MODULE TEMPLATE

1. Title of module: International Monetary System

2. Introduction:

Over the years, numerous foreign financial markets have been established
because of the rise in international business. MNC financial managers need to
consider the numerous available international financial markets so that they can use
those markets to facilitate their international business transactions.

3. Learning Outcome/Objective
At the end of the unit, the students are expected to:
 describe the background and corporate use of the following international
financial markets:
 Foreign exchange markets,
 International money markets,
 International credit markets and
 International stock markets;
 describe the history of foreign exchange;
 explain foreign exchange transactions;
 describe the attributes of banks that provide foreign exchange;
 determine factors that affect the spread;
 determine and explain the important components of money market;
 describe how stock market varies ; and
 explain how financial market facilitates MNC functions.
4. Learning Content/Topic
Unit 3: International Monetary System
 Foreign Exchange Market
 History of Foreign Exchange
 Foreign Exchange Transactions
 Attributes of banks that provide foreign exchange
 Foreign exchange quotations and factors that affect the spread
 International money market
 Two important components of money market
  International credit market
 International stock market
 How stock market characteristics vary among countries
 How financial market facilitate MNC functions

Foreign Exchange Market

The foreign-exchange market allows one currency to be exchanged for
another. Large commercial banks support this demand by keeping individual
currency inventories in order to satisfy customer or MNC demands. As individuals fly
to foreign countries, they depend on the foreign-exchange market. Citizens from the
Philippines, when they visit Mexico, trade their pesos for Mexican pesos, or euros
when they visit Italy.
In order for one currency to be exchanged for another currency, an exchange
rate must be set which specifies the rate at which one currency can be exchanged
for another. The Philippine peso's exchange rate would calculate how much dollars
you need to stay in a US hotel that costs $100 per night. The Philippine peso's
exchange rate would also determine how many dollars an MNC will need to buy
deliveries invoiced at 1 million pesos.

History of Foreign Exchange

The mechanism used for foreign currency trade has developed from the gold
standard, to a fixed exchange rate arrangement, to a floating rate regime.

Gold Standard. From 1876 to 1913, exchange rates were dictated by the
gold standard. Each currency was convertible into gold at a defined rate and its
relative convertibility levels per ounce of gold determined the exchange rate between
two currencies. Each nation was using gold to back up its currency.

The Gold Standard was suspended after World War I began in 1914. Some
countries returned to the gold standard in the 1920s but abandoned it during the
Great Depression as a result of a financial crisis in the USA and Europe. Some
countries tried to peg their currency to the British pound dollar in the 1930s but there
were regular revisions. The amount of international trade decreased as a result of
the foreign-exchange market volatility and severe restrictions on international
transactions during this time.

Agreements on Fixed Exchange Rates. In 1944 an international agreement,

called the Bretton Woods Agreement, provided for fixed currency exchange rates.
The agreement lasted until 1971. Governments should intervene during this time to
prevent exchange rates from rising above or below their initially set levels by more
than 1 per cent.
By 1971, the US dollar seemed to have been overvalued; international
demand for US dollars was considerably lower than dollar supply for sale. Major-
nation leaders met to resolve this issue. As a result of this conference which led to
the Smithsonian Agreement, the US dollar was devalued in comparison with the
other major currencies. The degree to which each foreign currency devalued the
dollar varied. Not only was the value reset of the dollar, but exchange rates were
also authorized to fluctuate from the newly defined rates by 2.25 per cent in either
direction. This has been the first step in letting market forces decide a currency's
acceptable price. While exchange-rate thresholds still existed, they were widened
allowing the currency values to move freely to their correct rates.

Floating Exchange Rate System. Governments still struggled to maintain

exchange rates within the stated limits even after the Smithsonian Agreement By
March 1973, market forces allowed the more commonly traded currencies to
fluctuate and the official borders were abolished.

Foreign Exchange Transactions

The "foreign exchange market" should not be seen as a single building or
location where traders exchange currencies. Organizations usually exchange one
currency through a telephone network, via a commercial bank.

Spot Market. The most common type of foreign exchange transaction is the
so-called spot-rate for immediate exchange. The market in which such transactions
take place is known as the spot market. Banks around the world currently surpass
$1.5 trillion in total daily foreign-exchange trade. In the United States alone the total
daily foreign exchange trade reaches 200 billion dollars.
 Spot Market Structure. Thousands of banks facilitate foreign exchange
trades, but about 50 percent of the trades are conducted by top 20. Citibank (a
subsidiary of Citigroup), Deutsche Bank (Germany), and J.P. Morgan Stanley are
the top foreign-exchange dealers. Some banks and other financial institutions form
alliances to deliver online currency transactions.

Banks facilitate foreign-exchange transactions between MNCs in virtually

every major city. Commercial transactions between countries frequently take place
electronically, and the exchange rate at the time defines the amount of funds needed
for the transaction.

Spot Market Time Zones. While foreign exchange trading is done at a given
location only during regular business hours, due to different time zones these hours
vary between locations. While a bank is open and able to satisfy foreign exchange
requests at any given time on a weekday, anywhere in the world.

Foreign currency transactions are arranged on computer terminals with the

newest electronic equipment, and the exchange is verified by a click of a button.
Traders now use electronic trading boards which allow them to register transactions
instantly and check the positions of their bank in different currencies. Largest banks
and even some medium-sized banks are now offering night trading to capitalize on
foreign exchange movements at night and to accommodate corporate requests for
currency trading.
Spot Market Liquidity. The spot market can be represented for each currency
by its liquidity which reflects the level of trading activity. The more willing buyers and
sellers there are, the more competitive a market is. There are very liquid cash
markets for widely traded currencies such as the euro, the British pound and the
Japanese yen. In contrast, the spot markets for less developed countries '
currencies are less liquid. Liquidity of a currency affects the case where that
currency may be obtained or sold by an MNC. If a currency is illiquid, the number of
willing buyers and sellers is small and an MNC may not be able to buy or sell the
currency quickly at a fair exchange rate.
Attributes of Banks That Provide Foreign Exchange. The following
characteristics of banks are important to customers in need of foreign exchange:
1. Competitiveness of quote. A savings of 1 cent. per unit on an order of
one million units of currency is worth 10,000. dollar.
2. Special relationship with the bank. The bank may provide cash
management services or may be able to make a special effort for the
company to acquire even hard-to - find foreign currencies.
3. Speed of execution. Banks can vary in the efficiency they handle an order
with. A company that needs the currency would choose a bank that carries
out the trade efficiently and manages any paperwork correctly.
4. Advice about current market conditions. Some banks can provide
assessments of foreign economies and related international financial
activities relating to corporate clients.
5. Forecasting advice. Some banks may provide forecasts of the future state
of foreign economies and the future value of exchange rates.

Foreign Exchange Quotations

Spot Market Interaction among Banks. The exchange rate between two
currencies should be similar across the different banks which provide foreign
exchange services at any given point in time. If there is a significant difference,
clients or other banks can buy huge quantities of a currency from whatever bank
quotes a relatively low price and sell it to whatever bank quotes a relatively high
price immediately. These actions trigger exchange rate quotation adjustments which
remove any discrepancy.

Bid/Ask Spread of Banks. Commercial banks charge foreign-exchange

transaction fees. A bid (buy) quote from a bank for a foreign currency would be less
than its offer (sell) quote at any given point in time. The spread of bid / ask reflects
the discrepancy between bid and request quotes, which is intended to offset the
costs involved in handling foreign currency requests. Normally, the bid / ask spread
is expressed as a percentage of the quote asking.
Illustrative problem:
Assume you have $1,000 and plan to travel from the United States to the
United Kingdom. Assume further that the bank’s bid rate for the British pound is
$1.52 and its ask rate is $1.60. before leaving on your trip, you go to this bank to
exchange dollars for pounds. Your $1,000 will be converted to 625 pounds.

Amount of US dollars to be converted = $1,000 = 625 pounds

Price charged by bank per pound $1.60

Further, suppose that because of an emergency you cannot take the trip, and
you reconvert the 625 pounds back to dollars, just after purchasing the pounds. If
the exchange rate has not changed, you will receive

625 pounds X $1.52 (bank’s bid) = $950

Due to the bid/ask spread, you have $50 or 5% less than what you started
with. Obviously, the dollar amount of less would be larger if you originally converted
more than $1,000 into pounds.

Comparison of Bid/Ask Spread among Currencies. The differential between a

bid quote and an ask quote will look much smaller for currencies that have a smaller
value. This differential can be standardized by measuring it as a percentage of the
currency’s spot rate.

A common way to compute the bid/ask spread in percentage terms follows:

Bid/ask spread = Ask rate - Bid rate
Ask rate
= $1.60 - $1.52
$1.60

= .05 or 5%
Factors That Affect the Spread. The spread on currency quotations is influenced
by the following factors:
 Order costs. These include the costs for processing orders, i.e. clearing costs
and costs of recording the transactions.
  Inventory costs. These refer to the costs of keeping a specific currency
inventory. Maintaining an inventory entails an opportunity costs because the
currency inventory being held could have been used for some other purpose.
The opportunity cost of holding an inventory should be relatively high if the
interest rates are relatively high. The higher the cost of inventories, the
greater the amount of spread that will be established to cover costs.
 Competition. If there will be more competition, there will be smaller spread to
be quoted by intermediaries. Competition for the more commonly traded
currencies is more serious, as there is more firm in those currencies.
 Volume. The more liquid the currencies are they are less likely to experience
change in price abruptly. Further, currencies that are trading in a large
volume are said to be more liquid because at any given time, there are large
numbers of buyers and sellers. This means that the market has sufficient
depth that a few large transactions are unlikely to cause the currency’s price
to change abruptly.
 Currency risk. Most currencies exhibit more volatility than others due to
economic or political conditions which cause abrupt change in currency
demand and supply.

International Money Market

Local companies in most countries typically have to borrow short-term funds
to finance their operations. In order to finance budget deficits, country governments
be likely to borrow short-term funds. Through short-term deposits at commercial
banks, Individuals or local institutional investors in those countries can provide
funds. Likewise, issuance of short-term securities by corporations and governments
to be purchased by local investors is one way. In each region, therefore, a domestic
money market serves to move short-term funds denominated in local currency from
local surplus units (saves) to local deficit units (borrowers).

Growth in foreign business has led a specific country's companies or

governments to require short-term funds denominated in a currency other than their
home currency. First, they may need to borrow funds to pay for imports
denominated in a foreign currency. Second, they can consider borrowing in a
currency in which the interest rate is lower, even though they need funds to finance
local operations. This strategy is particularly desirable if the corporations in the
future will have receivables denominated in that currency. Third, they might
consider borrowing in a currency that would depreciate against their home currency,
as they could repay the loan over time at a more favorable exchange rate. Therefore
the real borrowing expense will be less than the currency's interest rate.

Meanwhile, there are some corporations and institutional investors that have
no motives to invest in a foreign currency rather than their home currency. Primarily,
they could earn higher interest rate on short-term investments denominated in other
currencies than what they could earn from investments in their home currency.
Secondly, investments in a currency that appreciates against the home currency
would be able to give them favourable exchange rate when they matures. Thus, the
actual return on their investment would be higher than the quoted interest rate on
that foreign currency.

The corporate and government intentions to borrow in foreign currencies and

investors to make short-term foreign currency investments culminated in the
development of the international money market.

Origins and Development. In countries around the world, the international

money market involves major banks. The European money market and the Asian
money market are also two significant elements of the foreign money market.

European Money Market.

The European money market's roots can be traced back to the Eurocurrency
market that evolved during the 1960s and 1970s. The emerging of international
financial intermediation intends to accommodate the needs of MNCs’ expansion of
operations during that time. Since the US dollar was widely used as a medium for
international trade including by foreign countries, dollars were needed consistently in
Europe and elsewhere. Corporations in the United States deposited US dollars into
European banks to facilitate international trade with European countries. The banks
are likely to accept dollar deposits because they could lend the dollars to European-
based corporate clients. These dollar deposits also came to be known as
Eurodollars in banks in Europe and on other continents, and the Eurodollar market
came to be known as the Eurocurrency market.

Eurocurrency demand growth has been driven by reform measures in the US.
Likewise, the increasing importance of the Organization of Petroleum Exporting
Countries (OPEC) has also contributed to Eurocurrency market growth. Since
OPEC generally requires payment in dollars for oil, OPEC countries have started
using the Eurocurrency market to deposit a portion of their oil revenues. Such
investments, denominated in dollars, are also called petrodollars. In certain
situations, oil revenues deposited in banks is lent to oil-importing countries that are
short of cash. When these countries purchase more oil, the funds are again
transferred to the oil-exporting countries, generating new reserves in exchange.
This recycling process has been an important source of funding for some countries.
Today, since many other international financial markets have been created,
the word Eurocurrency market isn't used as much as in the past. However, the
European money market is still an important part of the international money market
network.

Asian Money Market.

Unlike the European money market, the Asian money market emerged as a
market that included deposits mainly denominated in dollars. This was also initially
recognized as the market for the Asian Dollar. The market emerged to meet the
needs of companies that used the US dollar (and some other foreign currencies) as
a tool for international trade exchange. Because of the distance and various time
zones these companies do not rely on banks in Europe. As it is now known, the
Asian money market today is based in Hong Kong and Singapore, where major
banks accept deposits and make loans in various foreign currencies.
MNCs with surplus cash and government entities are the principal sources of
deposits on the Asian money market. In this market, manufacturers are the big
borrowers. Interbank lending and borrowing are another function. Banks use the
interbank market in obtaining additional funds to accommodate more qualified loan
applicants they can barely serve. Banks usually borrow from or lend to banks in the
Eurpoean market on the Asian money market.
 Money Market Interest Rates Among Countries. The rates of the money
market differ significantly for certain currencies. This is due to differences in the
interaction of total supply of available short-term funds (bank deposits) in a particular
country versus total demand by borrowers in that country for short-term funding.
When there's a significant savings supply compared to the demand for short-term
funds, the country's interest rate would be fairly weak. By contrast, if there is a
strong demand for borrowing a currency, and a low savings supply in that currency,
the interest rate will be relatively high. Interest levels are usually higher in developing
countries than those in other nations.

Standardizing Global Bank Regulations. Regulations have led to the growth

of the international money market as they have placed limitations on some local
markets, thus allowing domestic investors and lenders to bypass local market
limitations. Regulations differ from one country to another and these differences in
regulations among countries allowed banks in some countries to have comparative
advantages over banks in other countries. Overtime, international banking rules
have become more streamlined, making global banking more efficient. Three of the
more significant regulatory events allowing for a more competitive global playing
field are (1) the Single European Act, (2) the Basel Accord, and (3) the Basel II
Accord.

Single European Act. One of the most important developments concerning

international banking was the Single European Act, which was implemented by 1992
in the European Union ( EU ) countries. The following are some of the more
relevant provisions of this act for the banking industry:
 Capital can flow freely throughout Europe.
 Banks can offer a wide variety of lending, leasing, and securities activities
in the EU.
 Regulations regarding competition, mergers, and taxes are similar
throughout the EU.
 A bank established in any one of the EU countries has the right to expand
into any or all of the other EU countries.
 As a result of this act, banks have been expanding across European
countries. European banking markets efficiency has increased for the very reason
that banks cross countries more easily than before without thinking about country-
specific regulations that have existed in the past.
Another main provision of the act is that the same banking powers are
granted to banks entering Europe as to other banks there. Specific rules extend to
non-US banks coming into the U.S.

Basel Accord. Prior to 1987, the capital requirements levied on banks

differed across countries, enabling some banks to have a competitive global
advantage over others. 12 major developed countries sought to overcome the
difference by introducing universal banking requirements in December 1987. In July
1988, the central bank governors of the 12 countries agreed on common guidelines,
known as the Basel Agreement. Depending on these requirements, banks must
retain equity of at least four percent of their assets. To this end, the assets of banks
are weighted by the risk. This ultimately results in a higher capital ratio required for
riskier assets. Off-balance sheet items are often accounted for so that banks cannot
avoid capital requirements by relying on activities that are not specifically displayed
as assets on a balance sheet.

Basel II Accord. Banking regulations that form the Basel Committee are
finalizing a new agreement to fix some of the contradictions that still remain. The
Basel II accord aims to take account of these gaps between banks. In addition, this
agreement must take into account the operational risk identified by the Basel
Committee as the risk of losses arising from insufficient or ineffective foreign
processes or systems. The Basel Committee aims to enable banks to develop their
strategies for managing operating risks, which could reduce failures in the banking
system. The Basel Committee also aims to allow banks to provide current and
prospective shareholders with more detail on their exposure to various types of risk.

International Credit Market

Multinational corporations and domestic firms often issue notes (medium-term
debt obligations) in the local markets or avail term loans from local institutions to
obtain medium-term funds. Nevertheless, MNCs do have access to medium-term
funds through banks based on foreign markets. Loans of one year or more
extended by banks to MNCs or government entities in Eutope are commonly
referred to as Eurocredit loans. These are loans issued on the so-called Eurocredit
market. Loans may be denominated in dollars or in some other currency and may
have a term of five years.

Since banks take short-term deposits and often offer longer-term loans, their
assets and liabilities do not match their maturity. It may adversely affect the
profitability of a bank during times of growing interest rates, as the bank may have
locked in its longer-term lending rate, whilst the rate it charges for short-term
deposits is growing over time. Banks typically use floating rate loans to avoid this
risk. The loan rate is floating in accordance with the movements of the interest rates
in the markets.
The foreign credit market in Asia is well developed and is expanding in South
America. Periodically, certain areas are affected by an economic crisis that raises
credit risk. Financial institutions continue to reduce their presence in these markets
when credit risk rises. Hence, funding then becomes widely available in many
markets however, funds tend to move toward the markets with strong economic
conditions and with tolerable credit risk.

Syndicated Loans. Often a single bank is unwilling or unable to lend the sum
requested by a specific company or government agency. A syndicate of banks may
be coordinated in this situation. Each bank in the syndicate participates in the
lending process. Negotiation with the borrower of the terms the loans is the
responsibility of the lead bank. Afterwhich, a group of banks to underwrite the loans
will be organized by the lead bank. It usually takes about 6 weeks to form the
syndicate of banks or it could be lesser if the borrower is well known because credit
assessment can be carried out quickly.
Borrowers seeking a syndicated loan pay different fees in addition to the
interest on the loan. Front-end management fees shall be paid to cover the cost of
organizing the syndicate and subscribing the loan. In addition, the investment fee of
approximately.25 or.50 per cent is paid annually on the unpaid portion of the
available credit provided by the syndicate.
 In a number of currencies syndicated loans can be denominated. The basis
In determining the interest rate of the loan (1.) currency of the loan, (2.) the maturity
of the loan, and (3.) the creditworthiness of the borrower. Further, interest rates on
syndicated loans are typically adjustable on the basis of interbank lending
movements, and changes may be made every 6 months or every year.
In addition to reducing the default risk of a large loan to the degree of
participation for each individual bank, syndicated loans can also add an additional
incentive for the borrower to pay back the loan. When a government defaults on a
syndicated loan, most likely word will rapidly spread among the different banks, and
consequently, government will find it difficult to secure loans in the future. For the
borrowers should promptly repay the syndicated loans. Form the point of view of
banks, syndicated loans are more likely to repaid promptly.
International Stock Markets
MNCs and domestic firms generally get long-term funding through local stock
issuance. Nevertheless, MNCs can also raise funds from foreign investors through
the issuance of stocks on international markets. Once released in many countries,
the stock offering can be more easily digested. Moreover, issuing stock in a foreign
country may boost the image and name recognition of the firm there.
Issuance of Stock in Foreign Markets. As a way of improving firm’s global
image, some firms recourse to issuing of stocks to foreign markets. The emergence
of various markets for new issues offers an option for equity-needing companies.
This competition among various new-issues markets should increase the efficiency
of new issues.
The locations of the operations of an MNC will affect the decision as to where
to position its stock, because the MNC may want a country where it is likely to
produce sufficient future cash flows to cover dividend payments. Several MNC's
securities are commonly traded on various stock exchanges worldwide.
The stocks of the MNCs need to be listed on an exchange in the country
where the issuance of stocks takes place. Investors from foreign countries are most
likely to consider purchase of stocks if their holdings can be easily sold in the
secondary market locally. Stocks denomination depends on the country of issuance.

How Stock Market Characteristics Vary Among Countries

 First, legal and other characteristics of the country have impact on the trading
activity degree in each stock market. Shareholders in some countries have more
rights than in other countries. For example, in some countries, shareholders have
more voting power than others. They may have an impact on a wider range of
management issues in some countries.
Second, countries extend legal protection to shareholders which significantly
varies from one country to another. In the event that executives or directors commit
financial fraud shareholders in some countries exercise more power to sue firms that
are publicly traded. In general, the countries of common law provide more legal
protection than the countries of civil law.
Third, the enforcement of securities laws by the government varies across
countries. Sometimes shareholders are not protected because laws to protect them
are not being enforced although laws exist.
Fourth, corporate corruption tends to be lesser in some countries than the
other. Thus, shareholders are better off protected from major losses brought by
agency problems like for instance managers use the money of shareholder to enrich
themselves.
Fifthly, the level of financial information that public companies need to provide
varies from country to country. Accounting laws for public companies or reporting
rules prescribed by local stock exchange are some of the reasons for the variation.
Shareholders are most likely to be protected from losses due to lack of information if
transparent financial reporting will be required from the public companies.
Generally speaking, investors are more attracted and willing to invest in
stocks if stock markets permits shareholders to have more voting rights, more legal
protection, more enforcement of the laws, less corruption, and more stringent
accounting requirements. It allows for greater stock market trust and a higher price
efficiency. Furthermore, businesses are drawn to the stock market when there are a
lot of buyers because under these circumstances they can quickly collect funds in
the market. On the contrary, companies that need funding will not be attracted if
stock markets fail to attract investors.

How Financial Markets Facilitate MNC Functions

There are four classification of corporate functions of the cash flow
movements of a typical MNC where all are required to use foreign exchange
markets. The spot market, forward market, currency features market, and currency
options market are all classified as foreign exchange markets.

The first function is foreign trade with business clients. Foreign cash inflows
are generated through exports while cash outflows requires imports. A second
function is direct foreign investment, or the acquisition of foreign real assets. This
function entails cash outflows, but will produce future inflows by remitting earnings to
the MNC parent or selling those foreign assets. A third function is short-term
investment or financing in foreign securities. As fourth function is longer-term
financing in the international bond or stock markets. A parent of MNCs may use
foreign money or bond markets to get funds at a lower cost than can be raised
locally.

5. Teaching and Learning Activities

Teaching and learning activities shall be made by the subject instructor by
lecture method or assigned readings thru the use of this module with the aid of
learning materials from youtube, articles and published researches lifted from google
and google scholar related to the subject for discussion. Messenger, video calls
shall be utilized from time to time to raise questions or clarifications about the topics
whenever necessary. When circumstances permit, learners may have individual or
group activities to allow them to collaborate with other peer learners.

6. Recommended learning materials and resources for supplementary reading.

For further readings:
International Financial Management. 13 th edition
www.slideshare,net
7. Flexible Teaching Learning Modality (FTLM) adapted
For students who will have the chance to participate online:

Online (synchronous)

 google classroom

 messenger ( thru group chat)

  facebook video call

 text messages ( for additional announcements)

 electronic mail

For those who do not have internet connections:

Remote (asynchronous)

 module, case study, exercises, problems sets, etc

 text messages

 submission thru identified drop boxes located at the

school guard house or barangay halls

8. Assessment Task
Recitation

Quiz

Essay

Motives for Investing in Foreign Money Markets.

1. Explain why an MNC may invest funds in a financial market outside its own
country.

2. Explain why some financial institutions prefer to provide credit in financial

markets outside their own country.

3. Utah Bank’s bid price for Canadian dollars is $.7938 and its ask price is
$.81. What is the bid/ask percentage spread?

4. Compute the bid/ask percentage spread for Mexican peso retail

transactions in which the ask rate is $.11 and the bid rate is $.10.

5. Explain how syndicated loans are used in international markets.

6. You just came back from Canada, where the Canadian dollar was worth
$.70. You still have C$200 from your trip and could exchange them for dollars at the
airport, but the airport foreign exchange desk will only buy them for $.60. Next week,
you will be going to Mexico and will need pesos. The airport foreign exchange desk
will sell you pesos for $.10 per peso. You met a tourist at the airport who is from
Mexico and is on his way to Canada. He is willing to buy your C$200 for 1,300
pesos. Should you accept the offer or cash the Canadian dollars in at the airport?
Explain.

Case study for online presentation:

As a financial analyst for Blades, Inc., you are reasonably satisfied with Blades’
current setup of exporting “Speedos” (roller blades) to Thailand. Due to the unique
arrangement with Blades’ primary customer in Thailand, forecasting the revenue to
be generated there is a relatively easy task. Specifically, your customer has agreed
to purchase 180,000 pairs of Speedos annually, for a period of 3 years, at a price of
THB4,594 (THB Thai baht) per pair. The current direct quotation of the dollar-baht
exchange rate is $0.024. The cost of goods sold incurred in Thailand (due to imports
of the rubber and plastic components from Thailand) runs at approximately
THB2,871 per pair of Speedos, but Blades currently only imports materials sufficient
to manufacture about 72,000 pairs of Speedos. Blades’ primary reasons for using a
Thai supplier are the high quality of the components and the low cost, which has
been facilitated by a continuing depreciation of the Thai baht against the U.S. dollar.
If the dollar cost of buying components becomes more expensive in Thailand than in
the United States, Blades is contemplating providing its U.S. supplier with the
additional business. Your plan is quite simple; Blades is currently using its Thai-
denominated revenues to cover the cost of goods sold incurred there. During the last
year, excess revenue was converted to U.S. dollars at the prevailing exchange rate.
Although your cost of goods sold is not fixed contractually as the Thai revenues are,
you expect them to remain relatively constant in the near future. Consequently, the
baht-denominated cash inflows are fairly predictable each year because the Thai
customer has committed to the purchase of 180,000 pairs of Speedos at a fixed
price. The excess dollar revenue resulting from the conversion of baht is used either
to support the U.S. production of Speedos if needed or to invest in the United States.
Specifically, the revenues are used to cover cost of goods sold in the U.S.
manufacturing plant, located in Omaha, Nebraska. Ben Holt, Blades’ CFO, notices
that Thailand’s interest rates are approximately 15 percent (versus 8 percent in the
United States). You interpret the high interest rates in Thailand as an indication of
the uncertainty resulting from Thailand’s unstable economy. Holt asks you to assess
the feasibility of investing Blades’ excess funds from Thailand operations in Thailand
at an interest rate of 15 percent. After you express your opposition to his plan, Holt
asks you to detail the reasons in a detailed report.

1. One point of concern for you is that there is a tradeoff between the higher
interest rates in Thailand and the delayed conversion of baht into dollars. Explain
what this means.

2. If the net baht received from the Thailand operation are invested in Thailand,
how will U.S. operations be affected? (Assume that Blades is currently paying 10
percent on dollars borrowed and needs more financing for its firm.)

9. References
Online references:
https://content.personalfinancelab.com
https://www.academia.edu
https://poseidon01.ssrn.com
https://talentedge.com

ebook:
Jeff Madura. (2018) International Financial Management. Cengage
Learning, ISBN 978-1-337-26996-4 (13th edition).
http://www.cengagebrain.co.nz/shop/isbn/978-1-337-26996-4