International Business

Foreign Exchange & Monetary System

Sept 6
Toshiya Ozaki
 Schedule National
Characteristics

28 Aug Intro to IB #6 9 Sep Nat’l Difference #1: 6 - 8

- Globalization #1: 1/2/5 - Political/Legal #2
- Firms & IB (#10) - Economic #16
30 Aug Trade & FDI #1: 3/4 11 Sep Cultural Diff #5
#4 Case: McDonald #10
4 Sep Trade Theory #7 13 Sep Global Strategy #1: 11 – 14
Case: DDD #11 - Foundation
6 Sep Money 16 Sep Global Strategy #4
- Foreign Exch #1: 9/10 - Perspectives #1: 15 – 17
- Global Fin Case: Nike #12
Institutions Tbc Final Exam
9 Sep Mid-term
Strategy as
Firm Response
Framework for
Globalization 2
 4 Sept 2011: DDD
1. What is the business model of DDD? What
value does it offer to customers? What value
chain does it have? (Group 4)
2. Which aspects of the case involve trading?
Does it follow the pattern of trade? (Group 9 )
3. Which aspects of the case involve FDI? Does
it follow the pattern of FDI? (Group 2)
4. What has made DDD successful? What are its
constraints? Which strategies should DDD
pursue for the next step? (Group 11)
3
 Key Success Factors
– Good business model (combining social
mission and IT business) as a “social
enterprise”,
– Resources & Capabilities to execute the
business model (i.e., Ownership Advantage)
– Location Advantage (Cambodia/Laos) &
Internalization Advantages (ability to arbitrage
gaps, integrate various advantages)

4
 Constraints
– Human resource management challenges in
Cambodia and Laos
– Lack of adequate infrastructure, especially in
Battambang Office
– Lack of standardized processes for recruitment
and training creating extra work and cost
– Difficulty of balanced allocation of projects
among host country offices under the
constraints of local specialization and resources
& capabilities
5
 Strategic options
– Organic growth
– Partnership/JV with a local entrepreneur
– Social Franchising
– Partnership with an International Organization

6
NATIONAL DIFFERENCE IN
CURRENCY
7
 Flows of Goods/Services and Payments
• Trade
– Goods & Services from Firm A in Country X to Client B in Country
Y
– Cash (Payment) from Client B in Country Y to Firm A in Country X
• FDI
– Cash（Investment), Technologies & Know-How from Firm A in
Country X to Firm A’ (subsidiary) in Country Y
– Cash (Dividend & Royalty) from Firm A’ in Country Y to Firm A in
Country X
• License/Franchising
– Technologies and Know-how from Firm A (Licensor) in Country X
to Firm B (Licensee) in Country Y
– Cash (License Fee) from Firm B (Licensee) in Country Y to Firm A
(Licensor) in Country X
8
 Payments across Countries involve
Foreign Currencies
– Country X (e.g. Japan) uses one currency (e.g. Yen)
– Country Y (e.g. Vietnam) uses another currency
(e.g. VND)

9
 Foreign Exchange
– How do firms exchange JPY with VND?
– Who handles the exchange ?
– What is the exchange rate?
– Why does it fluctuate (change)?
– Is the exchange rate fair?

10
 The FX (Foreign Exchange) Market

• Many (but not all) currencies are

“convertible” by using the FX market
– converting the currency of one country into
that of another country
– traders (bank dealers and FX brokers) buy
and sell through “interbank FX market” (i.e.,
computer network) on behalf of their
customers (firms and individuals)

• The Exchange Rate is the rate at which

one currency is converted into another
11
PROBLEMS: EXCHANGE RISK

12
 FX poses Risk to a Firm
– Import
• On 1 Sept a dealer in Hanoi ordered
JPY
10 Prius at JPY2M per car
2M
• On 1 Oct products delivered
• Sold all during the month of Oct
• On 1 Nov, payment due (JPY20M)
• How much should a retail price be?
– 1 Sept (VND200/¥) VND400m
– 1 Oct (VND210/¥) VND420m
– 1 Nov (VND220/¥) VND440m

13
VND ⇄ JPY

14
 Exchange Risk in
Trade from Japan to Vietnam
Price at D200/¥ D210/¥ D220/¥
Factory
Toyota JPY 2m VND VND VND
Prius 400m 420m 440m

Hyundai Thành Công

VND 420m

Same product,
Different Competitive Levels
15
 Exchange Risk
– Currencies go up and down

– Difficult to predict which ways to go

– Trading involves a long process

order shipment warehouse delivery payment

16
FX poses Risk to a Firm
• Risk
– Caused by factors
outside of a firm
– Difficult to anticipate and
control
– Managing FX Risks
including Insurance,
Hedging, Portfolio, etc

• JPY 1 up/down leads

to JPN 40 billion extra
profit/loss 17
 Same product, different prices
• A dealer exposed to FX risk – setting a
higher price may minimize the risk

But….
• Opportunity for someone else to trade at
lower prices

• Opportunity for rivals to increase share

18
WHY FLUCTUATE (GOES UP
AND DOWN)?
19
Why Fluctuate?
VND ⇄ JPY

20
 Exchange Rate – Fluctuate
(goes up and down)
– VND/JPY rate moves from D170/¥ to D220/¥
• JPY “appreciates” relative to VND
• VND “depreciates” relative to JPY

– VND/JPY rate moves from D220/¥ to D170/¥

• JPY “depreciates” relative to VND
• VND “appreciates” relative to JPY

21
 Why Fluctuate?
VND ⇄ JPY
Expensive
JPY!

JPY
Appreciates!
Cheap
JPY! VND
Depreciates!

22
 Why fluctuate?
Based on Supply & Demand

Price in
JPY

Amount of VND

23
Who sells and buys currency?

• Those who make payments in foreign currencies

– Business transaction: Exporter, importer, investor (both
FDI and indirect-portfolio, licensor, licensee, etc),
– Personal transaction: Traveler, international resident and
student, overseas friend and relative, international
indirect-portfolio investor
• Those who receive payments in foreign currencies
– Ditto
• Those who try to gain from foreign exchange
markets
– Currency Speculator

24
 Demand & Supply
• Current Account Balance (Export, Import, License)
• Long term “Law of One Price” & PPP (Purchasing
Power Parity)
• Financial Account Balance (FDI, Investment)
• Long term Returns, Future Growth Prospects & Risks
(of both firms and economies)
• Influenced by Price Inflation, Interest Rate, Country
Risk, Growth Potentials, Market Psychology, etc.

25
 The Law of One Price & PPP

– Assumption:
• Competitive markets, no transportation/transaction
costs, no barriers to trade
– The Law:
• Identical products sold in different countries must
sell for the same price when their price is
expressed in terms of the same currency
– Purchasing Power Parity:
• The price of a “basket of goods” should be roughly
equivalent in each country
• Example: Big Mac Index

26
CNN on National Difference in Price (2015/4/24)

https://youtu.be/gJXoEpiOlxs
27
 Summary

– Predictors of “long-run” (but not short-run)

changes in exchange rates
• Relative price level
• Relative monetary growth
• Relative inflation rates
• Interest rate differentials

– International businesses should pay attention

to them, even if they may not predict
tomorrow’s exchange rate
28
MONETARY SYSTEM

29
International Monetary System
– Current (since 1976):
• Floating Exchange Rate System
• Pegged Exchange Rate System

– Past (before 1971):

• Fixed Exchange Rate System

30
 Floating Exchange Rate System

• the foreign exchange market determines

the relative value of a currency
– Examples - the U.S. dollar, the European
Union’s euro, the Japanese yen, the British
pound, etc.

31
 Pegged Exchange Rate System

• The value of a currency is fixed to a

reference country (such as the US)
• The exchange rate between that currency
and other currencies is determined by the
reference currency exchange rate
– Example – Danish Krone (7.46/€), HK$
(7.75/US$)

32
 Fixed Exchange System

• Pegging currencies to gold (Gold Standard)

and guaranteeing convertibility
– Till 1971, one ounce of gold equivalent to US$35
– Gold as monetary “reserve” to guarantee the
value of currency
– Exchange rate between currencies was based
on the amount of a currency needed to purchase
one ounce of gold
• e.g. Value of Japanese Yen fixed at ¥360 per US$

33
 The Bretton Woods System
– Agreed in 1944 to develop the postwar
international monetary system
– The goal: to build a stable & sustainable
economic order for economic growth (and
avoid prewar catastrophe of unilateral policy)
• the US dollar – the only currency to be convertible
to gold, and other currencies would set their
exchange rates relative to the dollar (no
competitive devaluation)
– The Bretton Woods System comprising of
• The International Monetary Fund (IMF) to maintain
order in the international monetary system
• The World Bank to promote general economic
development 34
End of Bretton Woods System in 1971
(from fixed to floating exchange rate system)

35
 Why Bretton Woods Collapsed?
– The Bretton Woods system relied on a stable
value of US$ (i.e., well managed US economy)
– US economy during 1960’s:
• Huge increases in welfare programs and the Vietnam
War financed by increasing its money supply
• Growing trade deficit
• Inflation
– Speculation that the dollar would have to be
devalued relative to most other currencies
• Trigger: The oil crisis in 1971 – oil price (in $) went up
dramatically, forcing other countries to increase the
value of their currencies relative to the dollar 36
 The Jamaica Agreement (1976)

– At the IMF Jamaica meeting

• The IMF Agreement – revised to reflect the new
reality of floating exchange rates

– Under the Jamaican agreement

• floating rates were declared acceptable
• gold was abandoned as a reserve asset

– Today’s system still under the same agreement

37
 Today’s International Monetary System

• In reality, several different exchange rate

“regimes” running in parallel

– 14% of IMF members allow their currencies to

float freely (green)

– 64% of IMF members follow a managed/

pegged float system (blue, incl. China &
Vietnam)

– 22% of IMF members have no legal tender of

their own
38
 Free Managed/
Floating Others
Pegged

http://commons.wikimedia.org/wiki/File:Exchange_rate_arrangements_map.svg#mediaviewer/File:
Exchange_rate_arrangements_map.svg 39
STABILITY OF MONETARY
SYSTEM
40
 Three types of financial crises

1. Currency crisis – occurs when

• a speculative attack on the exchange value of a
currency
• results in a sharp depreciation in the value of the
currency, or
• forces authorities to expend large volumes of
international currency reserves, and
• to sharply increase interest rates in order to
defend prevailing exchange rates
[e.g. UK pound crisis (1992), Mexican Peso crisis (1995),
Thai Baht crisis (1997)]

41
2. Banking crisis – refers to a situation in which
• a loss of confidence in the banking system leads
to
• a run on the banks, as individuals and companies
withdraw their deposits
[e.g. Asian Crisis, 1997; Lehmann Shock 2008)]

3. Foreign debt crisis – a situation in which

• a country cannot service its foreign debt
obligations, whether private sector or government
debt
[(e.g. Mexican crisis (1995); Asian Crisis (1997);
Lehmann Shock (2008)]
42
 The Mexican Currency Crisis of 1995

• High Mexican debts under a pegged

exchange rate
– in order to keep Mexico from defaulting on its
debt, a $50 billion aid package was created
by the IMF
– By 1997, Mexico was well on the way to
recovery

43
 The Asian Crisis (1997) –
initially started as currency crisis
– Thai Baht under the pegged system
– Several Thai banks on the verge of default
– Foreign exchange dealers and hedge funds
started to speculate against the Thai baht,
selling it short
– After struggling to defend the peg, the Thai
government abandoned its defense and
announced that the baht would float freely
against the dollar

44
 The Asian Crisis (1997) –
spread to banking & foreign debt crises
– Thai Baht depreciated substantially…
triggering baking & foreign debt crises
– Thailand turned to the IMF for help
– Spread across Asia
• Speculation continued to affect other Asian
countries including Malaysia, Indonesia, Singapore
which all saw their currencies drop
• these devaluations were mainly a result of excess
investment, high borrowings, much of it in dollar
denominated debt, and a deteriorating balance of
payments position
• South Korea was the final country in the region to
fall
45
Is the Current System Stable?
Currency
crisis

Foreign Banking
debt crisis crisis
46
IMPLICATIONS FOR FIRMS

47
 Implications for Managers

The international monetary system affects

international business

1. Business strategy (longer term)

2. Currency management (both short and long

term)

48
 Business Strategy

• Exchange rate movements can have a

major impact on the competitive position of
businesses
– Foreign revenues may go up/down
– Foreign costs may go up/down
– Location of business may be affected
– Return on Investment may be affected

49
 Business Strategy

• Firms can protect themselves from the

uncertainty of exchange rate movements
over the longer term by:
– Hedging
– Managing location in portfolio
– Outsource manufacturing
– Other strategies…

50
 Currency Management

• Firms need to follow closely with exchange

risk
– Understand that the current exchange rate
system is a managed float – government
intervention and speculative activity influence
currency values
– Follow the markets
– Several financial mechanisms (e.g., forward
markets and swaps) help minimize exposure

51
 Schedule National
Characteristics

28 Aug Intro to IB #6 9 Sep Nat’l Difference #1: 6 - 8

- Globalization #1: 1/2/5 - Political/Legal #2
- Firms & IB (#10) - Economic #16
30 Aug Trade & FDI #1: 3/4 11 Sep Cultural Diff #5
#4 Case: McDonald #10
4 Sep Trade Theory #7 13 Sep Global Strategy #1: 11 – 14
Case: DDD #11 - Foundation
6 Sep Money 16 Sep Global Strategy #4
- Foreign Exch #1: 9/10 - Perspectives #1: 15 – 17
- Global Fin Case: Nike #12
Institutions Tbc Final Exam
9 Sep Mid-term
Strategy as
Firm Response
Framework for
Globalization 52
 See you on 9 Sept!

9 Sept Nat’l Difference #1: 6 - 8

- Political/Legal #2
- Economic #16

53