In order for regional
integration to be beneficial to participants, the amount of trade
it creates must be greater than the amount of trade it diverts.

If the people of the trading nations believe that regional
integration is not in their best interests, integration can become
a political liability — regardless of economic benefits.
Integration of the Americas through NAFTA (1 of 5)
The NAFTA controversy continues! For insight into different
perspectives, do a keyword search using “NAFTA TEN years
later”. There is also, a click to explore Web link:
NAFTA — Years Later
As we’ve learned about the various levels of regional economic
integration, let’s discuss the integration of the Americas, as
accomplished by NAFTA.
NAFTA may be the most controversial trade agreement ever
negotiated! Since its inception, it has drawn a long line of
supporters and critics.
Many believe that NAFTA has been beneficial only to the
United States by:
Helping to create approximately 20 million U.S. jobs.
Nearly doubling U.S. exports to Canada and Mexico.
Initiating a significant increase in U.S. manufacturing wages.
But on the other hand, critics state that implementing NAFTA
has been costly for the United States, resulting in the loss of
American jobs, increasing trade deficits with Canada and
Mexico, and hindering wage growth.
When the United States, Canada, and Mexico entered into
NAFTA on January 1, 1994, it was considered one of the most
comprehensive agreements of the century. Not only did the
agreement contain provisions relating to the trade of goods, but
also included guidelines for the trade of services, protection of
intellectual property, and protection of foreign investments.

Many believe that NAFTA has served as a model for follow-up
agreements including the recently signed Central America-
Dominican Republic Free Trade Agreement (CAFTA-DR).
Impact of NAFTA on Mexico
Perhaps the greatest benefit to the United States has been the
economic stabilization of its southern neighbor — Mexico.
NAFTA has helped spur trade and investment in Mexico as well
as productivity gains, which is the driver for higher living
standards.
Mexico reports significant and positive outcomes due to
NAFTA membership. According to the United States Embassy
in Mexico, Mexico has exported $139 billion to its NAFTA
partners in 2001 — 225% more than in 1993, prior to the
NAFTA implementation.
According to a June 2009 report by the U.S. Embassy in
Mexico, “Mexico’s agriculture exports to the U.S. have
expanded nearly 9% per year, growing twice as fast as they did
before NAFTA.”
According to data collected by the United States International
Trade Commission (2008):
In 2008, the U.S. trade deficit with Mexico decreased by 7
percent as the growth of U.S. exports outpaced the growth of
U.S. imports. The reduction of the U.S. trade deficit with
Mexico was the second since 1994 when NAFTA was
implemented and the first since 1997. A large share of U.S.
bilateral trade with Mexico is accounted for by intrafirm
transfers and other foreign direct investment and foreign-based
manufacturing activity.
In 2008, Mexico was the second-largest U.S. export market.
U.S. exports to Mexico rose by $12.1 billion (10 percent) to
$131.5 billion, driven in part by a Mexican economy that

expanded by 1 percent. The largest export increases were in
energy-related products, agricultural products, and minerals and
metals. The increase in value of these exports is attributable, in
large part, to an increase in commodity prices.
In 2008, the largest U.S. import increases from Mexico were in
energy-related products, minerals and metals, agricultural
products, and chemicals and related products. U.S. imports from
Mexico increased by approximately 3 percent, due principally to
global price increases for crude petroleum.
Total trade between Mexico and the United States, as reported
by the Census Bureau, is shown below:
United States International Trade Commission (2008). USITC -
Mexico: Exports, imports, and trade balance. Retrieved from
http://www.usitc.gov/research_and_analysis/tradeshifts/2008/me
xico.htm
Similarly, according to a joint report by the Canadian Minister
of Trade, the Mexican Secretary of Economy, and the United
States Trade Representative (2009):
“Mexican exports to the United States reached $138 billion.
Exports to Canada also grew substantially from $2.7 to $8.7
billion, an increase of almost 227%.”
Mexican exports included a wide range of products, such as
machinery and vehicles, miscellaneous manufacturing articles,
fuels, and food and livestock.

Click here to read
The Government of Canada’s Department of
Foreign Affairs and International Trade – Canada and the
United States: A Strong Partnership
Impact of NAFTA on Canada
The impact of NAFTA on Canada was not as dramatic, in part
because Canada and the United States actively traded before the
agreement. However it is important to note that Canada is the
largest export market for 37 of the 50 states of the United
States, and the United States trades more with Canada than with
all the members of the European Union. According to the Office
of U.S. Trade Representative, Canada and Mexico were the top
two purchasers of U.S. exports in 2008 – Canada $216.2 billion
and Mexico $151.2 billion.
Trade in goods and services, combined with investment income,
resulted in cross-border payments of about $1.7 billion per day
(USTR, 2009).
Canada’s exports to NAFTA member nations increased by 104%
in value. Exports to the United States increased by 250% since
1989 (USTR, 2010) according to a joint report of the Canadian
Minister of Trade, the Mexican Secretary of Economy, and the
United States Trade Representative. Similarly U.S. exports to
Canada and Mexico grew from $134.3 billion to $250.6 billion
(USTR, 2009).

Click here to read the USTR’s NAFTA fact sheets, including
“NAFTA at 10: Myth - NAFTA Was a Failure for the United
States”.
Impact of NAFTA on USA
Not only has there been a change in the value of imports and
exports within NAFTA member nations, but also in quantity,
prices, and the range of goods traded.
Russell Hillberry and Christine McDaniel published "A
Decomposition of North American Trade Growth since NAFTA"
for the U.S. International Trade Commission in 2002. Their
research indicated that U.S. export prices have not kept up with
inflation but have in fact, declined. The authors suggest that
Mexican export prices for products exported to the United
States have risen, possibly signaling rising Mexican production
costs, including exchange rates.
Many are concerned that U.S. trade deficits have accelerated
rapidly since NAFTA took effect in 1994, resulting in the loss
of jobs for U.S. workers. According to the Economic Policy
Institute (EPI):
Since the North American Free Trade Agreement (NAFTA) was
signed in 1993, the rise in the U.S. trade deficit with Canada
and Mexico through 2002 has caused the displacement of
production that supported 879,280 U.S. jobs. Most of those lost
jobs were high-wage positions in manufacturing industries. The
loss of these jobs is just the most visible tip of NAFTA's impact
on the U.S. economy. In fact, NAFTA has also contributed to
rising income inequality, suppressed real wages for production
workers, weakened workers' collective bargaining powers and
ability to organize unions, and reduced fringe benefits
Scott, R. E. (2003, November 17). The high price of 'free' trade:
NAFTA's failure has cost the United Sates jobs across the

nation. Economic Policy Institute: Briefing Paper, 147.
Since its inception, NAFTA has faced controversy. What does
the future hold?
The Foreign Exchange Market (1 of 4)
Click here to read A Primer on the Forex Market.
As a global business player, you’ll want to understand the
dynamics of the foreign exchange market!
From your textbook reading assignment this module, you
learned about the various factors that determine exchange rates
— all related to a trading relationship between two nations.
Your text discusses numerous reasons for the determinants of
exchange rate movements, including:
Inflation
Differentials in interest
Current account deficits
Public debt
Terms of trade
Political stability and economic performance
The last determinant, political stability and economic
performance, relates to foreign investors who search for stable
countries with strong economic performance in which to invest
their capital. A country with positive performance attributes is
an obvious candidate for investment and is favored by investors
over countries with economic investment risks.
We’ll now discuss factors that affect investor actions.
Graphic with caption that reads: The bandwagon effect is the
observation that people often do (or believe) things because
many other people do (or believe) the same. The effect is often
pejoratively referred to as herd instinct, particularly as applied
to adolescents. Without examining the merits of the particular
thing, people tend to "follow the crowd".

Investor Psychology
Your text discusses economic theories that have been devised to
explain
short-term movements in exchange rates:
Purchasing power parity (PPP)
International Fisher effect (IFF)
However, empirical evidence suggests these explanations are
not telling the whole story. Investors are not always rational
when making decisions! They may imitate the actions of other
people or groups who are influential, contrary to logic.
Investors also make trades based on hunches or speculation,
which are psychological in nature. When investors follow the
lead of others who may positively or negatively affect the value
of a currency, we call this the bandwagon effect.
As the bandwagon effect builds up momentum, investor
expectations become a self-fulfilling prophecy and the market
moves in the way the investors expected — not necessarily
where it should have moved based on rational economic factors.
This psychological aspect of investing and the bandwagon effect
can profoundly affect exchange rate movements.
Behavioral Finance
How can we explain what drives investor behavior? The
psychology of investment has its roots in the study of
behavioral finance. This discipline applies the insights of
psychologists in order to understand the behavior of investors,
financial markets, and corporate financial managers.
Of course, from a global perspective, behavioral finance has
significant implications for international markets and exchange
rates. Three central theories attempt to explain investor
psychology and provide insights on how investors approach
decision-making:

Prospect theory
Regret theory
Anchoring theory
Prospect Theory
Prospect theory suggests that people respond differently to the
same situation depending on whether the situation is presented
in the context of a loss or a gain. Investors may be more
concerned about the prospect of losses than be happy about
equivalent gains.
What is the implication of this for investors? Even when faced
with sure investment gains, they are averse to risks. However,
when confronted with the certainty of loss, they become risk-
takers.
Click here to explore Investopedia’s financial dictionary.
Regret Theory
This theory says that people anticipate regret if they make a
wrong choice, and take this anticipation into consideration when
making decisions. For example, investors may avoid selling a
stock that has declined in value to later avoid regretting making
a bad investment and/or the embarrassment of admitting the
mistake of not selling it in time.
The bandwagon effect may also arise because investors may
find it easier to follow the crowd when considering investment
opportunities or when rationalizing financial loss — misery
loves company! Consider the implications of this for global
investments.
Anchoring Theory
Anchoring refers to a phenomenon that causes investors to
assume current investment conditions in the absence of better
information. In other words, while making assessments,
decision makers anchor on an initial value and then adjust this
up or down accordingly.

The traditional process of budgeting in businesses is an example
of anchoring, where available figures are used to anchor the
budget for future years of operation.
Graphic depicting the effect of investor behavior on exchange
rates.
Global Monetary System (1 of 3)
Click to explore Foreign Policy Association (FPA) Web site and
review issues and news about the IMF/World Bank.
As we discussed in Module 1, the 1944 Bretton Woods
conference resulted in the birth of a new international monetary
system. The goal of the conference was to create an economic
order to facilitate economic growth and cooperation.
The conference achieved three things:
Establishment of the International Monetary Fund (IMF)
Establishment of the World Bank
Decision to establish a set of fixed currency exchange rates
monitored by the IMF
Today the IMF and the World Bank remain major players in the
international monetary system. The system of fixed exchange
rates established at Bretton Woods worked satisfactorily until
the late 1960s — it began to show signs of strain thereafter. In
1973, the system was replaced with a managed float system that
continues today.
Graphic with facts about the Barbados dollar. “The Barbadian
dollar, which was fixed at Bds.$2.00 = US$1.00 on July 05,
1975 retains the same value today.”
Exchange Rate System
Under a fixed rate system, the value of a currency is usually
fixed in terms of the U.S. dollar and can change only under
specific circumstances.

A fixed rate system offers four benefits:
It introduces monetary discipline
It discourages currency speculation
It reduces uncertainty with regard to future currency movements
It has little or no effect on trade balance adjustments
Alternatively, a floating rate system allows currency prices to
float freely. In practice, the majority of floating rate systems
are either managed in some way by government intervention, or
pegged to another currency. The benefits of a floating rate
system include providing autonomy to countries on their
monetary policies and giving them a way to correct trade
deficits through exchange rate depreciation. Depreciation of
exchange rates helps correct trade imbalances by making a
country's exports cheaper and imports more expensive.
Experts continue to debate on the issue of which system is
better — and there doesn’t appear to be sufficient data to
choose one system over another. From the Bretton Woods
system experience, we could conclude that a fixed rate system
doesn’t work. But many scholars argue that speculation is a
major disadvantage of floating rates. They support the value of
a modified fixed rate system, with hopes that it will produce the
type of economic stability required for growth in international
trade and investments.
Currency Management
The mix of government intervention and speculation can be
volatile drivers of exchange rate values. The buying and selling
of currencies can create an environment of instability within
certain countries and across the world.
In your textbook, you learned about tools used by the foreign
exchange market to mitigate foreign exchanges risks. The
textbook also discusses theories that do not always hold true —
although we base our predictions on them.

As a global business manager, you need to recognize that the
foreign exchange market is unpredictable. Should you be
engaged in foreign exchange activities, you’ll be required to
apply consistent and skillful management techniques. In fact,
many companies dealing in the foreign exchange market
regularly employ staff members who are dedicated to foreign
currency management.
The unpredictability of foreign exchange rates creates risks for
organizations in every country on returns on investment. Today,
a sudden change in the money markets of Paris can disrupt the
economic well-being of retail shop owners throughout the
United States — whether or not they have ever ventured out of
town!
Global Business Strategy (1 of 3)
Global Strategy and the Organization
The demands you face as a global business manager have
increased significantly over the past few decades. Strategic
initiatives made during the 1970s and 1980s have transformed
international business into the agile, innovative, and adaptive
operations you see in today’s world marketplace.
The current situation resulted from:
Rapid advancements in technology
Increased competition
Volatility of markets
Organizational restructuring during the 1960s, 1970s, and 1980s
Companies continued the restructuring process through the
1990s, to ensure readiness for the 21st century — and
experienced great financial success for their efforts. But the
challenge of adapting to continuous change doesn’t stop.
Powerful macroeconomic forces affect the international arena,
and may become even stronger over time. As a result
organizations will be pushed to reduce costs, improve the

quality of products and services, locate new opportunities for
growth, and increase productivity.
Your role as a global manager will be to help align your
organization strategically to achieve competitive advantage and
market agility. This means quickly adjusting and adapting to
environmental changes in order to achieve market position and
share. Maintaining this competitive advantage requires strategy,
the process of making appropriate business decisions.
Quote by Cynthia D. Churchwell: Today's scarce resource is the
information, knowledge, and expertise that are embedded in
people's heads and human relationships. But we've built
companies to allocate and control financial capital, and now
we've got to completely change them so they can develop and
diffuse intellectual capital and manage human capital.
Strategic Thinking and Strategic Planning
To achieve and maintain competitive advantage, your company
needs a vision for the future, and a strategic plan to get there.
Strategic planning first requires strategic thinking — applying
critical thought to what needs to get done, how it should get
done, deciding how it will get done, and then doing it!
Strategic planning is the activity that strategic thinking
delivers. Many methods have been devised, and several books
have been published on the topic. Generally speaking, the
following are major considerations in strategic planning:
Graphic depicting the major considerations in strategic
planning: What needs to be done and why? How should it be
done and why? How will it then be done and why? When will it
be done? Who will do it? How will the success of it be
measured? Execute the plan to get it done.

So, what is the importance of strategy? What will happen to
your organization if it does not have an effective strategy for
entering international markets?
Simply put, the chances for success are not great. Failure to
follow a systematic approach is a serious oversight for many
small- and intermediate-sized companies. Let’s examine a
general model for systematic strategic planning that is
applicable to companies that plan to enter international markets.
Click to Explore link to an example of a SWOT analysis.
The SWOT Analysis
Many believe there’s no greater changing environment than that
of global business! And as a global manager, an important part
of the strategic planning process is the scanning of the internal
and external environment factors that affect your business.
Internal environment factors are the strengths and weaknesses
within your organization — those factors you have some control
over in the quest for competitive advantage. External
environment factors are the threats and opportunities generally
beyond your organization’s control. However, they can provide
an impetus for positive change and organizational growth. We
refer to this analysis of the strategic environment as a SWOT
analysis.
Opportunities can quickly transform into threats. When market
conditions are not accurately monitored, an organization may
experience unexpected events such as hostile takeovers,
unanticipated mergers, and loss of market positioning. As
threats, these environmental factors can have second- and third-
order effects on internal operations, such as:
Loss of human capital
Degradation of organizational culture

Communication gaps with internal stakeholders
Uncompetitive compensation and benefits package
In a worst case scenario, your organization may go out of
business. On the other hand, when external opportunities are
united with internal strengths, your organization can experience
unmatched success.
We’ll examine external and internal business environments in
greater detail next.
Monitoring the External Business Environment (1 of 6)
Introduction
The external business environment comprises three subsystems
that interact with each other:
Trends
Market Influences
Resource Influences
When you monitor and analyze these factors accurately, they
can provide you with the information needed to make timely and
accurate management decisions.
Trends
The first external subsystem is perhaps the least controllable by
organizational leadership. Therefore, many organizations
perform a PEST analysis to gain an understanding of their
position in the market. This business tool measures the
following factors:
Political
Economic
Sociological
Technical
Analysis of these factors is essential to remain competitive and
profitable. The PEST analytical approach is often used with
Porter’s (1980) Five Forces model to reduce the risks associated

with external factors.
Macro-environment is another term used to describe these
external factors that can influence an organization, but are out
of its direct control. We’ll take a closer look at each of these
external factors next.
Introduction
The external business environment comprises three subsystems
that interact with each other:
Trends
Market Influences
Resource Influences
When you monitor and analyze these factors accurately, they
can provide you with the information needed to make timely and
accurate management decisions.
Trends
The first external subsystem is perhaps the least controllable by
organizational leadership. Therefore, many organizations
perform a PEST analysis to gain an understanding of their
position in the market. This business tool measures the
following factors:
Political
Economic
Sociological
Technical
Analysis of these factors is essential to remain competitive and
profitable. The PEST analytical approach is often used with
Porter’s (1980) Five Forces model to reduce the risks associated
with external factors.

Macro-environment is another term used to describe these
external factors that can influence an organization, but are out
of its direct control. We’ll take a closer look at each of these
external factors next.
Political Factors
The political environment can affect your organization in
several ways and should be monitored closely. Legislative
initiatives and lobbying efforts may offer new opportunities or
create prohibitive environments, which limit the possibility of
profitable transactions.
For example, legislation that permits offshore drilling or
logging may be beneficial for an oil, gas, or timber company,
but may pose risks to the fishing and wildlife industries.
Maintaining relations with political and professional
organizations will help you to stay informed about current
industry-specific political initiatives.
Economic Factors
Slow economic growth, floating foreign exchange rates, fewer
tariffs as a result of GATT, and emerging world markets are
external economic factors that should be considered in your
organization’s strategic decision-making processes.
Sociological Factors
Your organization must pay attention to changes in the
sociological environment as well. Demographic shifts and
changing consumer needs can have a profound impact on the
bottom line.
Technological Factors
The most dramatic of these external factors is technological
change. The advent of low-cost personal computers, high-speed
signal carriers, the Internet, and satellite communications have
revolutionized business operations. As a global business

manager, you need to recognize the commercial impact of
emerging new technologies.
As just one example, the emergence of Web-based technologies
has transformed corporate functions such as HR management.
The open access to personalized information and online
transaction capabilities has revolutionized the traditional
employer-employee relationship.
Considered individually, each factor can have a significant
impact on your company. When viewed together as a subsystem,
the impact is even greater. This underscores the importance of
monitoring and evaluating these factors for inclusion in your
organization’s decision-making.
Monitoring External Business Environment (3 of 6)
Image depicting the relationship of collaborators and
competitors to the market influence upon your business.
We now come to the second subsystem of external business
environment
factors: market influences.
This subsystem is linked with the other two—trends and
resource influences—through such resources as collaborators
and external stakeholders. Collaborators would include
distributors, suppliers, alliances, and informal partnerships and
alliances.
The main component of this subsystem is the competitor — both
current and emerging. And it’s vital to know what your
competitors are doing! Why can’t you just ignore the
competition?
There are several key benefits to conducting competitor
analysis:
Help your organization understand its competitive
advantages/disadvantages relative to its competitors.

Develop an understanding of competitor’s past and present
strategies, with the hopes of predicting future strategies.
Gain insight for developing strategies for achieving competitive
advantage in the future.
Help forecast potential returns made from future investments
(knowing how competitors have responded to marketing
strategies).
Predict probable reactions to industry changes of each
competitor.
Obviously, it makes sense to study your competitors! But this
means looking not only at current competitors, but also
potential or emerging ones. The evaluation of competitors
should include a complete assessment of capabilities such as:
Products
Operations
Research and development
Cost positioning
Financial strengths
Monitoring and evaluation of competitors will also provide the
requisite change management and strategic information for
decision-making within your organization.
Resource Influences
The third external environmental subsystem also requires
monitoring, as their activities can have a profound effect on
your organization’s resources. Resource influences include:
Regulators
Customers
Board of directors and other governance bodies
External stakeholders
Regulators
One example of regulators would be new political appointees
whose views represent a shift in government philosophy. It is
important to monitor these regulators not only for who they are,

but also for their political agendas.
Regulations relating to scientific developments such as cloning
and use of food additives and safety equipment are influenced
by public opinion and those holding political office.
Regulations have the potential of making a huge impact on the
resources of a company. We see a dramatic instance of this
principle where the Food and Drug Administration has been
given authority over the regulation of nicotine. Here,
governmental regulation would be catastrophic to the tobacco
industry.
Customers
Having knowledge of the current regulatory climate can help
you provide solutions to clients — ones that will comply with
current and future statutes. And by scanning trends and market
influence factors, you’ll be able to improve customer
relationship management. Customers are your company’s most
valuable resource. To attract and retain good customers, you’ll
need to keep an eye on changes in their attitudes, preferences,
and buying power.
Consumer behavior is explained in part by economic theory and
in part by social and psychological factors. However, regardless
of market stimuli or buyer characteristics, it is essential to
include monitoring of customer-related factors in your
organization’s external environmental evaluation and
assessment processes.
Quote: Corporate Governance looks at the institutional and
policy framework for corporations The integrity of
corporations, financial institutions and markets is particularly
central to the health of our economies and their stability.
Board of Directors and Other Governance Bodies
Another group of resource influencers you need to monitor is
the board of directors and other governance bodies. These

groups should be scanned to so that you understand their
perspectives and orientation.
As an organizational leader, you can be well equipped to
position your company for any change that results from the
preferences and biases of board members. How do you
accomplish this? Do your research and find out:
Who makes up the board?
How do these members manage their own organizations?
What interests do they represent (i.e. bankers, lawyers)?
External Stakeholders
In his book Strategic Management. A Stakeholders Approach
(1984), R. Edward Freeman defined the term stakeholder as
"any group or individual who can affect or is affected by the
achievements of the organization's objectives." To further
explain the stakeholder approach to strategic planning, he
introduced many of the current themes of stakeholder-related
research, stakeholder relationships, stakeholder management,
stakeholder behavior, and stakeholder analysis.
As a global manager, you may find it useful to include external
stakeholders when addressing core strategic issues within your
organization. They are often better at assessing external threats
and opportunities than employees. In strategy formulation, be
sure to discuss and evaluate strategies in relation to key
stakeholders. Strategies deemed unacceptable by this group are
likely to fail.
Summary
External monitoring is crucial to help your organization adapt to
changing environments. The degree of change and turbulence in
the external environment will determine the extent to which this
monitoring is needed.

Gary A. Yukl, author of Leadership in Organizations (2009),
suggests five guidelines while monitoring external
environmental conditions:
Identify relevant information to gather.
Use multiple sources of relevant information.
Learn what clients and customers need and want.
Learn about the products and activities of competitors.
Relate environmental information to strategic plans.
This process of monitoring and evaluating external conditions
forms a critical part of managing change within an organization
— essential to its ability to adapt to a changing environment.
Image depicting the external environmental elements to monitor
and evaluate to help your organization succeed.
Yukl, G. A. (2009). Leadership in organizations (7th ed.).
Upper Saddle River, NJ: Prentice Hall.
===============================================
=============================
Monitoring the Internal Business Environment (1 of 8)
Downsizing the workforce may be a prudent and necessary step,
however, it can adversely affect staff morale and add to
employee stress.
Introduction
The external environmental conditions we’ve just examined can
lead to turbulence within the organization. Often, what is often
perceived as an astute managerial decision based on external
environmental conditions results in creating havoc for
employees.
One scenario would be a company’s decision to downsize in
reaction to adverse external conditions. Such a managerial
decision affects the organization’s employees in many ways:
Lower morale

Higher stress
Reduced organizational trust
Fewer promotions
Minimized compensation packages
Another example would be the decision to outsource services.
Food service workers, security guards, clerical workers,
cleaners, maintenance workers, telephone operators,
receptionists, and others at the bottom of the organizational
ladder are affected. These workers face salary cuts of 20-40%,
depending on the job market. Under new agreements, they
typically lose all or most of their nonwage benefits.
These examples illustrate how internal business environment
conditions are shaped by the decisions made from monitoring
and evaluating external environments. They underscore the
importance of reacting with sound strategic decisions.
Essentially, three internal environmental subsystems are likely
to be affected by external environments:
Strategic leadership and management
Internal resources and human capital
Measuring organizational performance
As with external environmental factors, these subsystems
interact with each other. Let’s take a closer look!
Strategic Leadership and Management
Analysis of external environment factors often means an
organization must implement a new strategic direction. As an
organizational leader, you’ll need to evaluate what internal
changes will be needed, and to what degree they should be
implemented.
Generally speaking, when making these decisions, focus on your
company’s culture, structure, and human resource practices.

You’ll also need to consider your organization’s vision,
mission, and business objectives.
Turbulent conditions may require that you conduct an analysis
in order to redirect the company. In the event of transformation,
you’ll need to build consensus and confidence if the company is
to be successful.
The leaders and managers of an organization undergoing change
must provide guidance that instills confidence in employees.
The CEO who is successful in this type of organizational change
is called a transformational leader. According to Bass (1990),
this type of leader is one who:
Displays conviction and trust
Takes a stand on difficult issues
Demonstrates values
Emphasizes the importance of purposefulness and ethical
consequences of decisions
Brings about pride, loyalty, confidence, and alignment around a
shared purpose
Jack Welch, former CEO of G.E., is one leader who
demonstrated a keen awareness of the importance of internal
environmental factors. Welch’s change process, known as the
Workout, required all managers to involve employees in the
identification of barriers and development of change plan
solutions.
Internal Resources and Human Capital
This internal subsystem encompasses all aspects of the human
resources domain, as well as organizational behavioral factors.
Employees often experience stress and insecurity when a
company undergoes change due to external factors, which can
lead to increased illness and absenteeism. Other effects they
may face on the job include:

Elevated expectations
Redefinition of careers
Requirements for continuous learning
Individual responsibility for maintaining competencies
These internal human resource-related factors will become
apparent in the organization’s culture and climate. However,
they can be directly addressed through your organization’s
human resources (HR) policies and practices. Successful
implementation of organizational strategies is directly related to
the organization’s ability to change its culture.
Organizational culture has a significant and positive impact on
organizational effectiveness and long-term performance.
Monitoring organizational culture and HR practices can provide
a more holistic assessment for your change management
decisions.
HR practices are linked to organizational performance through
the selection and development of employees who achieve
organizational goals. Rewards and training motivate employees
to improve processes and organizational citizenship behavior
(OCB). This refers to individual helping behaviors and gestures
that are organizationally beneficial, but are not formally
required (Organ, 1990). Such practices can help improve
workforce quality and create human capital assets that
contribute to competitive advantage.
Quote: “Organizational culture" can be defined as an
organization's values, beliefs, principles, practices, and
behaviors. "Organizational climate," is found in the private
language of the organization, such as the conversations about
work among staff during coffee breaks. Source: “Effecting
Extension Organizational Change Toward Cultural Diversity: A
Conceptual Framework” by Ann C. Schauber

As a global business leader, you’ll need to examine specific HR
practices as part of the monitoring and evaluating process. Your
analysis should focus on the main categories of HR practices
that are affected by change:
Staffing
Employee development
Appraisal
Rewards
Organizational design
Communication
Change initiatives
Keep in mind that your organization’s culture may have a
positive or negative influence on each of these practices. (The
reverse is also true: these practices may affect your
organizational culture!)
Staffing becomes an area of concern during turbulent times for
several reasons. The organization’s inability to recruit and
retain the best talent can adversely affect the success of the
change initiative and decrease employee morale and confidence.
Similarly, instability may reduce or eliminate the benefits of in-
house training and other employee development programs. If
not monitored appropriately, this can result in employee
attrition.
Performance appraisal systems can also be affected by change
— appraisals may fall behind schedule because senior
employees have left the organization. If these systems are not
monitored and evaluated properly, employees may be denied
feedback or opportunities for promotions.
As a leader, you can help reduce feelings of fear and insecurity
throughout the change process. Ensure that news of proactive

steps taken by the organization reach your employees through
strong internal communications, such as:
Newsletters
The Internet
Intranet sites
Line management
All-hands meetings
Finally, the third internal environmental subsystem likely to be
affected by external environments is the measurement of an
organization’s performance.Measuring Organizational
Performance
Often during organizational transformation, measurement of
change is given low priority. But measurement processes should
be monitored to ensure they include appropriate techniques and
performance areas. Your organizational measurement systems
may need to be re-engineered to incorporate performance
measurements of revised policies, practices, and procedures.
Numerous corporate measurement data may be included in
formal measurement systems, such as profitability, customer
service, returns on equity, assets and sales, and cash flow and
liquidity projections. The inclusion of additional factors in the
organizational measurement system such as HR, internal
processes, innovation, and improvement activities should be
linked to organizational strategy and change management
processes.
Four measurement systems often used by organizations today
are:
Economic Value Added (EVA)
Activity-Based Costing/Management (ABC/ABM)
Process Value Analysis (PVA)

Balanced Scorecard (BSC)
We’ll take a closer look at these systems next.
Measuring Organizational Performance (Continued)
Economic Value Added (EVA)
EVA was devised by Stern Stewart & Co., a global consulting
firm, to help clients measure their true economic profits. EVA
measures a company’s financial performance by calculating the
net operating profit, minus an appropriate charge for the cost of
all capital invested in the business.
As Bennett Stewart puts it, “By taking all capital costs into
account, including the cost of equity, EVA shows the dollar
amount of wealth a business has created or destroyed in each
reporting period. In other words, EVA is profit the way
shareholders define it.”
This is how you would calculate EVA:
EVA = Net Operating Profit After Taxes (NOPAT) – (Capital x
Cost of Capital)
Activity-Based Costing/Management (ABC/ABM)
ABC/ABM is an activity-based costing tool used to improve the
operations of an organization, by enhancing profits through cost
control and tracking practices. As a manager, you would look
for deficiencies in the system, then attempt to correct them in
order to improve efficiency. These are the steps you would
follow:
Analyze activities.
Gather costs.
Trace costs to activities.
Establish output measures.
Analyze costs.

Process Value Analysis (PVA)
From your reading this module, you learned that a company's
value chain identifies the primary activities that create value for
customers and the related support activities.
PVA is used to estimate the value added by each activity to the
value chain. Some consider PVA to be the foundation for
ABC/ABM. These are the steps you’d follow in process value
analysis:
Study the flow of activities needed to design, create, and deliver
a service.
Determine the associated cost and its cause for each activity and
step within the activity.
Determine how the step adds value, and if it doesn’t add value,
consider ways you might eliminate it and its associated cost.
Determine the time needed to complete each activity and
whether the activity is performed efficiently.
Look for ways to improve efficiency and reduce associated
costs due to delays, excesses, etc.
Balanced Scorecard (BSC)
BSC is an approach to strategic management that was developed
in the early 1990s by Drs. Robert Kaplan (Harvard Business
School) and David Norton.
Kaplan and Norton describe the innovation of the balanced
scorecard:
The balanced scorecard retains traditional financial measures.
But financial measures tell the story of past events, an adequate
story for industrial age companies for which investments in
long-term capabilities and customer relationships were not
critical for success. These financial measures are inadequate,

however, for guiding and evaluating the journey that
information age companies must make to create future value
through investment in customers, suppliers, employees,
processes, technology, and innovation. (What is the Balance
Scorecared?, 2010)
As a manager, you would use the BSC model to evaluate your
organization’s performance by balancing measures of:
Financial performance
Internal operations
Innovation and learning
Customer satisfaction
We’ve looked briefly at how these management control systems
are used to measure performance in an organization.
These systems have proven to be solid methods for assessing
overall business performance. While there has been extensive
debate about which system is best, it really depends on the type
of organization you manage, along with its structure and vision.
Many companies choose to implement a combination of
measurement tools and techniques.
Balanced Scorecard Institute (2010). What is the balanced
scorecard? Retrieved from
http://www.balancedscorecard.org/BSCResources/AbouttheBala
ncedScorecard/tabid/55/Default.aspx
===============================================
======================================
The International Business Environment (1 of 3)
The Internationalization Process
We’ve looked at the importance of environmental monitoring
and evaluation from external and internal perspectives. The
models we’ve studied represent factors you should pay close
attention to during turbulent business environments. In fact,
these factors require your attention regardless of the current

business climate.
Now that we’ve examined the basic components of the
systematic approach to organizational strategy, we’ll apply a
systems-oriented strategy to the international business
environment.
The internationalization process refers to companies that are
increasing their involvement in international operations. In the
study, “The Role of the Internationalization Process in the
Performance of Newly Internationalizing Firms” (Yip, Biscarri,
and Monti, 2000), Dr. George Yip focused on the extent to
which 68 small- and midsized U.S.–based companies used a
systematic approach to globalization.
Yip found that newly internationalized companies experience
significant issues during the process. Most either fail, or
achieve only limited success. This is particularly true at the
stage of commitment — making an international investment.
Such investments may be in the form of sales offices, equity
investments, acquisitions, alliances, and so on.
Unlike existing multinational companies, small- to
intermediate-sized companies undergoing the
internationalization process are constrained by two issues:
inexperience and lack of sufficient resources to handle the new
international venture. Yip found that the use of a more
systematic approach — a strategic approach — resulted in
improved organizational performance.
This study introduced the Way Station Model, a six-step process
to internationalization. Yip concluded that a combination of
thorough strategic planning and motivation to enter foreign
markets would help companies, regardless of their size, to be
successful in internationalizing. A key aspect of success lies in
identifying and leveraging organizational core competencies —

our next topic!
Yip, G. S., Biscarri, J. G., & Monti, J. A. (2000). The role of
the internationalization process in the performance of newly
internationalizing firms. Journal of International Marketing,
8(3), 10–35.
Organizational Core Competencies
Narrowing of markets and focusing on organizational expertise
have long been proposed as the solution to depleting profits. In
the 1990s, C.K. Prahalad and Gary Hamel coined the term “core
competencies” in their article, “The Core Competence of the
Corporation.” Core competence refers to organizational skills
that are unique and cannot be easily imitated.
Prahalad and Hamel (1990) claim that three assessments can be
applied in order to identify an organization’s core
competencies. Each core competency should:
Provide potential and future access to varied markets.
Make a key contribution to customer benefits through the
product or service.
Be difficult for competitors to duplicate.
Core competence is not easy to develop, and harder to maintain.
Few companies are likely to build world leadership in more than
five or six fundamental competencies.
Quinn and Hilmer (1994) identified several characteristics of
core competence. They claim that core competence refers to
corporate skills or knowledge — not the company’s products or
functions. In other words, it is the process of creating the
product rather than the product itself.
An important characteristic of core competence is flexibility
and long-term approach that enables you to adapt to the needs
of your customers. Another is focusing your resources on
activities where your organization is a market leader.

Core competence lies with activities that are reflected in your
organization’s values, structures, and management systems —
and ones that don’t rely on a few talented individuals to
maintain. Core competencies become extremely important when
considering entry into foreign markets.
Prahalad, C. K., & Hamel, G. (1990). The core competence of
the corporation. Harvard Business Review, 68(3), 79–91.
Quinn, J. B., & Hilmer, F. G. (1994). Strategic outsourcing.
Sloan Management Review, 35(4), 43–55.
Core Competencies and Foreign Entry Modes
Once you’ve decided to enter a foreign market, how do you
choose the best mode of entry? Here, we’ll discuss the
advantages and disadvantages of various foreign entry modes.
Knowing your organization’s core competencies can help you
select the best approach.
Companies often expand so that they can transfer their core
competencies to foreign markets where these skills are not
present. The author Charles W. L. Hill, in his book, Global
Business Today, refers to these competencies as know-how that
is technological and management know-how (2010). He offers
this advice:
If your organization’s core competence is proprietary
technological
know-how, licensing and joint venture arrangements should be
avoided.
If your organization perceives its technological advantage as
temporary, licensing may be appropriate.
Management know-how is a unique and hard-to-imitate skill set.
The organization benefits by receiving more visibility through
the brand name, which is usually protected by international law.

Management style as a competence is less likely to be copied by
others in foreign markets. If your company possesses this as a
core competency, you may decide that a joint venture,
subsidiary — or a combination of the two — may be the best
mode of entry to a foreign market.
Entering a foreign market requires an in-depth analysis of the
differentiators between your organization’s unique
competencies, and those existing in the foreign market. Without
this information, many companies fail in their
internationalization efforts.
Hill, C. W. L. (2010). Global business today (7th ed.). New
York, NY: McGraw-Hill/Irwin.
Core Competencies and Foreign Entry Modes
Once you’ve decided to enter a foreign market, how do you
choose the best mode of entry? Here, we’ll discuss the
advantages and disadvantages of various foreign entry modes.
Knowing your organization’s core competencies can help you
select the best approach.
Companies often expand so that they can transfer their core
competencies to foreign markets where these skills are not
present. The author Charles W. L. Hill, in his book, Global
Business Today, refers to these competencies as know-how that
is technological and management know-how (2010). He offers
this advice:
If your organization’s core competence is proprietary
technological
know-how, licensing and joint venture arrangements should be
avoided.
If your organization perceives its technological advantage as
temporary, licensing may be appropriate.
Management know-how is a unique and hard-to-imitate skill set.

The organization benefits by receiving more visibility through
the brand name, which is usually protected by international law.
Management style as a competence is less likely to be copied by
others in foreign markets. If your company possesses this as a
core competency, you may decide that a joint venture,
subsidiary — or a combination of the two — may be the best
mode of entry to a foreign market.
Entering a foreign market requires an in-depth analysis of the
differentiators between your organization’s unique
competencies, and those existing in the foreign market. Without
this information, many companies fail in their
internationalization efforts.
Hill, C. W. L. (2010). Global business today (7th ed.). New
York, NY: McGraw-Hill/Irwin.
===============================================
====================
Export, Import, and Countertrade (1 of 2)
Graphic with links to sources of information for US companies
mentioned in lecture.
Export and Import
Now that we’ve looked at modes for entering foreign markets,
we’ll briefly discuss export, import, and countertrade.
New exporters often underestimate the resources required to
conduct business outside domestic boundaries. Common pitfalls
include:
Weak market analysis
Poor understanding of competitive conditions in the foreign
market
Failure to customize the product offering to the needs of foreign
customers
Lack of effective distribution programs
Poorly executed promotional campaigns in the foreign market

Problems securing financing
If you’re managing a U.S. organization, you can overcome some
of these pitfalls by investigating the various Web sites provided
by the U.S. Department of Commerce (DOC). One example is
Export.gov, designed to provide “online trade resources and
one-on-one assistance for your international business —
whether you’re just starting or expanding your global sales.”
The U.S. Commercial Service Web site offers four ways to help
you grow the international sales:
Sources for market research
Trade events opportunities
Introductions to qualified buyers and distributors
Guidance through each step of the export process
TradeStats Express will help you find information about the
export activities of each state. This information is helpful in
determining global patterns in state exports, including
geographical regions and products.
We’ve provided several links in the sidebar graphic — so start
exploring!
Countertrade
Countertrade is another method of structuring international
sales when alternative means of payment are difficult or
expensive. The primary objective of countertrade is to trade
goods and services for other goods and services without using
money.
A major advantage of countertrade is that it provides financial
opportunities when other means are not available. In some
countries it is preferred even when there are other options
available.
There are many disadvantages to countertrade agreements.
Companies usually prefer to be paid in hard currency.

Countertrade contracts sometimes involve the exchange of
lower-quality goods, which makes it difficult for the
organization to maintain profitability levels. Countertrade also
requires the organization to have an in-house trading
department, which increases human capital and management
overheads.
Countertrade is a logical choice for larger companies that are
geographically dispersed with a world-wide network and which
can effectively relocate and sell products acquired through
countertrade measures.
Countertrade
Countertrade is another method of structuring international
sales when alternative means of payment are difficult or
expensive. The primary objective of countertrade is to trade
goods and services for other goods and services without using
money.
A major advantage of countertrade is that it provides financial
opportunities when other means are not available. In some
countries it is preferred even when there are other options
available.
There are many disadvantages to countertrade agreements.
Companies usually prefer to be paid in hard currency.
Countertrade contracts sometimes involve the exchange of
lower-quality goods, which makes it difficult for the
organization to maintain profitability levels. Countertrade also
requires the organization to have an in-house trading
department, which increases human capital and management
overheads.
Countertrade is a logical choice for larger companies that are
geographically dispersed with a world-wide network and which
can effectively relocate and sell products acquired through

countertrade measures.
===============================================
==================================
Summary
This module you examined the various levels of regional
economic integration and changes in trade patterns between
NAFTA member nations. You also examined the foreign
exchange market and investor psychology using behavioral
finance theories. We also explored the volatile world of the
global monetary system.
You learned about global strategy, external and internal
environmental conditions that affect strategy formulation, and
organizational core competencies required for global strategy
formulation. You also learned about foreign entry modes, and
issues related to export, import, and countertrade.
In Module 4 we will examine international marketing and
product development focusing on cultural differences. We will
also explore how to plan and develop global communication
strategies and overcome cultural barriers to communication. In
addition, we will discuss global operations management with
the focus on technological enablers and strategies for successful
initiatives.
World View Chart Assignments
Due Weeks 2 through 10 and worth 35 points each week, with a
total of 315 points.
A world view is a fundamental or basic orientation of thinking –
like a mindset – which guides a culture and / or a person’s life.
Like a point of view, it can be built of concepts, ideas, values,
emotions, and ethics. Weltanschauung is the German word for
this idea. Your goal for this course is to understand the world
views of these various religions. In order to prepare you for
your final assignment, you will outline the world views of

various religions in the chart below, adding to it each week.
For this assignment, students will complete the weekly area of
the chart, filling in the aspects of each religion as it is presented
in the readings and resources. This chart, when complete, will
be the starting point for the written assignment, due in Week 10.
For each weekly submission:
1. Review the weekly lectures and supplemental materials
provided, then complete the chart by elaborating on each
section related to the weekly content.
2. Identify key details and examples from the weekly resources
to serve as a basis for the content being recorded in your chart.
3. Write clearly and coherently using correct grammar,
punctuation, spelling, and mechanics.
Religion
Cosmogony - Origin of the Universe
Nature of God
View of Human Nature
View of Good and Evil
View of “Salvation”
View of After Life
Practices and Rituals
Celebrations and Festivals
Week 2Hinduism and Jainism

Week 3Buddhism
Week 4Daoism andConfucianism

Week 7Christianity
Week 8Islam

Week 9Sikhism
Week 10New Religious Movements

The specific course learning outcomes associated with this
assignment are:
· Analyze what is meant by religion.
· Analyze the similarities and differences in the primary beliefs
held by major religious traditions and the cultures in which
these religions evolved.
· Describe the varieties of religious experience and practice in a
wide range of cultures.
· Recognize how daily life within various religions and current
affairs are influenced by religion.
· Use technology and information resources to research issues in
religion.
· Write clearly and concisely about world religions using proper
writing mechanics.
Click here to view the grading rubric for this assignment.
Module 3 Readings and Assignments
Complete the following reading before starting work on the
assignments:
Module 3 online lectures
From your course text, Global Business Today,9th read the

following:
Regional Economic Integration
The Foreign Exchange Market
The International Monetary System
From the Argosy University online library:
Drucker, P. F. (2004). What makes an effective executive.
Harvard Business Review. 82(6), 58–63.
Heifetz, R. A. & Linsky, M. (2002). A survival guide for
leaders. Harvard Business Review, 80(6) 65-72.
https://myclasses.argosy.edu/d2l/le/content/17886/viewContent/
740034/View
learning objectives
10-1 Describe the functions of the foreign exchange market.
10-2 Understand what is meant by spot exchange rates.
10-3 Recognize the role that forward exchange rates play in
insuring against foreign exchange risk.
10-4 Understand the different theories explaining how currency
exchange rates are determined and their relative merits.
10-5 Identify the merits of different approaches toward
exchange rate forecasting.
10-6 Compare and contrast the differences among translation,
transaction, and economic exposure, and what managers can do
to manage each type of exposure.
Page 285
images

The Foreign Exchange Market
Embraer and the Wild Ride of the Brazilian Real
opening case
For many years Brazil was a country battered by persistently
high inflation. As a result the value of its currency, the real,
depreciated steadily against the U.S. dollar. This changed in the
early 2000s when the Brazilian government was successful in
bringing down annual inflation rates into the single digits.
Lower inflation, coupled with policies that paved the way for
the expansion of the Brazilian economy, resulted in a steady
appreciation of the real against the U.S. dollar. In May 2004, 1
real bought $0.3121; by August 2008, 1 real bought $0.65, an
appreciation of more than 100 percent.
The appreciation of the real against the dollar was a mixed bag
for Embraer, the world’s largest manufacturer of regional jets of
up to 110 seats and one of Brazil’s most prominent industrial
companies. Embraer purchases many of the parts that go into its
jets, including the engines and electronics, from U.S.
manufacturers. As the real appreciated against the dollar, these
parts cost less when translated into reals, which benefited
Embraer’s profit margins. However, the company also prices its
aircraft in U.S. dollars, as do all manufacturers in the global
market for commercial jet aircraft. So, as the real appreciated
against the dollar, Embraer’s dollar revenues were compressed
when exchanged back into reals.
To try and deal with the impact of currency appreciation on its
revenues, in the mid-2000s Embraer started to hedge against
future appreciation of the real by buying forward contracts
(forward contracts give the holder the right to exchange one
currency—in this case dollars—for another—in this case reals—
at some point in the future at a predetermined exchange rate). If
the real had continued to appreciate, this would have been a

great strategy for Embraer because the company could have
locked in the rate at which sales made in dollars were
exchanged back into reals. Unfortunately for Embraer, as the
global financial crisis unfolded in 2008, investors fled to the
dollar, which they viewed as a safe haven, and the real
depreciated against the dollar. Between August 2008 and
November 2008, the value of the real fell by almost 40 percent
against the dollar. But for the hedging, this depreciation would
have actually increased Embraer’s revenues in reals. Embraer,
however, had locked itself into a much higher real/dollar
exchange rate, and the company was forced to take a
$121million loss on what was essentially a bad currency bet.
Page 286Since the shock of 2008, Embraer has cut back on
currency hedging, and most of its dollar sales and purchases are
not hedged. This makes Embraer’s sales revenues very sensitive
to the real/dollar exchange rate. By 2010, the Brazilian real was
once more appreciating against the U.S. dollar, which pressured
Embraer’s revenues. By 2012, however, the Brazilian economy
was stagnating, while inflation was starting to increase again.
This led to a sustained fall in the value of the real, which fell
from 1 real = $0.644 in July 2011 to 1 real = $0.40 by January
2014, a depreciation of 38 percent. What was bad for the
Brazilian currency, however, was good for Embraer, whose
stock price surged to the highest price since February 2008 on
speculation that the decline on the real would lead to a boost in
Embraer’s revenues when expressed in reals. images
Sources: D. Godoy, “Embraer Rallies as Brazilian Currency
Weakens,” Bloomberg, May 31, 2013; K. Kroll, “Embraer
Fourth Quarter Profits Plunge 44% on Currency Woes,”
Cleveland.com, March 27, 2009; “A fall from Grace: Brazil’s
Mediocre Economy,” The Economist, June 8, 2013; and
“Brazil’s Economy: The Deterioration,” The Economist,
December 7, 2013.
Introduction

Like many enterprises in the global economy, the Brazilian
aircraft manufacturer Embraer is affected by changes in the
value of currencies on the foreign exchange market. As
described in the opening case, Embraer’s revenues are helped
when the Brazilian currency is weak against the U.S. dollar, and
vice versa. The case illustrates that what happens in the foreign
exchange market can have a fundamental impact on the sales,
profits, and strategy of an enterprise. Accordingly, it is very
important for managers to understand the foreign exchange
market, and what the impact of changes in currency exchange
rates might be for their enterprise.
This chapter has three main objectives. The first is to explain
how the foreign exchange market works. The second is to
examine the forces that determine exchange rates and to discuss
the degree to which it is possible to predict future exchange rate
movements. The third objective is to map the implications for
international business of exchange rate movements. This chapter
is the first of two that deal with the international monetary
system and its relationship to international business. The next
chapter explores the institutional structure of the international
monetary system. The institutional structure is the context
within which the foreign exchange market functions. As we
shall see, changes in the institutional structure of the
international monetary system can exert a profound influence on
the development of foreign exchange markets.
The foreign exchange market is a market for converting the
currency of one country into that of another country. An
exchange rate is simply the rate at which one currency is
converted into another. For example, Toyota uses the foreign
exchange market to convert the dollars it earns from selling cars
in the United States into Japanese yen. Without the foreign
exchange market, international trade and international
investment on the scale that we see today would be impossible;
companies would have to resort to barter. The foreign exchange

market is the lubricant that enables companies based in
countries that use different currencies to trade with each other.
We know from earlier chapters that international trade and
investment have their risks. Some of these risks exist because
future exchange rates cannot be perfectly predicted. The rate at
which one currency is converted into another can change over
time. For example, at the start of 2001, one U.S. dollar bought
1.065 euros, but by early 2014 one U.S. dollar only bought 0.74
euro. The dollar had fallen sharply in value against the euro.
This made American goods cheaper in Europe, boosting export
sales. At the same time, it made European goods more
expensive in the United States, which hurt the sales and profits
of European companies that sold goods and services to the
United States.
Foreign Exchange Market
A market for converting the currency of one country into that of
another country.
Exchange Rate
The rate at which one currency is converted into another.
Page 287images global EDGE Database of International
Business Statistics
With Chapter 10, we begin a two-chapter series focused on
issues related to what we call the “global money system.” The
broad topics that are covered include the foreign exchange
market and international monetary system. These are critically
important topics that can have a significant effect on how
companies operate globally. Often times, companies have to
deal with exchange rates, monetary systems, and the capital
market on both country and regional levels. But the influences

of countries on the regional and global money system are
significant (i.e., countries set the tone for the parameters of the
foreign exchange market and the international monetary
system). The global EDGE Database of International Business
Statistics (DIBS) includes time-series data beginning in the
1990s until today and covers more than 200 countries and more
than 5,000 data variables. Countries, regions, and the world use
these types of data points to drive the global money system, and
everyone who is interested in better understanding the global
capital market needs to know about them! Register free on
globalEDGE to gain access to the DIBS database right now;
students have free access to DIBS!
One function of the foreign exchange market is to provide some
insurance against the risks that arise from such volatile changes
in exchange rates, commonly referred to as foreign exchange
risk. Although the foreign exchange market offers some
insurance against foreign exchange risk, it cannot provide
complete insurance. It is not unusual for international
businesses to suffer losses because of unpredicted changes in
exchange rates. Currency fluctuations can make seemingly
profitable trade and investment deals unprofitable, and vice
versa.
We begin this chapter by looking at the functions and the form
of the foreign exchange market. This includes distinguishing
among spot exchanges, forward exchanges, and currency swaps.
Then we consider the factors that determine exchange rates. We
also look at how foreign trade is conducted when a country’s
currency cannot be exchanged for other currencies, that is, when
its currency is not convertible. The chapter closes with a
discussion of these things in terms of their implications for
business.
The Functions of the Foreign Exchange Market
The foreign exchange market serves two main functions. The

first is to convert the currency of one country into the currency
of another. The second is to provide some insurance against
foreign exchange risk, or the adverse consequences of
unpredictable changes in exchange rates.1
Foreign Exchange Risk
The risk that changes in exchange rates will hurt the
profitability of a business deal.
images LO 10-1
Describe the functions of the foreign exchange market.
Should Countries Be Free to Set Currency Policy?
Exchange rates are critically important in the global economy.
They affect the price of every country’s imports and exports,
companies’ foreign direct investment, and—directly or
indirectly—people’s spending behaviors. In recent years,
disagreements among countries over exchange rates have
become much more widespread. Some government officials and
analysts even suggest that there is a “currency war” among
certain countries. The main issue is whether or not some
countries are using exchange rate policies to undermine free
currency markets and whether they intentionally, in essence,
devalue their currency to gain a trade advantage at the expense
of other countries. A weaker currency makes exports
inexpensive (or at least cheaper) to foreigners, which can lead
to higher exports and job creation in the export sector.
Source: R. M. Nelson, “Current Debates over Exchange Rates:
Overview and Issues for Congress,” Congressional Research
Service, November 12, 2013.
images

CURRENCY CONVERSION Each country has a currency in
which the prices of goods and services are quoted. In the United
States, it is the dollar ($); in Great Britain, the pound (£); in
France, Germany, and the other 15 members of the euro zone it
is the euro (€); in Japan, the yen (¥); and so on. In general,
within the borders of a particular country, one must use the
national currency. A U.S. tourist cannot walk into a store in
Edinburgh, Scotland, and use U.S. dollars to buy a bottle of
Scotch whisky. Dollars are not recognized as legal tender in
Scotland; the tourist must use British pounds. Fortunately, the
tourist can go to a bank and exchange her dollars for pounds.
Then she can buy the whisky.
When a tourist changes one currency into another, she is
participating in the foreign exchange market. The exchange rate
is the rate at which the market converts one currency into
another. For example, an exchange rate of €1 = $1.30 specifies
that 1 euro buys 1.30 U.S. dollars. Page 288The exchange rate
allows us to compare the relative prices of goods and services in
different countries. Our U.S. tourist wishing to buy a bottle of
Scotch whisky in Edinburgh may find that she must pay £30 for
the bottle, knowing that the same bottle costs $45 in the United
States. Is this a good deal? Imagine the current pound/dollar
exchange rate is £1.00 = $2.00 (i.e., one British pound buys
$2.00). Our intrepid tourist takes out her calculator and
converts £30 into dollars. (The calculation is 30 × 2.) She finds
that the bottle of Scotch costs the equivalent of $60. She is
surprised that a bottle of Scotch whisky could cost less in the
United States than in Scotland (alcohol is taxed heavily in Great
Britain).
Tourists are minor participants in the foreign exchange market;
companies engaged in international trade and investment are
major ones. International businesses have four main uses of
foreign exchange markets. First, the payments a company
receives for its exports, the income it receives from foreign

investments, or the income it receives from licensing
agreements with foreign firms may be in foreign currencies. To
use those funds in its home country, the company must convert
them to its home country’s currency. Consider the Scotch
distillery that exports its whisky to the United States. The
distillery is paid in dollars, but because those dollars cannot be
spent in Great Britain, they must be converted into British
pounds. Similarly, Toyota sells its cars in the United States for
dollars; it must convert the U.S. dollars it receives into
Japanese yen to use them in Japan.
Second, international businesses use foreign exchange markets
when they must pay a foreign company for its products or
services in its country’s currency. For example, Dell buys many
of the components for its computers from Malaysian firms. The
Malaysian companies must be paid in Malaysia’s currency, the
ringgit, so Dell must convert money from dollars into ringgit to
pay them.
Every time a tourist changes money in a foreign country they
are participating in the foreign exchange market.
Third, international businesses also use foreign exchange
markets when they have spare cash that they wish to invest for
short terms in money markets. For example, consider a U.S.
company that has $10 million it wants to invest for three
months. The best interest rate it can earn on these funds in the
United States may be 2 percent. Investing in a South Korean
money market account, however, may earn 6 percent. Thus, the
company may change its $10 million into Korean won and
invest it in South Korea. Note, however, that the rate of return
it earns on this investment depends not only on the Korean
interest rate but also on the changes in the value of the Korean
won against the dollar in the intervening period.
Currency speculation is another use of foreign exchange

markets. Currency speculation typically involves the short-term
movement of funds from one currency to another in the hopes of
profiting from shifts in exchange rates. Consider again a U.S.
company with $10 million to invest for three months. Suppose
the company suspects that the U.S. dollar is overvalued against
the Japanese yen. That is, the company expects the value of the
dollar to depreciate (fall) against that of the yen. Imagine the
current dollar/yen exchange rate is $1 = ¥120. The company
exchanges its $10 million into yen, receiving ¥1.2 billion ($10
million × 120 = ¥1.2 billion). Over the next three months, the
value of the dollar depreciates against the yen until $1 = ¥100.
Now the company exchanges its ¥1.2 billion back into dollars
and finds that it has $12 million. The company has made a $2
million profit on currency speculation in three months on an
initial investment of $10 million! In general, however,
companies should beware, for speculation by definition is a
very risky business. The company cannot know for sure what
will happen to exchange rates. While a speculator may profit
handsomely if his speculation about future currency movements
turns out to be correct, he can also lose vast amounts of money
if he turns out to be wrong.
Currency Speculation
Involves short-term movement of funds from one currency to
another in hopes of profiting from shifts in exchange rates.
A kind of speculation that has become more common in recent
years is known as the carry trade. The carry trade involves
borrowing in one currency where interest rates are low and then
using the proceeds to invest in another currency where interest
rates are high. For example, if the interest rate on borrowings in
Japan is 1 percent, but the interest rate on deposits in American
banks is 6 percent, it can make sense to borrow in Japanese yen,
convert the money into U.S. dollars, and deposit it in an
American bank. The trader can make a 5 percent margin by

doing so, minus the transaction costs associated with changing
one currency into another. The speculative element of this trade
is that its success is based on a belief that there will be no
adverse movement in exchange rates (or interest rates for that
matter) that will make the trade unprofitable. However, if the
yen were to rapidly increase in value against the dollar, then it
would take more U.S. dollars to repay the original loan, and the
trade could fast become unprofitable. The dollar/yen carry trade
was actually very significant during the mid-2000s, peaking at
more than $1 trillion in 2007, when some 30 percent of trade on
the Tokyo foreign exchange market was related to the carry
trade.2 This carry trade declined in importance during 2008–
2009 because interest rate differentials were falling as U.S.
rates came down, making the trade less profitable.
Carry Trade
A kind of speculation that involves borrowing in one currency
where interest rates are low, and then using the proceeds to
invest in another currency where interest rates are high.
Page 289INSURING AGAINST FOREIGN EXCHANGE RISK
A second function of the foreign exchange market is to provide
insurance against foreign exchange risk, which is the possibility
that unpredicted changes in future exchange rates will have
adverse consequences for the firm. When a firm insures itself
against foreign exchange risk, it is engaging in hedging. To
explain how the market performs this function, we must first
distinguish among spot exchange rates, forward exchange rates,
and currency swaps.
images LO 10-2
Understand what is meant by spot exchange rates.
Spot Exchange Rates When two parties agree to exchange
currency and execute the deal immediately, the transaction is

referred to as a spot exchange. Exchange rates governing such
“on the spot” trades are referred to as spot exchange rates. The
spot exchange rate is the rate at which a foreign exchange
dealer converts one currency into another currency on a
particular day. Thus, when our U.S. tourist in Edinburgh goes to
a bank to convert her dollars into pounds, the exchange rate is
the spot rate for that day.
Spot Exchange Rate
The exchange rate at which a foreign exchange dealer will
convert one currency into another that particular day.
Spot exchange rates are reported on a real-time basis on many
financial websites. An exchange rate can be quoted in two ways:
as the amount of foreign currency one U.S. dollar will buy or as
the value of a dollar for one unit of foreign currency. Thus, on
January 20, 2014, at 1:11 p.m., Eastern Standard Time, one U.S.
dollar bought €0.74, and one euro bought $1.36.
Spot rates change continually, often on a minute-by-minute
basis (although the magnitude of changes over such short
periods is usually small). The value of a currency is determined
by the interaction between the demand and supply of that
currency relative to the demand and supply of other currencies.
For example, if lots of people want U.S. dollars and dollars are
in short supply, and few people want British pounds and pounds
are in plentiful supply, the spot exchange rate for converting
dollars into pounds will change. The dollar is likely to
appreciate against the pound (or the pound will depreciate
against the dollar). Imagine the spot exchange rate is £1 = $2.00
when the market opens. As the day progresses, dealers demand
more dollars and fewer pounds. By the end of the day, the spot
exchange rate might be £1 = $1.98. Each pound now buys fewer
dollars than at the start of the day. The dollar has appreciated,
and the pound has depreciated.

images LO 10-3
Recognize the role that forward exchange rates play in insuring
against foreign exchange risk.
Forward Exchange Rates Changes in spot exchange rates can
be problematic for an international business. For example, a
U.S. company that imports high-end cameras from Japan knows
that in 30 days it must pay yen to a Japanese supplier when a
shipment arrives. The company will pay the Japanese supplier
¥200,000 for each camera, and the current dollar/yen spot
exchange rate is $1 = ¥120. At this rate, each camera costs the
importer $1,667 (i.e., 1,667 = 200,000/120). The importer
knows she can sell the camera the day they arrive for $2,000
each, which yields a gross profit of $333 on each ($2,000 −
$1,667). However, the importer will not have the funds to pay
the Japanese supplier until the cameras are sold. If, over the
next 30 days, the dollar unexpectedly depreciates against the
yen, say, to $1 = ¥95, the importer will still have to pay the
Japanese company ¥200,000 per camera, but in dollar terms that
would be equivalent to $2,105 per camera, which is more than
she can sell the cameras for. A depreciation in the value of the
dollar against the yen from $1 = ¥120 to $1 = ¥95 would
transform a profitable deal into an unprofitable one.
Page 290To insure or hedge against this risk, the U.S. importer
might want to engage in a forward exchange. A forward
exchange occurs when two parties agree to exchange currency
and execute the deal at some specific date in the future.
Exchange rates governing such future transactions are referred
to as forward exchange rates. The Brazilian aircraft
manufacturer Embraer entered into a forward exchange when it
tried to hedge against further appreciation of the Brazilian real
against the U.S. dollar (see the opening case). For most major
currencies, forward exchange rates are quoted for 30 days, 90
days, and 180 days into the future. In some cases, it is possible
to get forward exchange rates for several years into the future.

Returning to our camera importer example, let us assume the
30-day forward exchange rate for converting dollars into yen is
$1 = ¥110. The importer enters into a 30-day forward exchange
transaction with a foreign exchange dealer at this rate and is
guaranteed that she will have to pay no more than $1,818 for
each camera (1,818 = 200,000/110). This guarantees her a profit
of $182 per camera ($2,000 − $1,818). She also insures herself
against the possibility that an unanticipated change in the
dollar/yen exchange rate will turn a profitable deal into an
unprofitable one.
Forward Exchange
When two parties agree to exchange currency and execute a deal
at some specific date in the future.
Forward Exchange Rate
The exchange rates governing forward exchange transactions.
In this example, the spot exchange rate ($1 = ¥120) and the 30-
day forward rate ($1 = ¥110) differ. Such differences are
normal; they reflect the expectations of the foreign exchange
market about future currency movements. In our example, the
fact that $1 bought more yen with a spot exchange than with a
30-day forward exchange indicates foreign exchange dealers
expected the dollar to depreciate against the yen in the next 30
days. When this occurs, we say the dollar is selling at a
discount on the 30-day forward market (i.e., it is worth less than
on the spot market). Of course, the opposite can also occur. If
the 30-day forward exchange rate were $1 = ¥130, for example,
$1 would buy more yen with a forward exchange than with a
spot exchange. In such a case, we say the dollar is selling at a
premium on the 30-day forward market. This reflects the foreign
exchange dealers’ expectations that the dollar will appreciate
against the yen over the next 30 days.

Currency Swap
Simultaneous purchase and sale of a given amount of foreign
exchange for two different value dates.
In sum, when a firm enters into a forward exchange contract, it
is taking out insurance against the possibility that future
exchange rate movements will make a transaction unprofitable
by the time that transaction has been executed. Although many
firms routinely enter into forward exchange contracts to hedge
their foreign exchange risk, there are some spectacular
examples of what happens when firms don’t take out this
insurance. An example is given in the accompanying
Management Focus, which explains how a failure to fully insure
against foreign exchange risk cost Volkswagen dearly.
Currency Swaps The preceding discussion of spot and forward
exchange rates might lead you to conclude that the option to
buy forward is very important to companies engaged in
international trade—and you would be right. According to the
most recent data, forward instruments account for almost two-
thirds of all foreign exchange transactions, while spot
exchanges account for about one-third.3 However, the vast
majority of these forward exchanges are not forward exchanges
of the type we have been discussing, but rather a more
sophisticated instrument known as currency swaps.
A currency swap is the simultaneous purchase and sale of a
given amount of foreign exchange for two different value dates.
Swaps are transacted between international businesses and their
banks, between banks, and between governments when it is
desirable to move out of one currency into another for a limited
period without incurring foreign exchange risk. A common kind
of swap is spot against forward. Consider a company such as
Apple Computer. Apple assembles laptop computers in the

United States, but the screens are made in Japan. Apple also
sells some of the finished laptops in Japan. So, like many
companies, Apple both buys from and sells to Japan. Imagine
Apple needs to change $1 million into yen to pay its supplier of
laptop screens today. Apple knows that in 90 days it will be
paid ¥120 million by the Japanese importer that buys its
finished laptops. It will want to convert these yen into dollars
for use in the United States. Let us say today’s spot exchange
rate is $1 = ¥120 and the 90-day forward exchange rate is $1 =
¥110. Apple sells $1 million to its bank in return for ¥120
million. Now Apple can pay its Japanese supplier. At the same
time, Apple enters into a 90-day forward exchange deal with its
bank for converting ¥120 million into dollars. Thus, in 90 days
Apple will receive $1.09 million (¥120 million/110 = $1.09
million). Because the yen is trading at a premium on the 90-day
forward market, Apple ends up with more dollars than it started
with (although the opposite could also occur). The swap deal is
just like a conventional forward deal in one important respect:
It enables Apple to insure itself against foreign exchange risk.
By engaging in a swap, Apple knows today that the ¥120
million payment it will receive in 90 days will yield $1.09
million.
Should Currency Speculation Be Allowed?
Currency speculation involves the short-term movement of
funds from one currency to another in the hopes of profiting
from shifts in exchange rates. Sometimes this speculation is
done as what is called a carry trade. As we describe in Chapter
10, this involves borrowing in one currency where interest rates
are low and then using the proceeds to invest in another
currency where interest rates are high. In effect, it can be
argued that currency speculation tactics may have a strong
negative effect on some countries’ economic foundation (e.g.,
Iceland, Thailand). For years, Iceland was a respected country
for its unmatchable standards of living. The 2008 economic

turmoil threw the island nation’s currency off the cliff. The
hedge funds closed in, and the government had to try to fight
off the predators. Several years later, Iceland is still feeling the
effect of these currency woes, albeit the country is now in
recovery mode and progressing in a positive direction. But, the
issue remains that large-scale currency speculation has the
potential to adversely affect global markets. So, should
currency speculation be allowed?
Source: A. Jung and C. Pauly, “Currency Woes: Crashing the
Party of Icelandic Prosperity,” Spiegel Online International,
April 10, 2008.
management FOCUS
Volkswagen’s Hedging Strategy
In January 2004, Volkswagen, Europe’s largest carmaker,
reported a 95 percent drop in 2003 fourth-quarter profits, which
slumped from €1.05 billion to a mere €50 million. For all of
2003, Volkswagen’s operating profit fell by 50 percent from the
record levels attained in 2002. Although the profit slump had
multiple causes, two factors were the focus of much attention—
the sharp rise in the value of the euro against the dollar during
2003 and Volkswagen’s decision to only hedge 30 percent of its
foreign currency exposure, as opposed to the 70 percent it had
traditionally hedged. In total, currency losses due to the dollar’s
rise are estimated to have reduced Volkswagen’s operating
profits by some €1.2 billion ($1.5 billion).
The rise in the value of the euro during 2003 took many
companies by surprise. Since its introduction January 1, 1999,
when it became the currency unit of 12 members of the
European Union, the euro had recorded a volatile trading
history against the U.S. dollar. In early 1999, the exchange rate
stood at €1 = $1.17, but by October 2000 it had slumped to €1 =

$0.83. Although it recovered, reaching parity of €1 = $1.00 in
late 2002, few analysts predicted a rapid rise in the value of the
euro against the dollar during 2003. As so often happens in the
foreign exchange markets, the experts were wrong; by late
2003, the exchange rate stood at €1 = $1.25. For Volkswagen,
which made cars in Germany and exported them to the United
States, the fall in the value of the dollar against the euro during
2003 was devastating. To understand what happened, consider a
Volkswagen Jetta built in Germany for export to the United
States.
Volkswagen could have insured against this adverse movement
in exchange rates by entering the foreign exchange market in
late 2002 and buying a forward contract for dollars at an
exchange rate of around $1 = €1 (a forward contract gives the
holder the right to exchange one currency for another at some
point in the future at a predetermined exchange rate). Called
hedging, the financial strategy of buying forward guarantees
that at some future point, such as 180 days, Volkswagen would
have been able to exchange the dollars it got from selling Jettas
in the United States into euros at $1 = €1, irrespective of what
the actual exchange rate was at that time. In 2003, such a
strategy would have been good for Volkswagen. However,
hedging is not without its costs. For one thing, if the euro had
declined in value against the dollar, instead of appreciating as it
did, Volkswagen would have made even more profit per car in
euros by not hedging (a dollar at the end of 2003 would have
bought more euros than a dollar at the end of 2002). For another
thing, hedging is expensive because foreign exchange dealers
will charge a high commission for selling currency forward.
Volkswagen decided to hedge just 30 percent of its anticipated
U.S. sales in 2003 through forward contracts, rather than the 70
percent it had historically hedged. The decision cost the
company more than €1 billion. For 2004, the company reverted
back to hedging 70 percent of its foreign currency exposure.

Sources: Mark Landler, “As Exchange Rates Swing, Car Makers
Try to Duck,” The New York Times, January 17, 2004, pp. B1,
B4; N. Boudette, “Volkswagen Posts 95% Drop in Net,” The
Wall Street Journal, February 19, 2004, p. A3; and
“Volkswagen’s Financial Mechanic,” Corporate Finance, June
2003, p. 1.
images test PREP
Use LearnSmart to help retain what you have learned. Access
your instructor’s Connect course to check out LearnSmart or go
to learnsmartadvantage.com for help.
The Nature of the Foreign Exchange Market
The foreign exchange market is not located in any one place. It
is a global network of banks, brokers, and foreign exchange
dealers connected by electronic communications systems. When
companies wish to convert currencies, they typically go through
their own banks rather than entering the market directly. The
foreign exchange market has been growing at a rapid pace,
reflecting a general growth in the volume of cross-border trade
and investment (see Chapter 1). In March 1986, the average
total value of global foreign exchange trading Page 292was
about $200 billion per day. By April 2013, it had hit $5.3
trillion a day.4 The most important trading centers are London
(37 percent of activity), New York (18 percent of activity), and
Zurich, Tokyo, and Singapore (all with around 5 to 6 percent of
activity).5 Major secondary trading centers include Frankfurt,
Paris, Hong Kong, and Sydney.
London’s dominance in the foreign exchange market is due to
both history and geography. As the capital of the world’s first
major industrial trading nation, London had become the world’s
largest center for international banking by the end of the
nineteenth century, a position it has retained. Today, London’s
central position between Tokyo and Singapore to the east and

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