FOREIGN EXCHANGE AND FOREX

Exchange rate is the rate at which one currency is converted into another currency. 24-hour
market: the market is always open somewhere in the world.
 arbitrage: the process of buying a currency low and selling it high
 U.S. dollar is a vehicle currency
Fixed exchange rate system: fix currency rates at a mutually agreed value
positives of fixed exchange rates:
a) Imposed monetary discipline
b) It limits speculation
c) It limits uncertainty
d) Lack of connection between the trade balance and exchange rates
Pegged exchange rate system – the value of a currency is fixed to a reference country and
the exchange rate between that currency and other currencies is determined by the reference
currency exchange rate (e.g. Denmark to Euro) The US dollar the only currency to be
convertible to gold
Floating exchange rate system  the foreign exchange market determines the relative value
of a currency (e.g. US dollar, euro, yen, pound)
 positives of floating exchange rates:
a) Monetary Policy Autonomy  monetary control by the government. Ability to expand
or contract money supply is limited by the need to maintain exchange rate parity
b) Trade Balance Adjustments  the balance of payments adjustment works more
smoothly. Correction of permanent deficit in balance of trade by domestic policy.
Dirty float  central bank intervention in the value of a currency, if it depreciates too rapidly
against an important reference currency (China adopted this policy in 2005)
Implications for managers: the international monetary system affects international managers
in three ways:
1. Currency management(risk)  includes government interference and speculation,
protection through forward markets and swaps
2. Business strategy (Airbus and the Euro)
exchange rate movements impact the competitive position of businesses
 the forward market can offer some protection from volatile exchange rates in the
shorter term
longer term protection by building strategic flexibility into their operations that
minimizes economic exposure (firms can outsource manufacturing)
3. Corporate-government relations
firm can influence government policy towards the international monetary system
firms should focus their efforts on encouraging the government to promote the growth
of international trade and investment, adapt an international monetary system that
minimizes volatile exchange rates
Insuring against foreign exchange risk: HEDGING protection against foreign exchange risk
1. Spot exchange rates conversion rate of one currency into another currency on a
particular day
2. Forward exchange rates  future transaction of 30,90, or 180 days
3. Currency swaps  simultaneous purchase and sale of a given amount of foreign
exchange for two different value dates
Exchange Rate Determination  three factors that impact on future exchange rates:
a) A country´s price inflation
b) A country´s interest rate
c) Market psychology
Implications for managers: the influence of exchange rates on the profitability of trade and
investment deals. The exchange rate risk can be divided into:
1. Transaction exposure: income from individual transactions is affected by
fluctuations in foreign exchange values – might lead to monetary loss
2. Translation exposure: the impact of currency exchange rate changes on the
reported financial statements of a company. Gains and losses are reflected only on
paper.
3. Economic exposure: firm´s future international earning power is affected by
changes in exchange rates – long-term effect on future prices, sales and costs.
 reducing economic exposure: distribute productive assets to various location,
the firm´s assets are not overly concentrated in countries where likely rises in
currency values will lead to damaging increases in the foreign prices of the goods
and services they produce
Foreign Exchange Markets  part of financial market: a global network of banks, brokers,
and foreign exchange dealers connected by electronic communication systems.
 Enables the conversion of the currency of one country into the currency of another
 Provides some insurance against foreign exchange risk
Currency Conversion: International firms use foreign exchange markets to:
a) Convert export receipts, income received from foreign investments, or income received
from licensing agreements
b) Pay a foreign company for products or services
c) Invest spare cash for short-terms in money markets
d) For currency speculation  the short-term movement of funds from one currency to
another
Approaches to forecasting  two approaches to exchange rate forecasting:
1. Fundamental analysis  economic factors like interest rates, monetary policy,
inflation rates, or balance of payments
2. Technical analysis  trends and believes
1. Product def.  market entry mode and then external analysis (country and sector analysis)
 *Country analysispestel and political risk analysis
 *Sector analysis  porter´s 5 forces of industry, market structure
2. Currency risks  decide contract currency
3. Global- glocal  it is where the culture matters  HR/managements and marketing/
promotion (5P product, place, price, promotion, people)
 the marketing/promotion is going back to the product def. It may happen that after the
marketing/promotion you will have to revise the market entry mode
 Product and/or promotion decision - do I globalize or glocalize my product and/or
promotion (sugar content, campaign  extremely local)
 promotion cannot be more local than through word-of-mouth
 HR/management is also very important in terms of how to evaluate my workers etc.

How can firms enter foreign markets?

1) Decision factors
i) Which markets to enter
ii) When to enter them and on what scale
iii) How to enter them (choice of entry mode)
2) Entry Modes
i) Exporting
ii) Licensing or franchising to host country firms
iii) Turn-key projects, or a joint venture with a host county firm
iv) A wholly owned subsidiary in the host country to serve that market (green-field
investment or acquisitions)
3) Basic Entry Decisions
i) Transport costs and trade barriers
ii) Political and economic risks
iii) firm strategy

Which foreign markets, when?

1) Assess the long run profit potential of each market
i) Political stability
ii) With free market systems
iii) Low inflation, and low private sector debt
2) Entry – entering before other foreign firms
i) First mover advantage
3) Product positioning
i) Relatively new
ii) Potential for gaining market share
4) Small-scale entry or significant scale entry
IB forms of entry  from high to low
1. FDI  greenfield, merger, acquisition (hostile or regular acq. which can be either financial
or full)  high control high cost
2. joint ventures  joining for a project for a specific period of time  medium control and
cost
3. Licensing  type of technology and know-how
4.franchize selling a business model for a fee  not only one-time fee!
5. export or import

Core competencies and entry mode

1. Technological know-how  proprietary technological know how  avoid licensing
and joint venture in order to minimize the risk of losing control over the technology
2. Management know-how  international trademark laws are generally effective for
protecting trademarks
FOREIGN DIRECT INVESTMENT – a firm invest directly in new facilities to produce
and/or market in a foreign county. Once a firm undertakes FDI it becomes a multinational
enterprise.
There are two forms of FDI:
1. A greenfield investment: the establishment of a wholly new operation in a foreign
country
2. Acquisition or merging with an existing firm in the foreign country
Greenfield or acquisition? Question:
 Should a firm establish a wholly owned subsidiary in a country by building a subsidiary
from the ground up (greenfield), or by acquiring an established enterprise in the target
market (acquisition)?
Recent trends in FDI
a) Mostly mergers and acquisitions rather than greenfield investments  they are
quicker to execute, it is easier and perhaps less risky. Firms believe they can increase
the efficiency of an acquired unit by transferring capital, technology, or management
skills
b) Shift toward FDI in services  service ratio in GDP is rising, many services cannot
be exported, a liberalization of policies governing FDI in services, the rise of internet-
based global telecommunications networks
FDI in the World Economy: there are two ways to look at FDI
1. The flow of FDI: the amount of FDI undertaken over a given time period:
 Outflows of FDI are the flows of FDI out of a country
 Inflows of FDI are the flows of FDI into a country (Historically toward developed
nations, US being a favorite target. 2000s  high FDI inflows for the US and the EU,
increase of FDI inflows for Asia (particularly China), Latin America)
2. The stock of FDI: the total accumulated value of foreign-owned assets at a given time

Choosing FDI over Export or Licensing

A. Limitations of Exporting  constraints by transportation costs and trade barriers
B. Limitations of Licensing: Internalization theory: suggests that licensing has three major
drawbacks:
1. Giving away valuable technological know-how to a potential competitor
2. No control over manufacturing, marketing, and strategy
3. It may be difficult if the firm´s competitive advantage is not amenable to licensing
THE PATTERN OF FDI
1. Strategic Behavior
a. FDI flows  reflection of strategic rivalry between oligopolies in the global
marketplace
b. Extended theory  multipoint competition (two or more enterprises encounter
each other in different regional markets, national markets, or industries)
2. The Product Life Cycle and FDI
a) Firms invest when local demand in those countries grows large enough to support
local production
b) Firms then shift production to low-cost developing countries when product
standardization and market saturation give rise to price competition and cost
pressures
The Eclectic Paradigm  two additional factors:
a) Location-specific advantages  using resource endowments or assets that are tied to
a particular location and that a firm finds valuable to combine with its own unique assets
b) Externalities  knowledge spillovers that occur when companies in the same industry
locate in the same area
FDI Benefits and Cost
1) Resource Transfer Effects
2) Employment Effects
3) Balance-of-Payments Effects (FDI can help achieve a current account surplus; outflow of
capital and profit repatriation; input import and substitution for export)
4) Effects on Domestic Industry (power of MNCs)
5) Effect on Competition and Economic Growth
6) Issues of National Sovereignty (possible extension) & Autonomy (possible loss)
7) Issues of Offshore Production
Government Regulation and FDI  governments can implement policies to:
1) Encourage outward FDI  eliminated double taxation of foreign income, relaxed
restrictions on inbound FDI
2) Discourage outward FDI  control over outward FDI, tax rules to favor domestic
investment, restrict firms from investing in certain nations for political reasons
3) Encourage inward FDI  incentives to foreign firms to invest in their countries
4) Discourage inward FDI  controls over the behavior of the MNE´s local subsidiary
ACQUISITION  purchase of one or more firm by a company that retains its corporate
identity
Merger  transfer of assets, corporate headquarters, control functions and personal
MERGER  combining two or more firms into a new identity, affects the organization´s
economy through changes in regional and urban structure and firm concentration and
productions consolidations
SEVEN RULES OF MERGER SUCCESS EXAM!
1. Vision balancing dreams with reality, being clear on what the partners bring in
2. Leadership  charisma, empathy, quick move
3. Growth  being careful with cost reduction, building up possibilities
4. Early wins gaining substantial, sustainable and tangible results, proper
communication, targeting assets, customers and knowledge
5. Cultural differences  making assessment, understand and communicate the
differences
6. Communication  understanding the needs of the target audience, monitoring
outcome
7. Risk management  acceptance, prioritization, identification of issues and risks

POST-MERGER MANAGEMENT -EXAM!

Post-merger management control  justification for mergers: profitability, growth, control
of risk.
Two major fazes after mergers:
1. The Honeymoon period  transition after the announcement and redundancies
2. Merger of all business aspects: management plan
 Management plans and implantations of : the business, organizational structure, HRM
aspects, financial control, R and D, sales and marketing, production

The determinants of culture: religion, political philosophy, economic philosophy, education,

language, social structure
 In societies where the individual is emphasized  individual achievement and
entrepreneurship are promoted, but can encourage job switching, competition between
individuals in a company rather than team building, and a lack of loyalty to the firm.
 In societies with a strong identification with the group  cooperation and team work
are encouraged, and life time employment is common, but individual initiative and
creativity may be suppressed
 Religion is a system of shared beliefs and rituals that are concerned with the reals of the
sacred
Cultural Change
 Culture evolves over time, although changes in value systems can be slow and painful
for a society
 As countries become economically stronger, cultural change is particularly common
Managerial style and compensation scheme should follow the cultural dimension and there is a
need to recognize the differences between home culture and culture of the subsidiaries. Policies
need to be in line with overall strategies and culture but must take into account different values
and assumptions of the national cultures of subsidiaries.
GLOBALIZATION VS. GLOCALIZATION
Globalization  global village
Glocalization  the creation of products or services intended for the global market, but
customized to suit the local culture
REGIONAL ECONOMIC INTEGRATIONS
a) Economic  free flow of trade and investment between countries beyond what is attainable
through the WTO. An agreement between countries in a geographic region to reduce tariff and
nontariff barriers to the free flow of goods, services, and factors of production between each
other
b) Political  likelihood of violent conflict and wars will decrease, politically much stronger
in dealing with other nations
c) Impediments  cost of integration, concerns about national sovereignty

HOFSTEDE
1. Power Distance Index
HIGH PDI  centralized organizations, more complex hierarchies, authority and respect.
Acknowledge a leader´s status. Be aware that you may need to go to the top for answers.
LOW PDI  flatter organizations. Supervisors and employees are considered almost as equals.
Involve those in decision making who will be directly affected by the decision.
2. Individualism vs. collectivism
HIGH IDV  high value placed on people´s time and their need for privacy and freedom.
Enjoyment of challenges and expectation of individual reward for hard work. Respect for
privacy. Do not mix work life with social life too much. Encourage debate and expression of
people´s own ideas.
LOW IDV  emphasis on building skills and becoming master of something. People work for
intrinsic rewards. Maintaining harmony among group members overrides other moral issues.
Wisdom is important. Suppress feeling and emotions that may endanger harmony. Avoid
negative feedback in public. Declining an invitation several times is expected.
3. Masculinity vs. Femininity
HIGH MAS  strong egos, feelings of pride and importance are attributed to status. Money
and achievement are important. BE aware of the possibility of differentiated gender roles. A
long-hours culture may be the norm. People are motivated by precise targets, and by being able
to show that they achieved them either as a group or as individuals.
LOW MAS  relationship oriented, more focus on quality of life. Success is more likely to be
achieved through negotiation, and collaboration. Workplace flexibility and work-life balance
may be important, both in term of job design, organizational environment and culture, and the
way that performance management can be best realized.
4. Uncertainty Avoidance Index
HIGH UAI  conservative, structured, people are expressive. Be clear and concise about
expectations and goals and set clearly defined parameters.
LOW UAI  opened to change and innovation, and generally inclusive. Less sense of urgency.
Ensure that people remain focused, but don’t create too much structure. Titles are less
important, so avoid showing off your knowledge or experience. Respect is given to whose who
can cope under all circumstances.
5. Long- Term Orientation
HIGH LTO Behave in a modest way, avoid talking too much about yourself. People are
more willing to compromise.
LOW LTO  sell yourself to be taken seriously, people are less willing to compromise as this
would be seen as weakness.
6. Indulgence
HIGH I  optimistic, importance of freedom of speech, focus on personal happiness. Don’t
take life too seriously, encourage debate and dialogue in meetings. Prioritize feedback,
coaching and mentoring, emphasize flexible working and work-life balance.
LOW I (high resistance)  pessimistic, more controlled, avoid making jokes when engaged
in formal sessions.
 PRACTICE

Management Focus: Airbus and the Euro

Summary
This feature describes how Airbus is protecting itself from exchange rate fluctuations. French
aircraft maker Airbus prices its planes in dollars. However, because over half the company’s
costs are in euros, the company has the potential to see significant fluctuations in its earnings if
it does not hedge its foreign exchange exposure. The following questions can help in the
discussion of the feature:
1. What type of foreign exchange exposure does Airbus face? How can Airbus protect
itself from its exposure to changing exchange rates? How does the company’s switch to
more U.S. suppliers help the company?
Airbus can hedge its transaction exposure in the foreign exchange markets using forward
contracts, however to manage its economic exposure, the company is trying to reduce its costs
by shifting to American suppliers and asking European suppliers to price in dollars.
2. Airbus has asked its European based suppliers to start pricing in U.S. dollars. What
does Airbus hope to gain by this request? What does it mean for suppliers?
Airbus’ decision to ask suppliers to price their components in dollars is an effort to control
exchange rate risk. The company prices its planes in dollars but was paying for components in
a variety of currencies. By shifting to a strictly dollar run business, the company not only
consolidates all of its transactions and so hedges its exposure more easily and cheaply, it also
increases the proportion of its costs that are in dollars. For American suppliers, the shift to
pricing in dollars is beneficial because it eliminates exchange rate risk. For other suppliers
however, the shift may mean an introduction of exchange rate risk.

QUESTION:
A small Canadian firm that has developed some valuable new medical products using its unique
biotechnology knowhow is trying to decide how best to serve the European Community market.
Its choices are given below. The cost of investment in manufacturing facilities will be a major
one for the Canadian firm, but it is not outside its reach. If these are the firm’s only options,
which one would you advise it to choose? Why?
a) -Manufacture the product at home and let foreign sales agents handle marketing.
b) -Manufacture the products at home but set up a wholly owned subsidiary in Europe to
handle marketing.
c) -Enter into a strategic alliance with a large European pharmaceutical firm. The product
would be manufactured in Europe by a 50/50 joint venture and marketed by the
European firm.
ANSWER: If there were no significant barriers to exporting, then option (c) would seem
unnecessarily risky and expensive. After all, the transportation costs required to ship drugs are
small relative to the value of the product. Both options (a) and (b) would expose the firm to
less risk of technological loss and would allow the firm to maintain much tighter control over
the quality and costs of the drug.
The only other reason to consider option (c) would be if an existing pharmaceutical firm could
also give it much better access to the market and potentially access to its products and
technology, and that this same firm would insist on the 50/50 manufacturing joint venture rather
than agreeing to be a foreign sales agent.
The choice between (a) and (b) boils down to a question of which way will be the most effective
in attacking the market. If a foreign sales agent can be found that is already quite familiar
with the market and who will agree to aggressively market the product, the agent may be
able to increase market share more quickly than a wholly owned marketing subsidiary
that will take some time to get going. On the other hand, in the long run the firm will
learn a great deal more about the market and will likely earn greater profits if sets up its
own sales force.

Country Focus: The U.S. Dollar, Oil Prices, and Recycling Petrodollars
Summary
This feature explores what oil producing nations are likely to do with the dollars they have
earned. In 2008, oil prices reached new highs as a result of higher than expected demand, tight
supplies, and perceived geopolitical risks. Since oil is priced in dollars, oil producers have seen
their dollar reserves increase significantly. Now, speculation abounds as to what will happen
to the petrodollars. Some believe that the dollars will go toward public infrastructure projects,
others think that it is more likely that investments will be made in dollar denominated assets
like U.S. bonds, stocks, and real estate, or in non-dollar denominated assets such as European
or Japanese bonds and stocks. Discussion of the feature can revolve around the following
questions:
1. With oil prices at record highs, there is significant speculation as to what oil producing
states will do with the dollars they are earning. Discuss how a decision to invest in non-
dollar denominated assets could affect the value of the U.S. dollar.
As a result of higher demand from countries like China and India, tight supplies and perceived
geo-political risks, oil prices reached a new high in 2008. For oil producing countries, this has
proved to be an unexpected windfall. In 2007, the countries together earned over $1 trillion. If
the countries decide to invest their earnings in non-dollar denominated assets, the value of the
dollar could drop sharply.
2. How could a decision by oil producing countries to invest their petrodollars in public
infrastructure projects help the value of the dollar?
If the oil producing states invest the petrodollars in public infrastructure projects such as roads,
telecommunications systems, and education, the U.S. dollar could actually rise in value. The
infrastructure investments are likely to generate economic growth in the nations, which could
then translate into market opportunities for U.S. firms.
QUESTIONS
 1. Why did the gold standard collapse? Is there a case for returning to some type of gold
standard? What is it?
2. What opportunities might current IMF lending policies to developing nations create
for international businesses? What threats might they create?
3. Do you think the standard IMF policy prescriptions of tight monetary policy and
reduced government spending are always appropriate for developing nations
experiencing a currency crisis? How might the IMF change its approach? What would
the implications be for international businesses?

Answer: The gold standard worked reasonably well from the 1870s until the start of World
War I in 1914, when it was abandoned. During the war several governments financed their
massive military expenditures by printing money. This resulted in inflation, and by the war's
end in 1918, price levels were higher everywhere.
Several countries returned to the gold standard after World War I. However, the period that
ensued saw so many countries devalue their currencies that it became impossible to be certain
how much gold a currency could buy. Instead of holding onto another country's currency,
people often tried to exchange it into gold immediately, lest the country devalue its currency in
the intervening period. This put pressure on the gold reserves of various countries, forcing them
to suspend gold convertibility. As a result, by the start of World War II, the gold standard was
dead. The great strength of the gold standard was that it contained a powerful mechanism for
simultaneously achieving balance-of-trade equilibrium by all countries, as explained in the
example provided in the textbook. This strength is the reason for reconsidering the gold
standard as a basis for international monetary policy.

QUESTION
You are CFO of a U.S. firm whose wholly owned subsidiary in Mexico manufactures
component parts for your U.S. assembly operations. The subsidiary has been financed by bank
borrowings in the United States. One of your analysts told you that the Mexican peso is
expected to depreciate by 30 percent against the dollar on the foreign exchange markets
over the next year. What actions, if any, should you take?
Answer: If the peso depreciates by 30 percent as expected, the dollar value of the Mexican
subsidiary would decrease too. With the depreciation of peso, the demand for peso would
increase and more consumers would start buying goods in peso because the same amount of
money paid to buy a good carry a lesser value. In contrast, the demand for goods in U.S dollar
would decrease. This would result in the decreasing value of the company’s Mexican subsidiary
in U.S dollars.
With the expected depreciation in mind, the company would want to protect the company by
collecting the foreign receivables before the depreciation takes place, so that it would not lose
its value. Furthermore, by avoiding major peso-denominated costs until after devaluation,
would likely cut down costs for the company. In contrast, U.S dollar-denominated purchases
should be made before the devaluation and change peso-denominated major accounts into
dollars if it is possible. By doing this, it prevents the drop-in values of peso accounts.

FOREIGN EXCHANGE RATES

PRACTICES

A. The effect of changing exchange rates on the profits

1. Two Korean automakers. Hyundai and Kia are trying to expand their presence in the United
States using a low cost pricing strategy. In doing so, the South Korean automakers reduce their
margin per car, and so, are even more affected than other automakers by a weak dollar. To
minimize the effects of a weak dollar, Hyundai and its affiliate Kia have both recently changed
their strategy to include production in the United States

Q1: How do Hyundai and Kia use exchange rates in their daily activities? How did the
weak dollar affect the profits of the two companies between 2005 and 2007?

ANSWER: Hyundai and Kia are both South Korean companies that rely on the U.S. market for
a significant share of their revenues. Each time the companies sell vehicles in the United
States for dollars, the dollars must be converted to the South Korean currency, the won.
In 2005, one U.S. dollar bought 1,050 won. By late 2007, the exchange rate had changed, and
one U.S. dollar bought just 918 won. The falling dollar meant lower profits for the two
exporters.

Q 2: How can Hyundai and Kia limit the negative effects of exchange rates? Should the
two companies continue to move away from exporting toward more production in the
United States? Why or why not?

ANSWER: Hyundai and Kia were particularly vulnerable to the weak U.S. dollar because of
their reliance on exports. Production of the companies’ vehicles took place in South Korea,
the cars were shipped to the United States, sold in U.S. dollars which were then converted
back to won. In 2007, the won reached a 10 year high against the U.S. dollar. Even though
unit sales were rising for the companies, their profits actually fell. By shifting some
production to the United States, the two companies can limit their exposure to the weak
dollar.

2. Traditionally, Volkswagen hedged 70% of its foreign exchange exposure. In 2003, the
company made the unfortunate decision to hedge just 30 percent of its exposure. Volkswagen
saw a 95 percent drop in its fourth quarter profits after an unexpected surge in the value of the
euro left the company with losses of $1.5 billion.

Q: Why was Volkswagen so vulnerable to the change in the value of the euro relative to the
U.S. dollar?

ANSWER: Volkswagen was especially vulnerable to the rise of the euro against the U.S.
dollar in 2003 because the company manufactured its cars in Germany and then exported
them to the United States. When Volkswagen failed to adequately hedge its exposure to
foreign exchange rate changes, and the euro-dollar relationship shifted, the company lost out.
You should recognize, that if Volkswagen produced some of its cars in the United States,
the effects of the currency shift would have been much smaller.

3. SMS Elotherm and Keiper had to deal with the Rising Euro. Both companies supplied
DaimlerChrysler with parts, however, SMS Elotherm, which manufactured its parts in Germany
was hit hard by the dollar’s slide relative to the euro in the early 2000s. SMS Elotherm signed
a deal in late 2004, to sell parts to DaimlerChrsyler. The company anticipated making about
€30,000 profit on each part. However, within days, the anticipated profit was just €22,000.
Keiper, which had opened a plant in Canada, was able to avoid the negative effects of the
currency swing to a large extent.

Q: Could SMS Elotherm have taken steps to avoid the position it now found itself in? What
were those steps? Why do you think the company did not take these steps?

ANSWERS: SMS Elotherm, which had priced its parts in dollars, but had its costs in euros,
faced transaction exposure. The company could have done several things to limit its exposure
to exchange rates.

* One of the easiest strategies would have involved entering forward contracts to buy euros
with the dollars it would receive from DaimlerChrysler. The company could have followed a
similar strategy with options to buy euros.

* A more involved strategy would have been to diversify its manufacturing, so costs were
spread across more than one currency.

* Finally, the company might have negotiated a deal with DaimlerChrysler to price some of its
sales in dollars and others in euros.

B. International Fisher effect and Exchange rates

4. The interest rate on South Korean government securities with one-year maturity is 4 percent
and the expected inflation rate for the coming year is 2 percent. The interest rate on U.S.
government securities with one-year maturity is 7 percent and the expected rate of inflation is
5 percent. The current spot exchange rate for Korea won is $1 = W1,200. Forecast the spot
exchange rate one year from today. Explain the logic of your answer.

ANSWER:

* From the Fisher effect - real interest rate in both the USA and South Korea is 2%.

* International Fisher effect: nominal interest rate is 3% higher in the USA than in South Korea,
the dollar should depreciate by 3% relative to the South Korean Won.

(S1 - S2)/S2 x 100 = i$ - iWon

If: i$ = 7 iWon = 4 S1 = 1200 then: S2 $1=W1165

5. You manufacture wine goblets. In mid June you receive an order for 10,000 goblets from
Japan. Payment of ¥400,000 is due in mid December. You expect the yen to rise from its present
rate of $1=¥130 to $1=¥100 by December. You can borrow yen at 6% per annum. What should
you do?

Options:

a. The simplest solution: wait until December, take the ¥400,000 and convert it at the spot rate
at that time, which you assume will be $1=¥100. In this case you would have $4,000 in mid-

December. If the current 180 day forward rate is lower than 100¥/$, then it would be preferable
since it both locks in the rate at a better level and reduces risk.

b. If the rate is above ¥100/$, then whether you choose to lock in the forward rate or wait and
see what the spot does will depend upon your risk aversion.

c. You could borrow money from a bank that you will pay back with the ¥400,000 you will
receive (400,000/1.03 = ¥388,350 borrowed), convert this today to US$ (388,350/130 =
$2,987), and then invest these dollars in a US account.

* For this to be preferable to the simplest solution, you would have to be able to make a lot of
interest (4,000 - 2,987 = $1,013), which would turn out to be an annual rate of 51%
((1,013/4000) * 2).

* If, however, you could lock in these interest rates, then this method would also reduce any
exchange rate risk.

What you should do depends upon the interest rates available, the forward rates available, how
large a risk you are willing to take, and how certain you feel that the spot rate in December will
be ¥100 = $1.

C. Currency risk and strategy

6. In the space of a few months Korea saw its economy and currency move from prosperity to
critical lows. Much of the blame for Korea’s financial collapse can be placed with the country’s
chaebol (large industrial conglomerates) that had built up massive debts as they invested in new
factories. Speculators, concerned about the chaebol’s ability to repay their debts, began to
withdraw money from the Korean Stock and Bond markets fueling a depreciation in the Korean
Won. Despite government efforts to halt the fall in the currency, the won fell some 67% relative
to the dollar.

Q: As a CEO of a German company, how does Korea’s situation affect your operations?

ANSWER: The situation in South Korea increased the risk for any company doing business
with the nation. However, students should recognize that the effect on a German company
depends on the company situation itself. For some companies, exports to South Korea may dry
up if the South Korean buyer no longer exists or has significantly lower demand. However, for
other companies exporting to South Korea, or actually operating in the country, the situation
may actually increase opportunities as business that was formerly conducted by South Korean
companies becomes available.
 7. The strong dollar in the early 2000s had an important effect on STMicro, the world’s sixth
largest manufacturer of semiconductor chips, a commodity that is priced in dollars in world
markets. In the early 2000s, STMicro, which has 70 percent of its costs denominated in euros,
benefited from the strong dollar/weak euro relationship. However, when the euro began to rise
relative to the dollar in 2003, STMicro’s profits began to tumble.

What strategy should STMicro adopt in order to deal with possible future fluctuations in
exchange rates?

ANSWER: To deal with possible future fluctuations in exchange rates, STMicro should
actively cutting costs by closing some European operations and cutting jobs. In addition, the
company should be shifting some production to Asia with the idea of being able to switch
production between Asia and Europe as the situation warrants. It is not clear whether the
company intends to do any currency hedging, but it could complement SIMicro´s other
strategies.

The strong dollar in the early 2000s had an important effect on STMicro, the world’s sixth
largest manufacturer of semiconductor chips, a commodity that is priced in dollars in world
markets. In the early 2000s, STMicro, which has 70 percent of its costs denominated in euros,
benefited from the strong dollar/weak euro relationship. However, when the euro began to rise
relative to the dollar in 2003, STMicro’s profits began to tumble.

COSTS OF GLOBAL COMPLIANCE

To be able to conduct business in these countries, a company must understand how

these laws interrelate and impact their business.

In a globalized world, compliance with shifting regulatory regimes is a complex task.

Companies deal with differing regulations as well as expanding jurisdictions where
countries like the U.S. look at the sum total of a company’s operations to ensure
compliance with anti-bribery, anti-terrorism and anti-money laundering legislation.
Then there are places like the European Union, which seems to have a regulation for
every imaginable business practice. In 2016, all companies selling goods and services
were informed that they would have to be in compliance with the General Data
Protection Regulation (GDPR) which increases compliance costs by mandating the
appointment of a data protection officer(DPO) to oversee implementation of systems
and privacy reforms.

Compliance cost is the total cost incurred by a firm to comply with applicable
regulations. These costs can include the following:

 Cost of the systems needed to collect information for compliance reporting.

 Cost of the personnel needed to monitor the compliance systems.
 Cost to compile and issue reports.
Compliance costs can be so high in regulated industries that they represent a barrier to
entry, which effectively creates an oligopoly. When this is the case, companies already
competing in the industry may favor regulation in order to keep new entrants from
appearing and increasing the level of competition.

An organization operating in multiple jurisdictions may have to deal with a broader

range of regulations, and so may incur higher costs than smaller competitors operating
in fewer markets.

GLOBAL MARKETPLACE

"Commitment must come from the top of the organization, and it must be
personally reinforced. Commit the resources and the time, or risk losing credibility,
image and business. There is no substitute for hands-on. If you're not willing to
personally invest, don't invest at all."
BEST MANAGERs/LEADERS: (you should put only those in position to handle
responsibility)
1. Appreciation for and a sensitivity to other cultures
2. Fluent in world history and follow the world´s current events
3. Track record with diversity – experience with managing diverse workplace
4. Track record with emerging and changing businesses.
5. A rubbery mind. Manager accepts that there is more than one right way of doing things.
6. A sensitivity of differences. Diplomat.
7. Well-connected at home. Extended periods of travel and unique business demands don’t
create undue stress.
8. Possesses deep-seated principles.
9. An excellent planner.
10. Best representative of the company.
11. A builder and manager of relationships. Can easily connect with a wide variety of
people.
12. An ability to manage in difficult times.
CHOOSE YOU PARTNER:
1. Select your partners with care. Must be good marketers, and good managers.
2. Manage communications. Sensitivity to different values and ways od doing things.
Choose the best channels of communications.
3. Build relationships. Close personal relationships are expected.
4. Understand the market. Study the market very closely. Do the financial analysis,
understand the tariffs and costs, the total landed costs and your potential profits.
 5. Provide support.
6. Utilize contracts. Spell everything out in detail. Make sure there is a strong contract that
defines all the ruled and establishes clear, understandable roles and boundaries for
everyone.
7. Teach your partner. The partner must be comfortable and competent with your
technology, products, and services.
8. Exhibit integrity. Be credible.
9. Manage actively. Be out there and be involved.
10. Listen and be flexible.
11. Have a partner mentality. Treat their business as your business.

McDonald’s In India

Summary

The opening case explores the unique challenges faced by McDonald’s in India.
The cow is considered sacred in India’s Hindu culture prompting McDonald’s to
alter its menu to offer mutton and chicken alternatives to its traditional beef
burgers. McDonald’s now has over 130 restaurants in India and many more are
planned. However, the company was recently the target of negative reports when it
was discovered that its French fries were cooked in oil that contained beef extract.
Discussion of the case can revolve around the following questions:

QUESTION 1: How did McDonald’s change its product line to meet the needs
of the Indian market? Does the Indian version of McDonald’s still maintain
the company’s identity?

ANSWER 1: In response to the needs of the Indian market, McDonald’s changed

its menu to include mutton and chicken products rather than the beef-based
products that are featured in its regular menu. Most students will probably suggest
that even with the changes, the company remained true to its identity because it
used names similar to traditional names to describe the new products, and built its
restaurants following the traditional American style.

QUESTION 2: Did McDonald’s handle the revelation that its French fries
contained beef extract well? What would you have done differently?

ANSWER 2: The lawsuit against McDonald’s over the presence of beef extract in
its French fries caught the company off-guard. McDonald’s quickly acknowledged
its mistake and settled the lawsuit. The company also made a public apology and
vowed to be more accurate in its food labeling in the future. However, many
students will probably argue that the company failed to adequately reassure
consumers in India, where angry Hindus protested in the streets. Students
might suggest that the company should have responded not only to the Indians
located in the United States who prompted the lawsuit, but also to the citizens of
India, and other Hindu customers.

Wal-Mart’s Foreign Expansion

Summary

The closing case explores the international expansion of Wal-Mart, the world’s
largest retailer. Wal-Mart began its international expansion in the early 1990s in an
effort to continue its growth. The company began with a joint venture in Mexico
with local retailer, Cifra. Initially, the company tried to implement strategies
similar to those that had proved so successful in the United States, however Wal-
Mart quickly realized that to succeed, it would have to adapt to local demands.
The company hired local managers who understood the Mexican culture and
buying preferences, and changed its strategies accordingly. Wal-Mart continued
its international expansion by establishing operations in Europe and South Korea,
but in these markets, the company had less success. Not only did Wal-Mart
compete head-to-head with established retailers, but its product offerings did
not match the needs of consumers. Wal-Mart has had much greater success in
China where it has found some parallels between the shopping habits of Chinese
and Americans. Wal-Mart has also adapted its strategy to fit the local market and
now not only allows unions but is also selling a product mix designed to meet the
demands of China. Discussion of the case can revolve around the following
questions:

QUESTION 1: Do you think Wal-Mart could translate its merchandising strategy

wholesale to another country and succeed? If not, why not?

ANSWER 1: To date, Wal-Mart has found that in order to appeal to local markets,
it must be willing to make some changes in its merchandising strategy. In Mexico
for example, Wal-Mart hired local managers to handle its merchandising, and it an
effort to better meet the needs of local customers Wal-Mart built smaller stores that
people could walk to, and stocked more fresh produce. In China, Wal-Mart
changed its packaging of meat and offered live fish because the Chinese prefer
fresh meat and fish. In the countries where Wal-Mart stumbled, Germany and
South Korea, Wal-Mart’s discount strategy failed. Consumers in both countries
preferred to shop at rival stores that stocked higher quality merchandise.
Some students may wonder whether Wal-Mart might have succeeded in these
countries if it have been willing to stock some higher quality merchandise as well.
However, other students may note that doing so would go against the strategy that
has proved to be so successful for the company.

QUESTION 2: Why do you think Wal-Mart was successful in Mexico?

ANSWER 2: Most students will probably suggest that Wal-Mart’s success in

Mexico is linked to the company’s willingness to move in to the market slowly,
adapt to local market preferences, and join forces with local retailer, Cifra. After
entering the market, Wal-Mart quickly discovered that having a single large store
selling large packages would not be successful in Mexico where many people
walked to stores and lacked storage space. The company changed hired local
managers who understood the market and allowed the local managers to control the
merchandising strategy. Wal-Mart then worked to change the shopping habits of
Mexican consumers to come closer a typical Wal-Mart shopper. By teaming up
with the country’s largest retailer, the company was able to benefit from Cifra’s
knowledge of the local marketplace.

QUESTION 3: Why do you think Wal-Mart failed in South Korea and Germany?
What are the differences between these countries, and Mexico?

ANSWER 3: Wal-Mart stumbled badly in South Korea and Germany. In both

countries, consumers resisted the company’s discount strategy, and chose instead to
shop at rival stores that better met their shopping preferences. Some students may
suggest that Wal-Mart’s discount strategy worked better in Mexico because it fit
better with consumer preferences. Other students may note that in both South
Korea and Germany, Wal-Mart had to convince consumers to leave the competition
and shop in its stores, whereas in Mexico, Wal-Mart teamed up with Cifra, a large
retailer with a similar product line to the line carried by Wal-Mart. Some students
may wonder whether the company might have had more success in Germany and
South Korea had it also teamed with local retailers.

QUESTION 4: What must Wal-Mart do to succeed in China? Is it on track?

ANSWER 4: In China, Wal-Mart seems to be following a strategy similar to its

strategy in Mexico. The company is slowly expanding and is adapting its strategy
to meet the needs of Chinese consumers. Wal-Mart has found that the Chinese
share many buying behaviors with American consumers – they like the deep
discounts offered by Wal-Mart. To ensure its success in the country, Wal-Mart has
strayed from its traditional strategy to embrace the notion of unions. This decision
has led the company to purchase a stake in China’s Trust-Mart chain, which should
allow Wal-Mart to expand even further. Wal-Mart now considers China its most
important growth market. Most students will probably agree that Wal-Mart appears
to be on track in the country.

QUESTION 5: To what extent can a company like Wal-Mart change the culture of
the nation where it is doing business?

ANSWER 5: This question will probably generate some debate among students.
Some students will probably suggest that Wal-Mart can indeed change the
shopping habits, and therefore culture, of a country in which it does business.
Students taking this perspective may point to Wal-Mart’s experiences in Mexico as
evidence of this phenomenon. Other students however, may argue that the shopping
habits of Mexican consumers were not changed by Wal-Mart per se, but rather by
the effects of globalization which allowed companies like Cifra and Wal-Mart to
thrive. Students taking this perspective will probably note that China for example,
already had successful discount chains like Trust-Mart when Wal-Mart entered the
market. Students may further note that in countries like Germany and South Korea
where consumers preferred other types of retailers, Wal-Mart was unsuccessful.