Financial Forces

McGraw-Hill/Irwin
International Business, 11/e Copyright 2008 The McGraw-Hill Companies, Inc. All rights reserved.
chapter eleven
11-3
Learning Objectives
Explain how money can be made and lost in the
foreign exchange (FX) markets

Understand foreign exchange quotations, including
cross rates

Describe currency exchange controls

Explain how financial forces such as tariffs, taxes,
inflation and the balance of payments can affect
international management

11-4
Fluctuating Currency Values
Freely floating currencies fluctuate
against each other

Fluctuations may be quite large

Financial managers must understand
how to protect against losses or optimize
gains
11-5
Foreign Exchange Terminology
Foreign Exchange Quotation
The price of one currency expressed in terms of another
Reported in the worlds currency exchange markets
Central reserve asset
Asset, usually currency, held by a governments central bank
Vehicle currency
A currency used as a vehicle for international trade or investment
Intervention currency
A currency used by a country to intervene in the foreign currency
exchange markets, often to buy (strengthen) its own currency
11-6
Exchange Rates
Foreign currency Xs per US$ rate can be computed
from the reciprocal of the US$ equivalent rate of
currency X (and vice versa)


Foreign Exchange Quotations
(1) / (Currency X per US$ rate) =
= (US$ equivalent rate of currency X)
(1) / (US$ equivalent rate of currency X) =
= (Currency X per US$ rate)
11-7
Exchange Rate for June 19 and June 16,
2006


11-8
Exchange Rates
Spot rates
The exchange rate between two currencies
for delivery within two business days
Forward currency market
Trading market for currency contracts
deliverable 30, 60, 90, or 180 days in the
future
Forward rate
The exchange rate between two currencies
for delivery in the future, usually 30, 60, 90,
or 180 days

11-9
Exchange Rates
Trading at a premium
A currencys forward rate quote is stronger than
the spot rate
Trading at a discount
A currencys forward rate quotes is weaker than
the spot rate
Premium or a discount depends on the
expectations of the world financial community,
businesses, individuals, and governments
about what the future will bring
11-10
Exchange Rates
Cross Rates
Currency exchange rates for trading directly
between non-U.S. dollar currencies
Bid price
Price offered to buy
Ask price
Sales price
11-11
Influences of Exchange Rate Fluctuation
Supply and demand of the currency

Interest rates

Inflation

Expectations

11-12
Exchange Rate Fluctuation
Monetary policies
Government policies that control the amount of
money in circulation and its growth rate
Fiscal policies
Policies that address the collecting and spending of
money by the government
Law of one price
Concept that in an efficient market, like products
will have like prices
Arbitrage
The process of buying and selling instantaneously
to make profit with no risk



11-13
Exchange Rate Fluctuation
Fisher effect
The relationship between real and nominal interest
rates: the real interest rate will be the nominal
interest rate minus the expected rate of inflation
International Fisher effect
Concept that the interest rate differentials for any
two currencies will reflect the expected change in
their exchange rates
Purchasing Power Parity (PPP)
Theory that predicts that currency exchange rates
between two countries should equal the ratio of the
price levels of their commodity baskets



11-14
Exchange Rate Forecasting
Efficient market approach
Assumption that current market prices fully
reflect all available relevant information
Random walk hypothesis
Assumption that the unpredictability of
factors suggests that the best predictor of
tomorrows prices is todays prices



11-15
Exchange Rate Forecasting
Fundamental approach
Exchange rate prediction based on
econometric models that attempt to capture
the variables and their correct relationships
Technical analysis
An approach that analyzes data for trends
and then projects these trends forward


11-16
Currency Exchange Controls

Government controls that limit the legal uses
of a currency in international transactions
Value of currency is arbitrarily fixed at a rate
higher than its market value
If you see official rate next to a currency rate
quotation, that country has currency exchange
controls in place
11-17
Currency Exchange Controls
A black market typically surfaces as a
result of currency exchange controls
However, this type of currency exchange
transaction is illegal
The black market is rarely able to
accommodate transactions of the size
involved in international business

11-18
Tariffs

Tariffs
Taxes, usually on imported goods
May be ad valorem, specific, compound, or
variable
11-19
Taxation
Income tax
Direct tax on personal and corporate income
Value-added tax (VAT)
A tax charged on the value added to a good as it
moves through production from raw materials to
final purchaser
Withholding tax
Indirect tax levied on passive income that the
corporation would pay out to non residents
11-20
Corporate Tax Rates
11-21
Inflation
A trend of rising prices
May be caused by demand exceeding
supply
May be caused by an increase in the money
supply
Measured by consumer price index (CPI)
Basket of consumer goods
Gross domestic product deflator--OECD
Takes into account the prices of
intermediate goods and services
11-22
GDP Deflator. Average annual growth in
percentage, 1991-2004
11-23
Inflation and the International Company
High inflation rates

Make capital expenditure planning more
difficult
Cause the cost of goods and services to rise
Tend to cause BOP deficits
Could lead to more restrictive fiscal or
monetary policies, currency controls, export
incentives, and import obstacles

11-24
Inflation and the International Company
High inflation rates

Encourage borrowing because the loan will be repaid
with cheaper money

Bring high interest rates

Discourage lending

Make capital expenditure planning more difficult

11-25
Balance of Payments (BOP)
The state of a nations BOP reveals the state
of that countrys economy
If the BOP is slipping into deficit
the government is probably considering one or
more market or nonmarket measures to correct or
suppress that deficit
Currency devaluation or restrictive
monetary or fiscal policies to induce
deflation are likely
Currency or trade controls may be near