Chapter 6 ~~ Exchange rates and the international monetary system University College of isiamabad ff Prepared by eps Dr. Catalina Alliende for BMCG fi Chapter 6: Exchange rates and the international monetary system + 6.2 Markets for currencies. + 6.3 Implications for managers... + 6.4 Institutions of the international monetary system... 76 + 6.5 Managing exchange risks ~ implications for managers... ea Exchange rates and the international monetary system The aims of this chanter are to + expiain the factors that determine exchange 13 impact on the conduct of international busines + provide a history ofthe international monesa | and identify its role, importance end chali | + introduce the International Monetary Fund ( | its toes and performance + establish how a firm and its management ca to exchange rate risks in international business | et Exchange rates and the international monetary system ee] 6.2.2 Learning outeomess.ig z.nich affect Nee + describe the determinants of exchange rates sve" * track the development of the international monetary system + assess the role of the international Monetary Fund * identify the company’s possible management responses to dealing with currency exchange rate risks Exchange rates and the international monetary system 6.1.3 Essential reading + Peng, M. and K. Meyer International business. (London: Cengage Learning, 2011) Chapter 7 + Willcocks, L. Global business management foundations. (Stratford: Steve Brookes Publishing, 2013) Chapter 2, Sections 2.11. Exchange rates and the international monetary system 6.1.4 Synopsis of chapter content + International markets for currencies; issue around exchange rates; managerial impacts of exchange rate changes; the international monetary system and its institutions; managing exchange risk.. i simply a currency of one country into that of another country. * An exchange rate is the rate at which one currency is converted into another. + FEM helps 18 to deal with adverse consequences of unpredictable changes in exchange rates. University College of Islamabad Prepared by BMCG Foret er Catalina lend fo ras Bt 90.2 9 6.2 Markets for currencies Hedging + Aforward exchange occurs when two parties agree to ‘exchange currency and execute the deal at some specific date in the future using a forward exchange rate, + spot exchange rate is the rate at which a foreie exchange dealer converts one currency into anothe currency ona particular day. Hedging against + adverse exchange rate movernents is an ini (of an international company's financial stra «to pay a foreign compa! + for short term money to engage in curref SiS moved from one cure profit. wht peculation ency 10 3 6.2 Markets for currencies ne foreign exchange market located? work of banks, brokers and 's connected by electronic Where is t le ntres are London, New rket for currencies. dollar to facilitate the exchange uses.th 6.2 Markets for currencies What affects the supply and demand for 2 currency? + Relative price differences. Inflation and monetary supply. cad tem oe 6.2 Markets for currencies What affects the supply and demand fora currency? Interest rate er Fed reverse ~ weak + Forward exchange rates, the 3 Sertapame eines esate +. by market participants’the internat! nal 6.4 Institutions of monetary system Gold standard 1870-1944 + under which each currency was Ii ‘amount of gold. The US dollar, equal to 23.22 grains of fine gold. + The exchange rate between curt based on the gold par value, ort currency needed to purchase one oun + By the start of the Second World War in 1939, the old standard had been abandoned. for example, Was rrencies then Was University College ofsiamebad ff De Catalina Avende for BCG. FCaarssS)! 6.4 Institutions of the international monetary system IMF & Bretton Woods + The IMF using a combination of flexibility and discipline, was executing the main objectives of the Bretton Woods agreement, with the goal of avoiding the chaos that occurred during the time between the wars. stitutions of the internatio monetary system (1944-1973) tem agreement (1944-1 + the onl gold was the + Other cout ~ tothe dollar. + The international M designed t maintain o ary syste! . eae Bank was created tO promote ‘economic development 6.4 in change rates relative ind (IMF) was retary FU jones in the international der in th | 6.4 institutions of the international monetary system IMF & Bretton Woods + The fixed exchange rate system provides discipline in two ways + First, the need to maintain a fixed exchange rate limits competitive devaluations and brings stability to the world trade environment, 6.4 Institutions of the international monetary system +The fixed exchange rate system provides discipline in two “+ second, because the system imposes monetary discipline on ‘counties, inflation is mites. “+ The ME created a fund using contributions from members tthe ablity to lend foreign currencies to members short-term balance of payments 2 rapid tightening of monetary oF stu aa 4 Institutions of the international Monetary 8 IF Bretton Woods ee a etton Wo. oe when ecfete™ worked well until the ationany pa cOlepsed due to Ue elsewhere, and rising productivity + Bretton wi US nfiation rare ge + an6.4 Institutions of the international monetary system {64.1 The Post-Bretton Woods system — 1973 to the present Currencies float against each other Since 1973, exchange rates have become more volatile and less predictable for several reasons: the 2971 ol crisis the loss of confidencein the dollar that came after the US inflation rate spiked in 1877-78, the 1979 oil crisis that doubled the rice of ol, the ‘unanticipated rise in the dolar between 1980 and 1985, the partial collapse of the European Monetary System in 1952, {and the 1997 Asian currency crisis that saw various Asian Currencies lose between 50 and 80 per cent oftheir value. 6.4.1 The Post-Bretton Woods system ~ 1973 to the present Currencies float against each other. Since 1973 countries can choose between four major exchange rate policies: * 1 Floating exchange rate Policy + 2 Pegged exchange rate policy + 3 Fixed rate policy * 4Common currency policy Bniversity College of isiamabad _fN Prepared by Dr Catalina Altende for BMce TQ. m 4 6.4.1 The Post-Bretton Woods system — 1973 to the present Floating exchange rate policy * This policy allows demand and sup conditions to determine exchan; * Afree float is a pure market solutic * A managed float whereby exchange influenced by selective government intervention.(Pakistan) 6.4.1 The Post-Bretton Woods system — 1973 to the present ented exchange rate policy sOuntry's exchange rate to that of another county's lms fuctations within a warow band relate tothe other fchange rate regmes t oliy sees to stabilise import and export pices — ith ih ination see aavarages im peggng Say, tne US colar or eur, waren washeetaly 'sanybna offtmes ana floating * Danish krone is pegged to the euro 6.4.1 The Post-Bretton Woods system ~ 1973 to the present Fede. + Sef of eure ware ees * maneary discon requred ars xnugs tee estat Eovernmentwilret soar money nhs tose * pean tt ozs wih fosrg exe rterpmerey ecanecy cate 2 + Fetsampanis ths uncerainy mute lnnng mae clepn than would be thaert eeabe nese mie B De hs mentary way ses ee an cos may oegn sary aa es ngewe by er + Wena county ado cane burs commis convrin domestic Pacer tothe Seder ke ie aa oar " 6.4.1 The Post-Bretton Woods system — 1973 to the present ‘Common currency policy * Here a country gives up its monetary policy and relies on another country or common central ‘bank to manage inflation and exchange rate. * CFA franc shared by 14 West African countries Use the CFA franc which is fixed to the euro, * Euro shared by 16 countries (in 2010) and Controlled by the European Central Bank in Frankfurt,6.4.1 The Post-Bretton Woods system — 1973 to the present + Activity EURO Quiz 1 in 2014 how many countries use the Euro? 2 Name the latest country to use the Euro? 3 Which EU country does not use the Euro? 4 How do we represent the Euro? 5 On what date did the Euro become the common currency of Europe? 6.4.4 The Post-Bretton Woods system "4973 to the present EURO Quit Pt in 2014 how many € + 2 Name the latest cOUnRTY nia #sanuary 2035 : ae intry does not use the Euro? countries use the Euro? 18 10 use the Euro? ‘3 Which Important EU cour the UK + How do we represet sign: € code: EUR + Sn what date cid the currency of Eurore. ‘January 1998 int the Euro? Euro become the common Unis Dr. Cataiine. a>} nde for BCG 6.4.1 The Post-Bretton Woods system — 1973 to the present he Post-Bretton Woods system o the present + acareng inact wn ts teary eae faery et oe Scans teen cere: Serene eee aces en oto mente Taal 3997 Asin is rutoninwensinsoontencr nine ‘a pie Ong COD iceland s second ergest bank, atc, uno ve a cna ects. fermen Harare canyantennenncomeeanrene ent beers Merpentinian default on debt DaYEENS Read on: + 1995 Crisis in Mexico + 1997 Asian Financial crisis + 2008/09 financial crisis + 2010 Greek government debt‘omoaron of exchange aie acy &¢ 6.4.2 Crises and the role of the IMF Fseee? Toate Teena IM nut oun countries an eran Sa ae aman [Rae re an + oe sem aceon soley ah nee cy eeterremnt ier ee + nnant + onesie apreneh to maroeconome sey ome nea + SAMetsiaeraerees ene [Seve emeeeemen jlomare ae toreete Jecrrte re rat ear + iar been exceoningmorinana wen cer whe people Smears oie eee Senne retesny sense ney now nevi seraea thee foe eee + tet poser asl et counes may net suv mar tne bar ee Keene brs ile nv wie oman im crea ermine " loncomosmes dun tne sabts'uncs ney soeab shoals na | woven me peuree | + Fes too mecnbower natn te county feoree rie | IE oe Serer Se, 5 University College ofisiamatad f= { Prepared by \ Dr Catalina Aliende for BCG TO 2 erated 5 Managing exchange risks — implications ee for managers | [Fee |*Central paras have to | "can cope with speculauo Exchange intervene to guarantee | nes o bring dow [OCS See mate exenange rte inflation Table 16 Manapeg Exchange Fe is | Economic coliapse and |* Revaluation ofc Jdefautt when expor: reduce ana soir |stong ana currency | Ipoard needs to vorrow Loins to Fx. ee 6.5 Managing exchange risks - 6.5 Managing exchange risks - implications for managers | implications for managers «stm tste lnc tng ses Sie, IB Strategies for Reducing Rate Exchange risks reece Gan St eae rics: An additional response is to use financial than expand ts Uk operation markets to offset currency risk. Eureneywas eee uh se carers So eo, n h ly used Fartol he proausion ons occured aly ance tse ese io approaches are frequently use ‘eros, thus recucngexcange ate exposure + Currency hedging + Rislversfcation, vos reducing rk exoture by workin : i numbers ieren: arences Acasnt anthro ese Currency Swap Some regions ana currencies by gis moter repons ane currencies,ge risks — "6.5 Managing exchan 6. B! nagers implications for ma iene os a tions that e indertaking transa Ts races fom x08 the fluctuations of the currency spot rate- + However, there are no guarantees, because essentially you are betting on the current xchange rate and possible fluctuations in future ‘exchange rates, and making decisions that you think will be optimal. University College of isiamabad Prepared by 6.5 Managing exchange risks ~ implications for manage «the primar parteipats of the currency exchange market ae large imernaonalvank hat race smong thems: «+ Theymate money by sading mene. Tey 20th By. tienes beoreen the oe rte ihe pice fo el fine pce to buy, wth te dference or profit) between ie se ner approach beng cles the Sorex. cde trectroieracing ens ver fast hae vue baying 2rd SSSsons that can mata enormous pois on thins + Formanage's understanding te international con Feponnt lorcurencymanseemen, busines st (iporate- government reations «+ Ganks voiedin Currency manipultion fined in 1/320 fecord fines fr eurency market fix Rapido com/news/ business 32617214 6.5 Mana implicat! curren vurrency exchange transaction ney Or rency scone voonert eal in Time 1, with an agt mn arr! anya eR TINE? he future. This is 3 ¢ Dr Catalina Aliende for BCG Kegs 2 oes NY 6.5 Managing exchange risks ~ s for manage of currencies can create 2 need to protect tnemselves mplica ‘an be hedged through the to maintain strategic conomic exposure 7, for example, many companies faced the challenge of ealing with a weak US dollar. Some foreign suppliers decides that, rather than risk trying to pass the effects of the declining dollar on to consumers in the form of higher prices, te¥ would simply accept a smalier profit margin instead. 6.5 Managing exchange risks ~ implications for manage + Companies need to keep in mind that they can influence a government's policy towards the international monetary system. _*Exporters in the USA, for example, have sometimes lobbied for devaluations in the dollar to make exports more attractive in foreign markets, 6.5 Managing exchange risks — implications for manage ‘ction for managers Companies must realise nea ealise that the foreign system thats currentyin pace lea red syaten where government i Iahenes SeNment intervention and speculation can Risk analysis of, carrera rol anY Country must include an analysis Of incase Canon Regge hate paessary M2 ee