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Chapter 09 10forex IntlMoneSysRW

This document provides an overview of foreign exchange and currency conversion. It defines key terms like foreign exchange, exchange rate, and money. It explains how currency values are set through either fixed exchange rates determined by governments or floating rates set by supply and demand. It also discusses how businesses can hedge against foreign exchange risk using tools like spot exchange rates, forward rates, and currency swaps. Finally, it discusses some methods for predicting when currency values may change, such as fundamental and technical analysis of economic indicators.

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97 views31 pages

Chapter 09 10forex IntlMoneSysRW

This document provides an overview of foreign exchange and currency conversion. It defines key terms like foreign exchange, exchange rate, and money. It explains how currency values are set through either fixed exchange rates determined by governments or floating rates set by supply and demand. It also discusses how businesses can hedge against foreign exchange risk using tools like spot exchange rates, forward rates, and currency swaps. Finally, it discusses some methods for predicting when currency values may change, such as fundamental and technical analysis of economic indicators.

Uploaded by

pujakumarisinha88
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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International Business

Foreign Exchange:

Dealing with Currencies


with a basic introduction to the International Monetary System

2004 Prentice Hall, Inc

9-1

Foreign Exchange Terms


Foreign exchange: money denominated in the currency of another nation or group of nations
Cash Credit Bank deposits Other short-term claims (e.g., bonds)

Exchange rate: the price of a particular currency relative to another

Basic questions
What is money? How should you convert money from one currency into another? How are the values of currencies set? How can you limit foreign exchange risk
(the possibility that unpredicted changes in exchange rates will have adverse consequences for the firm)?

Can you predict when currency values will change? If so, how?

What is money?
The medium of exchange
that is, something widely accepted as means of payment

Usually, governments declare certain pieces of paper to be money


But people must accept them Alternatives are inconvenient, but possible
Tobacco in early American colonies U.S. dollar in Russia when ruble collapsed

Why and when do businesspeople deal with foreign money?


Sell abroad, and you may receive payment in foreign currency Buy abroad, and you may have to pay in foreign currency Travel abroad, you must spend foreign currency A foreign direct investment will have to pay expenses in foreign currency

How should you convert money from one currency into another?
Current values of major foreign currencies are available on the Web Most businesspeople normally buy from or sell to a bank
The bank often gives less than the rates offered on the Web, but handles all details Banks may vary a lot in how good a deal they give

A business with significant foreign activity creates a stable relationship with one or a few banks Nowadays, you can do your own currency trading

How are the values of currencies set?


There are two basic ways
Fixed or Pegged exchange rates
Governments decide the value of currency Example: Hong Kongs government keeps the value of its dollar at roughly US$0.129 (US$1=HK$7.75) With a fixed rate, there is absolutely no variability. A pegged rate implies small variability

The most important currencies float against each other


Supply and demand sets values
This is how exchange rates are set for the US dollar vs.
Euro, Japanese yen, British pound, Swiss franc, etc.

Insuring Against Foreign Exchange Risk


Businesses us the foreign exchange market to provide insurance against foreign exchange risk A firm that protects itself against foreign exchange risk is hedging You can buy or sell using 1. spot exchange rates 2. forward exchange rates 3. currency swaps

Insuring Against Foreign Exchange Risk


1. 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
Spot rates are determined by the interaction between supply and demand, and so change continually

Insuring Against Foreign Exchange Risk


2. Forward Exchange Rates A forward exchange occurs when two parties agree to exchange currency at some specific future date
Forward rates are typically quoted for 30, 90, or 180 days into the future Forward rates are typically the same as the spot rate plus or minus an adjustment for the interest the parties will pay/receive

Insuring Against Foreign Exchange Risk


3. Currency Swaps A currency swap is the simultaneous purchase and sale of an amount of foreign exchange on two different dates
Swaps are used when it is desirable to move out of one currency into another for a limited period without incurring foreign exchange rate risk

Fixed exchange rates have important benefits


They make business predictable In some very prosperous periods, most major exchange rates have been fixed
The late 19th century 1945-1971

The gold standard made the benefits of fixed rates clear


Before WW I, all major currencies were convertible into gold
UK 1=113 grains gold (.2354 oz) US $1= 23.22 grains (.0484 oz) So 1=4.87

Everyone knew what everything was and would be worth

But a fixed exchange rate requires discipline in the government and a willingness to create pain
Example: Suppose your nations economy is very prosperous Your people will have money to buy imports Their demand for foreign currencies will put upward pressure on their exchange rates Government has to slow the domestic economy to prevent change in exchange rate
Higher taxes, higher interest rates, lower spending

Many economists say if a country is having difficulty maintaining a fixed exchange rate, the economy is overheated
They say higher interest rates or higher taxes might be better for the economy in the long run in those circumstances But politicians dont like to take pain

U.S. abandoned fixed exchange rates when the Vietnam War created strong inflation

It seems that the more complicated an economy, the more difficult it is to maintain fixed/pegged rates
Many small countries succeed
Hong Kong, Bangladesh, Fiji

Few propose them for the largest developed countries today

But China maintains a pegged exchange rate


Its government buys all surplus dollars in the country In Dec. 2008 China had $1,946 billion US dollars

Most international business involves currencies with floating rates


Buyers and sellers establish prices in markets like those for tea and wheat $1,200,000,000,000 in foreign exchange is traded every day US dollar is most widely traded
involved in 90% of all transactions

London is the main foreign-exchange market

Key Foreign-Exchange Terms


Bid: the rate at which a trader will buy foreign currency from you Offer: the rate at which a trader will sell foreign currency to you Spread: the difference between bid and offer rates; the profit margin for the trader

9-6

Market Rhythms

9-13

How can you predict when currency values will change?


Business decisions demand you look far ahead
If exchange rates will change and you dont hedge adequately, your whole calculation will be off Some foreign currencies have lost 90% or more of their value in a year
Argentine peso went from $1=1 peso to $1=3.5 pesos in one jump

Fundamental analysis involves examining basic economic data


How fast are prices rising in the country? Is there a trade surplus or deficit? Is the government running budget deficits? How much? How do interest rates in the countries compare? How has the government been managing the currency?

Technical analysis involves examining trends in exchange rates


One principle: Trends once established often tend to continue
The trend is your friend

But if everyone agrees something will happen, it may not happen


When everyone thinks the dollar will go down, everyone has already sold dollars If the news changes, many may quickly change their minds and want to buy

Foreign exchange can be the difference between profit and loss


HSBC Bank in Argentina
They entered Argentina at a time when it appeared the government was starting to manage the economy effectively But they continued investing as government became more irresponsible They lost big

Material below here is not required

Foreign-Exchange Convertibility
Fully convertible currencies are those that the government allows both residents and nonresidents to purchase in unlimited amounts
Hard currencies are fully convertible Soft currencies (or weak currencies) are not fully convertible Typically from developing countries Known as exotic currencies

9-10

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