INTERNATIONAL TRADE FINANCE

TUTORIAL 4

1. Describe how these three typical transactions should affect present(Spot Rate) and future(Future
Rate) exchange rates.

Reminder : to understand the Demand and Supply

When DD increases, Value increases (vice versa)

When SS increases, Value decreases (vice versa)

1.a. Seagram imports a year's supply of French champagne. Payment in euros is due immediately.

Payment in Euro immediately > DD Euro NOW > Spot rate for Euro should appreciate.

1.b. MCI sells a new stock issue to Alcatel, the French telecommunications company. Payment in dollars
is due immediately.

Payment in $ is due immediately > Require pmt in $ NOW > DD $ now > Spot rate for $ should
appreciate.

MCI sells stock to Alcatel, MCI may need to pay a dividend in the FUTURE, hence, May need to SS $ to
pay dividend in future > Future rate for $ should depreciate.

1.c. Korean Airlines buys five Boeing 747s. As part of the deal, Boeing arranges a loan to KAL for the
purchase amount from the U.S. ExportImport Bank. The loan is to be paid back over the next seven
years with a two year grace period.

Spot rates remain unchanged since the loan is to be paid back over the next seven years.

Need to repay $ in the next 7 years > DD $ in the future to repay the loan > Future rate for $ should
appreciate.

2. The maintenance of money's value is said to depend on the monetary authorities. What might the
monetary authorities do to a currency that would cause its value to drop?

Monetary authorities, such as central banks, can cause a currency's value to drop through various
actions. These include increasing the money supply, lowering interest rates(cost of borrowing
decrease - promote more borrowing and increase money supply in the market), intervening in foreign
exchange markets, or failing to maintain credibility and confidence in the currency. Political
instability, economic uncertainty, and failure to control inflation can also contribute to depreciation.
Ultimately, the maintenance of a currency's value relies heavily on the effective management and
policies of the monetary authorities, as well as broader economic and political stability.
The value of any good or asset is driven by its scarcity.(the function of Supply and Demand) The
monetary authorities could make money less scarce by issuing more of it (SS rises, value drops). This
would lower its scarcity value. Even though its nominal value will always be the same, the added supply
will reduce the purchasing power per unit of money.

3. For each of the following six scenarios, say whether the value of the dollar will appreciate,
depreciate, or remain the same relative to the Japanese yen. Explain each answer. Assume that
exchange rates are free to vary and that other factors are held constant.

3.a. The growth rate of national income is higher in the United States than in Japan.

Slide 5 &6

Income in US > Income in Japan Income in US > Income in Japan

US purchasing power is higher This indicates US economy is better
US can buy more/import more from Japan US investment become more attractive
US will SS USD and DD Yen DD on USD will increase/ Japan will invest
USD will depreciate against Yen more in US, SS Yen to DD USD
USD will appreciate against Yen
 3.b. Inflation is higher in the U.S. than in Japan.

Slide 3

Inflation in US > Inflation in Japan

US g/s more expensive > US export will reduce > DD on USD decreases > USD will depreciate
against YEN

Japan g/s is relatively cheaper than US > US will import more from Japan > SS more USD to buy
Yen > USD will depreciate against YEN

The value of dollar will depreciate. This is due to the inflation will cause US imports become
more expensive to Japan customers. Japan customer will switch to domestic substitutes. Thus, the
demand for USD decrease.

3.c. Prices in Japan and the United States are rising at the same rate.

The value of dollar will remain the unchanged relative to the Japanese yen as the prices between
two country are rising at the same rate.

3.d. Real interest rates are higher in the United States than in Japan.

Slide 4

Interest in US > Interest in Japan

Us investment is more attractive due to higher interest/return> US will invest lesser in Japan > SS of USD
will decreases > USD will appreciate

DD on USD will increases > USD will appreciate

Japan will purchase more US investment, SS Yen to DD USD > USD will appreciate against YEN

The value of dollar will appreciate. This is because USD investment attractive due to the high
interest rate able to have higher rate of return to investor. Thus, Japan investors will buy more US
investment which then lead to an increase in USD demand.

3.e. The United States imposes new restrictions on the ability of foreigners to buy American companies
and real estate.

When there is a new restriction, this will make the investment in the US less attractive, foreigners will
purchase/invest lesser in the US > DD of USD decreases > The value of dollar will depreciate.

This is because USD with the new restrictions will lead to higher risk currencies. Thus, Japan investors
will demand less on higher risk currencies which then cause US currencies to depreciate.
3.f. U.S. wages rise relative to Japanese wages, and American productivity falls behind Japanese
productivity.

US wages > Japan Wages - US production cost is higher than Japan > US g/s become relatively more
expensive than Japan > US export reduce and Japan import increases > DD on USD will decreases
and SS of USD to DD yen will increases > USD will depreciate against Yen

Us productivity < Japan productivity - high Productivity shows better economy growth - it indicate US
investment become less attractive/ Japan investment is more attractive > DD on USD will decreases
and SS of USD to DD yen will increases > USD will depreciate against Yen

The value of USD will depreciate. As the US wages increase, it will increase the cost of US
goods. Thus, US good become expensive, US customers will spend more on Japan products.
Consequently, demand for yen will increase while demand for USD will decrease.

4. The Fed adopts an easier monetary policy. How is this likely to affect the value of the dollar and U.S.
interest rates?

Easy money is when the Fed allows cash to build up within the banking system—as this
lowers interest rates and makes it easier for banks and lenders to loan money

ANSWER. If the Fed switches to an easier monetary policy, the value of the dollar will drop as fears of
inflation rise. Shortterm U.S. interest rates will initially fall but will then rise as investors seek to protect
themselves from higher anticipated inflation. Longterm rates will probably rise immediately because of
fears of future inflation.

Easier monetary policy (increase the money supply) (USD initially depreciates)
Lower down the interest rate (US interest rate in short term will fall)
Lower down the cost of borrowing > to attract more borrowing > business activity can be improved >
employment rate increases > income level & purchasing power will increase too > Demand on G&S will
increase > Prices of G&S rises (Inflation)

When inflation > interest rate will increase (US interest rate in long term will rise to protect from
inflation)

Over time, however, if the growth in the money supply stimulated the economy to grow more rapidly than
it otherwise would, the value of the dollar could rise, and so could real interest rates. This is an unlikely
scenario, however, as indicated by the experiences of Latin American nations.

Value of the Dollar

Lowering interest rates and increasing the money supply tend to decrease the value of the dollar
relative to other currencies. This is because lower interest rates make dollar-denominated assets less
attractive to foreign investors seeking higher yields elsewhere. Additionally, increasing the money
supply can lead to inflationary pressures, which erode the purchasing power of the currency, further
weakening its value on the foreign exchange market.

U.S. Interest Rates

 Lowering interest rates is a key component of an easier monetary policy. When the Federal Reserve
System (Fed) cuts interest rates, it aims to stimulate borrowing and investment by making it cheaper
for businesses and consumers to access credit. Lower interest rates can also boost consumer spending
and support economic growth. Conversely, raising interest rates is associated with a tighter monetary
policy aimed at controlling inflation or cooling down an overheating economy.

5. Many Asian governments have attempted to promote their export competitiveness by holding down
the values of their currencies through foreign exchange market intervention.

5.a. What is the likely impact of this policy on Asian foreign exchange reserves? On Asian inflation?
On Asian export competitiveness? On Asian living standards?

ANSWER.
The result is:
1) increased foreign reserves as Asian central banks must buy up foreign exchange in the market to
hold down the value of their currencies,
2) and an expanded domestic money supply, which has the potential to increase inflation.
3) At the same time, the lower exchange rates boost Asian export competitiveness,
4) but at the expense of a lower living standards for their populations (who find foreign goods and
services more expensive).

When Asian government hold down the currency through foreign exchange market intervention,

Asian inflation may increase as weaker domestic currency makes import more expensive and inflation
will in turn affect interest rates.

Asian export competitiveness is likely to increase. Cheaper exports due to weaker domestic currency
become more attractive to foreign buyers.

Asian living standards may be decreased. Long term inflation can affect the purchasing power as living
cost is increasing for Asian.

5.b. Some Asian countries have attempted to sterilize their foreign exchange market intervention by
selling bonds. What are the likely consequences of sterilization on interest rates? On exchange rates
in the longer term? On export competitiveness?

The interest rates is likely to increase as selling bonds is taking money out of the domestic market. This
reduces money supply which can make the interest rates higher to attract new investment and
maintain equilibrium.

The export competitiveness might decrease as the interest rate is set higher, it can make the borrowing
more expensive for businesses and increasing the production costs and limit the export growth.

6. In 2002, one dollar bought ¥125. In 2006, it bought about ¥115.

6.a. What was the dollar value of the yen in 2002? What was the yen’s dollar value in 2006?

- In 2002, $1 bought ¥125

 - In 2006, $1 bought about ¥115
- 2002 = ¥125/$ = $___/¥
- 2006 = ¥115/$ = $___/¥
- In 2002 = $1 / ¥125 = $0.008 (dollar value of yen)
- In 2006 = $1 / ¥115 = $0.0087 (dollar value of yen)

6.b. By what percent has the yen risen in value between 2002 and 2006?

- In 2002 = $1 / ¥125 = $0.008/Yen

- In 2006 = $1 / ¥115 = $0.0087/Yen

Percentage change =[ (0.0087-0.008)/0.008] * 100%

= 8.75%

The yen’s value risen by approximately 8.75% between 2002 and 2006.

- 2002 = ¥125/$
- 2006 = ¥115/$

= (125 - 115) / 115 = 8.7% (slight decimal diff but both answers are acceptable)