Global Business 4th Edition Mike Peng Solutions Manual Download

Solution Manual for Global Business 4th Edition
by Mike Peng ISBN 130550089X

9781305500891
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CHAPTER 7
DEALING WITH FOREIGN EXCHANGE
LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1. understand the determinants of foreign exchange rates.
2. track the evolution of the international monetary system.
3. identify firms’ strategic responses to deal with foreign exchange movements.
4. participate in three leading debates concerning foreign exchange movements.
5. draw implications for action.
GENERAL TEACHING SUGGESTIONS

One way to help students understand the foreign exchange market is to relate it to an auction
market. This might help to develop a simulated experience and relate that experience to the
currency market. Pick a charity that most students would likely support if they could. Inform the
students that the charity is auctioning a valuable item to earn operating funds. Offer a small unit
of extra credit to the successful bidder. It is possible that not all will bid and the amounts that are
bid will vary – ask why. Students may indicate lack of funds or lack of need. Then, ask them if
the timing of the bidding might have an effect; after getting the results from an exam, their need
might have increased or decreased, making them more or less willing to bid. Some students may
acknowledge that it was their anticipation of a need caused by an upcoming exam (they were
confident or they were scared) that caused the level of the bid and they were trying to protect
themselves (insure or hedge) against that risk.
Go on to show the application to the currency market and apply it to the dollar. Discuss the
various forces that create a need for the dollar (such as other countries buying U.S. goods and
services or expansion of their firms’ operations into the U.S.), the supply of the dollar (our
purchases of goods and services from other nations and expansion of business operations
overseas), and the resulting value of the dollar in terms of other countries. Point out that the
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60
Chapter 7: Dealing With Foreign Exchange
exchange rate is affected not just by current transactions but also by anticipation of future needs
and risks – no one will accept a given value for a currency today if upcoming events are likely to
make the currency worth less and thus cause a loss. As a result, people needing currencies will
need to guard against that risk through some means of hedging or risk avoidance. With that as a
basis for discussion, you can then go on to cover the entire chapter.
OPENING CASE DISCUSSION GUIDE

Opening Case: Toyota’s Yen Advantage
When the value of the yen fell 16% against the dollar in 2012, Japanese companies, including
Toyota, gained funds that they could use to benefit their businesses. Toyota used the change to
stage a comeback by showing an increase in profit. The shift in currency values is a threat to
U.S. companies because it gives Japanese companies money to grow and compete successfully.
61
CHAPTER OUTLINE: KEY CONCEPTS AND TERMS

Sections I through V of Chapter 7
I. WHAT DETERMINES FOREIGN EXCHANGE RATES

1. Key Concept
A foreign exchange rate is the price of one currency expressed in another. Basic
determinants of foreign exchange rates include (1) relative price differences, (2) interest
rates and monetary supply, (3) productivity and balance of payments, (4) exchange rate
policies, and (5) investor psychology.
2. Key Terms
 Appreciation is an increase in the price of one currency in terms of another.
 Balance of payments (BOP) is a country’s international transaction statement,
which includes merchandise trade, service trade, and capital movement.
 Bandwagon effect is the effect of investors moving in the same direction at the same
time, like a herd.
 Capital flight is a phenomenon in which a large number of individuals and
companies exchange domestic currency for a foreign currency.
 Clean (or free) float is a pure market solution to determine exchange rates.
 Depreciation is a loss in the value of the currency.
 Dirty (or managed) float is using selective government intervention to determine
exchange rates.
 Fixed exchange rate policy is a government policy to set the exchange rate of a
currency relative to other currencies.
 Foreign exchange rate is the price of one currency in terms of another.
 Floating (or flexible) exchange rate policy is a government policy to let supply-
and-demand conditions determine exchange rates.
 Peg is a stabilizing policy of linking a developing country’s currency to a key
currency.
 Target exchange rate (or crawling band) is the specified upper or lower bounds
within which an exchange rate is allowed to fluctuate.
II. EVOLUTION OF THE INTERNATIONAL MONETARY SYSTEM

1. Key Concept
The international monetary system evolved from the gold standard (1870–1914), to the
Bretton Woods system (1944–1973), and eventually to the current post-Bretton Woods
system (1973–present). The IMF serves as a lender of last resort to help member
countries out of financial difficulty.
62
2. Key Terms
 Bretton Woods system is a system in which all currencies were pegged at a fixed
rate to the U.S. dollar.
 Common denominator is a currency or commodity to which the values of all
currencies are pegged.
 Gold standard is a system in which the value of most major currencies was
maintained by fixing their prices in terms of gold.
 International Monetary Fund (IMF) is an international organization that was
established to promote international monetary cooperation, exchange stability, and
orderly exchange arrangements.
 Post–Bretton Woods system is a system of flexible exchange rate regimes with no
official common denominator.
 Quota is the weight a member country carries within the IMF, which determines the
amount of its financial contribution (technically known as its “subscription”), its
capacity to borrow from the IMF, and its voting power.
III. STRATEGIC RESPONSES TO FOREIGN EXCHANGE MOVEMENTS

1. Key Concept
Three foreign exchange transactions are (1) spot transactions, (2) forward transactions,
and (3) swaps. Three strategic responses include (1) invoicing in their own currencies,
(2) currency hedging, and (3) strategic hedging.
2. Key Terms
 Bid rate is the price to buy a currency.
 Currency hedging is a transaction that protects traders and investors from exposure
to the fluctuations of the spot rate.
 Currency risk is the potential for loss associated with fluctuations in the foreign
exchange market.
 Currency swap is a foreign exchange transaction between two firms in which one
currency is converted into another at Time 1, with an agreement to revert it to the
original currency at a specific Time 2 in the future.
 Foreign exchange market is the market where individuals, firms, governments, and
banks buy and sell foreign currencies.
 Forward discount is a condition under which the forward rate of one currency
relative to another currency is higher than the spot rate.
 Forward premium is a condition under which the forward rate of one currency
relative to another currency is lower than the spot rate.
 Forward transaction is a foreign exchange transaction in which participants buy
and sell currencies now for future delivery.
 Offer rate is the price to sell a currency.
 Spot transaction is the classic single-shot exchange of one currency for another.
 Spread is the difference between the offer rate and the bid rate.
 Strategic hedging is spreading out activities in a number of countries in different
currency zones to offset any currency losses in one region through gains in other
regions.
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IV. DEBATES AND EXTENSIONS

1. Key Concepts
The debates are (1) fixed versus floating exchange rates, (2) a strong dollar versus a
weak dollar, and (3) currency hedging versus not hedging.
2. Key Terms
 Currency board is a monetary authority that issues notes and coins convertible into
a key foreign currency at a fixed exchange rate.
V. MANAGEMENT SAVVY
1. Key Concept
Fostering foreign exchange literacy is a must. Risk analysis of any country must include
an analysis of its currency risks. A currency risk management strategy is necessary via
currency hedging, strategic hedging, or both.
2. Key Terms
None
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END-OF-CHAPTER GUIDE
*Review Questions and Answers

*Critical Discussion Questions and Answers
*Global Action
*Closing Case
REVIEW QUESTIONS AND ANSWERS
1. ON CULTURE: Suppose that in country X, the culture is one that avoids risk and frowns
on gambling. Suppose the country uses the US dollar in its international transactions, and
a firm in X buys a product from Europe, which it will take delivery in 60 days and for
which it will have to pay 100,000 euros at that time. The firm does not know how many
dollars will be needed in order to obtain those 100,000 euros 60 days from now. One way
to know that would be to enter into a contract for the future delivery of that currency with
a speculator who would guarantee the firm that it will be able to obtain those euros for a
specific dollar value. The firm would thus avoid the risk of having to pay too much for
those euros 60 days from now by transferring the risk at the present time to a speculator.
The speculator takes the risk, because he or she is expecting that the actual costs of those
euros (in terms of dollars) will be less 60 days from now than what the speculator
promises to the firm. As a result, the speculator profits from the price differential. Some
in country X view contracts for the future delivery of a currency (forward contracts) as
risk avoidance, but others view it as gambling. What do you think?
The question is intended to get students to reexamine assumptions and biases. Risk
avoidance and risk taking can be two sides of the same coin. Whether it involves
currencies, wheat, oil, or securities, values (prices, exchange rates, etc.) can change and
some may wish to lock a given value to avoid a change that might be unfavorable.
Trucking and airline firms need to lock in the cost of fuel for upcoming periods. Firms in
the process of expanding may need to lock in the interest rates that they may have to pay.
And as described in the question, firms involved in exporting or importing need to know
what the exchange rate will be for a future transaction. The speculator enables those
firms to do that by taking the risk that others wish to avoid. Risk taking and pure
gambling differ in that gambling involves pure chance whereas risk taking involves
analysis of fact – one problem involves getting all the facts and doing the right analysis.
2. Do an online search regarding current challenges to the dollar, euro, and yen, and then
refer to PengAtlas Maps 2.1 (Top Merchandise Importers and Exporters) and 2.2 (Top
Service Importers and Exporters). To what extent do the users of these three currencies
tend to dominate world trade?
In addition to the students’ correct answers based on their observation, you might remind
them that the use of these currencies is not limited to the countries in which these
currencies are the official currency of the nation. For example, the dollar is used in
many transactions around the world even where no U.S. firm or agency is involved.
OPEC prices oil in dollars.
65
3. Refer to PengAtlas Map 2.3 (FDI Inflows and Outflows), and compare to what you
learned from Question 2 above. To what extent do the users of the three currencies
dominate? In your opinion, will the rise of the BRIC countries ultimately reduce the
dominance of those currencies?
This is an opinion question because one cannot know the future. However, stay in touch
with global news because China may be making more moves to give the Yuan the same
status as the dollar, euro, and yen.
4. What are foreign exchange rates?

Those rates are simply the price of a given currency in terms of how many units of
another currency one can obtain for a unit of that given currency. Suppose at one point
in time one can get 100 yen for a dollar and at later time one can get 110 yen for a dollar
– the value of the dollar has gone up in terms of the yen it can obtain. Suppose at a later
time the exchange rate is such that one can only get 90 yen for a dollar – the foreign
exchange rate for the dollar has gone down.
5. How are foreign exchange rates affected by differences in the interest rates prevailing in
various countries?
Anything that increases the demand for a currency can increase the value (exchange
rate) for that currency. For example, if one can get a higher yield in another country’s
currency, the demand for that currency will increase to purchase securities and thus its
exchange rate will increase – one will have to give up more of one’s own currency to
obtain that currency.
6. What happened toward the end of World War II that lifted the dollar to the commanding
heights of the global economy?
The Bretton Woods System pegged all currencies to the dollar.
7. What is the IMF, and how does it help countries?

International Monetary Fund (IMF): an international organization that was established
to promote international monetary cooperation, exchange stability, and orderly exchange
arrangements; to foster economic growth and high levels of employment; and to provide
temporary financial assistance to countries to help ease balance of payments adjustment.
8. In foreign exchange, what are spot and forward transactions? How do they differ?
A spot transaction is the classic single-shot exchange of one currency for another
currency now at whatever exchange rate now exists. A forward transaction involves a
future exchange of one currency for another at a currently agreed upon exchange rate
regardless of whatever the actual spot rate is at that time.
66
9. What is the difference between currency hedging and strategic hedging?

Strategic hedging is conceptually different from currency hedging. Currency hedging
focuses on using forward contracts and swaps to contain currency risks, a financial
management activity that can be performed by in-house financial specialists or outside
experts (such as currency traders). Strategic hedging refers to geographically dispersing
operations—through sourcing or FDI—in multiple currency zones. By definition, this is
more strategic, involving managers from many functional areas (such as production,
marketing, and sourcing) in addition to those from finance.
10. What is the role of currency boards regarding fixed exchange rates? Discuss at least one
problem that such boards may have in maintaining fixed rates.
The currency board maintains a fixed rate of exchange between its currency and another
currency and backs that by maintaining a supply of that currency so as to support that
rate of exchange. As a result, the supply of its own currency changes in line the amount
of the currency that goes into or out of that country which in turn affects the country’s
interest rates and economy. One problem is that such a country tends to lose control
over its own economy to another country.
11. Why is it that a strong dollar is not always desirable to the United States, while it may be
to other countries?
A strong dollar might not be desirable to the United States for three reasons. (1) US
exporters have a hard time competing on price abroad. (2) US firms in import-competing
industries have a hard time competing with low-cost imports. (3) Foreign tourists find it
more expensive when visiting the US.
12. Why should a savvy manager become literate about foreign exchange?
First, foreign exchange literacy must be fostered. Second, risk analysis of any country
must include its currency risks. A currency risk management strategy is necessary—via
currency hedging, strategic hedging, or both.
13. What is one example that illustrates why risk analysis of a country should include its
currency risk?
For example, prior to 2008, foreign and domestic banks in emerging European countries
such as Hungary, Latvia, and Poland let numerous home buyers take out mortgage loans
denominated in the euro, while a majority of these customers’ assets and incomes were in
local currencies. Unfortunately, local currencies in these countries were severely
devaluated in the 2008–2009 crisis, making many homebuyers unable to come up with
the higher mortgage payments. Both domestic and foreign banks in the region also
suffered from severe losses.
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CRITICAL DISCUSSION QUESTIONS AND ANSWERS
1. Suppose US$1 = €0.7809 in New York and US$1 = €0.7793 in Paris. How can
foreign exchange traders profit from these exchange rates? What actions can they take
that may result in the same dollar/euro exchange rate in both New York and Paris?
Arbitrageurs (traders) profit by buying low in one market and selling high in another.
However, as they dump more of a currency into the higher priced market, they are
increasing the supply of that currency in that market and as the supply increases relative
to the demand the price will go down until it reaches a level in which no arbitrage profits
can be obtained because the value of the currency in both markets is the same.
2. Identify the currencies of the top-three trading partners of your country in the last ten
years. Find the exchange rates of these currencies, relative to your country’s currency, ten
years ago and now. Explain the changes. Then predict the movement of these exchange
rates ten years from now.
This is a question in which the answer is not as important as the thought process and the
ability to clearly articulate. However, it should be noted that there is a risk in trying to
predict the future based on past trends in our rapidly changing global environment. It is
much like driving down the road with the windshield painted black and trying to predict
what lies ahead in the road by looking only in the rear view mirror.
3. As a manager, you are choosing to do business in two countries: One has a fixed
exchange rate, and the other has a floating rate. Which country would you prefer? Why?
The student should realize that doing business with a country that has a fixed exchange
rate will result in using a currency that will sometimes be overvalued or undervalued.
4. ON ETHICS: You are an IMF official going to a country whose export earnings are not
able to pay for imports. The government has requested a loan. Which areas would you
recommend the government to cut: (1) education, (2) salaries for officials, (3) food
subsidies, and/or (4) tax rebates for exporters?
Student answers will vary but it is unlikely that any would pick number four. Most
students will pick number two but that is the one choice which would probably be the
most difficult to sell to the officials.
GLOBAL ACTION
1. Based in the United States, your firm trades extensively in European countries
that have adopted the euro. You have been asked to evaluate the impact of
currency fluctuations on sales in this region over the past month. The first step
in this process is to develop an exchange rate table for daily exchange rates
over the past month between the U.S. dollar and the euro. Once this has been
accomplished, what general trends do you notice? How could these trends
impact your firm’s sales in countries that use the euro?
68
Exercise 1 Answers
One resource which can be used is “OANDA.com: The Currency Site”. This website can
be found by entering the search term “exchange rate table” at the globalEDGE™
Resource Desk search box located at http://globaledge.msu.edu/resourceDesk/. Once at
the OANDA website, enter the search term “history”. After accessing the exchange rate
data between the United States Dollar (USD) and the Euro, analysis can take place.
Generally, as the USD reduces in value versus the Euro, goods and services from the
United States are less expensive. As a result, this can encourage more sales in countries
using the Euro. Likewise, as the USD increases in value versus the Euro, goods and
services from the United States become more expensive – thus discouraging sales in
countries using the Euro.
Search Term: “exchange rate table”
Resource Name: OANDA.com
Website: http://www.oanda.com/
globalEDGE™ Tags: Reference, Standards and Conversions, Currency
2. Your company is examining possible market opportunities in the Asia Pacific

region. As a part of this possible strategic shift, the benchmark currencies of
the region must be identified to diversify currency risk for future operations.
Using a resource that examines foreign exchange, determine which predominant
currencies are likely candidates for your analysis.
Exercise 2 Answers
One resource which can be used is “FXStreet”. This website can be found by entering the
search term “foreign exchange” at the globalEDGE™ Resource Desk search box located
at http://globaledge.msu.edu/resourceDesk/. Once at the FXStreet website, view current
currency values and charts of historical currency values. The currencies students select
will vary but they should be able to support their selections.
Search Term: “foreign exchange”
Resource Name: Bloomberg Online: Foreign Exchange
Website: http://www.fxstreet.com
globalEDGE™ Tags: Money, Finance
69
CLOSING CASE DISCUSSION GUIDE AND ANSWERS

Emerging Markets: Jobek Do Brasil’s Foreign Exchange Challenges
1. How do you evaluate Jobek’s situation from the resource-based and institution-based
views? Why have resources and institutions hindered Barny to cope with the foreign
exchange situation, but simultaneously helped him to turn his company around?
The important thing is not so much the answer as the extent to which the student
demonstrates thought in providing the answer.
2. How do you evaluate Jobek’s strategic response to foreign exchange risks?

3. What would you do if you were Barny? Why?

70

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Solution Manual for Global Business 4th Edition

by Mike Peng ISBN 130550089X

DEALING WITH FOREIGN EXCHANGE

GENERAL TEACHING SUGGESTIONS

OPENING CASE DISCUSSION GUIDE

CHAPTER OUTLINE: KEY CONCEPTS AND TERMS

I. WHAT DETERMINES FOREIGN EXCHANGE RATES

II. EVOLUTION OF THE INTERNATIONAL MONETARY SYSTEM

III. STRATEGIC RESPONSES TO FOREIGN EXCHANGE MOVEMENTS

IV. DEBATES AND EXTENSIONS

*Review Questions and Answers

REVIEW QUESTIONS AND ANSWERS

4. What are foreign exchange rates?

7. What is the IMF, and how does it help countries?

9. What is the difference between currency hedging and strategic hedging?

CRITICAL DISCUSSION QUESTIONS AND ANSWERS

2. Your company is examining possible market opportunities in the Asia Pacific

CLOSING CASE DISCUSSION GUIDE AND ANSWERS

2. How do you evaluate Jobek’s strategic response to foreign exchange risks?

3. What would you do if you were Barny? Why?

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