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Solution Manual for International Business, 15/E 15th Edition : 0133457230

CHAPTER NINE
THE DETERMINATION OF EXCHANGE RATES

OBJECTIVES

• Describe the International Monetary Fund and its role in the determination of
exchange rates
• Discuss the major exchange-rate arrangements that countries use
• Explain how the European Monetary System works and how the euro became the
currency of the euro zone
• Identify the major determinants of exchange rates
• Show how managers try to forecast exchange-rate movements
• Explain how exchange-rate movements influence business decisions

CHAPTER OVERVIEW

From a managerial point of view, it is critical to understand how exchange-rate

movements influence business decisions and operations. Chapter Nine first describes the
International Monetary Fund and the role it plays in exchange-rate determination. Next
the chapter examines the various types of exchange-rate regimes countries may choose,
as well as the role central banks play in the currency valuation process. It then presents
the theories of purchasing power parity, the Fisher Effect, and the International Fisher
Effect and discusses their contributions to the explanation of exchange-rate movements.
The chapter concludes with a brief examination of the potential effects of exchange-rate
fluctuations on business operations.

CHAPTER OUTLINE

OPENING CASE: El Salvador Adopts the U.S. Dollar

[See Map 9.1]

This case describes El Salvador’s move toward dollarization. In 1994, El Salvador

pegged its currency, the colon, to the U.S. dollar. In 2001, the government decided to do
away with the colon and adopt the dollar as the country’s official currency. This was
done because of the close ties El Salvador had to the U.S. economy. At the time of
dollarization, over two-thirds of El Salvador’s exports went to the United States. In
addition, over 2 million Salvadoreans living in the United States wired home nearly $2
billion a year to relatives. After dollarization, the government and companies in El
Salvador were able to get access to cheaper interest rates due to the decreased risk of
currency devaluation. Consumers were also able to get lower interest rates and easier
access to credit. Ecuador also dollarized its economy in 2000 to control hyperinflation.
Dollarization has had some negative effects for El Salvador. The currencies of many of

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its neighbors have devalued against the dollar, giving those countries a competitive
advantage in exporting to the United States and other markets. This has forced many
companies in El Salvador to abandon low-end business and develop more advantages
based on flexibility, quality, and design.

Questions

9-1 Given the success in El Salvador, do you think the other countries in CAFTA-DR
should adopt the U.S. dollar as their currency? Why or why not?

One of the main advantages of adopting of a strong foreign currency as sole legal
tender is to reduce the transaction costs of trade among countries using the same
currency. Countries with full currency substitution economies can invoke greater
confidence among international investors, inducing increased investments and
growth. The elimination of the currency crisis risk due to full currency substitution
leads to a reduction of country risk premiums and then to lower interest rates. These
effects result in a higher level of investment. Official currency substitution helps to
promote fiscal and monetary discipline and thus greater macroeconomic stability and
lower inflation rates, to lower real exchange rate volatility, and possibly to deepen the
financial system. (LO: 2, Learning Outcome: To discuss the major exchange rate
arrangements that countries use, AACSB: Dynamics of the Global Economy)

9-2 In Chapter 7, we mentioned that Mexico and Canada have kept their own currency,
even though they are partnered with the U.S. in NAFTA. Why do you think they have
decided not to adopt the U.S. dollar as their currency, even though El Salvador and
Ecuador, who are not members of NAFTA, have adopted the dollar as their
currency?

The USD is a currency with a lot of “baggage.” It’s an international reserve currency,
which means a lot of governments keep supplies of it, and a lot of commodities are
priced in it. In the past, this has boosted the U.S. economy, since other people have
been willing to trade goods and services to the U.S. in exchange for money that the
U.S. government just prints. This boost also comes with a price in that there are big
stores of USD around the world, and if other countries suddenly decide those reserves
are not worth keeping, they can flood the market with USD, devaluing the currency at
will. In summary, the U.S. benefits from other countries’ faith in the USD but also
needs to go out of its way to maintain that faith or there are serious consequences. In
contrast, the CAD is not a major reserve currency. Canada does not get that “reserve
currency boost” in its economy, but also doesn’t have to answer to the rest of the
world as much. And I think the Canadian people prefer it that way. Certainly the last
decade has seen a substantially more fiscally prudent Canada compared to the U.S.,
and I doubt that Canadians would want to have their monetary policy pushed in the
U.S.’ direction as a common currency would warrant. Another important argument is
that under a common currency regime, Canada would be overwhelmingly dominated
by the United States. Inevitably, Canada would lose a substantial degree of control
over its monetary policy.

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 With reference to Mexico, due to their reliance on the U.S. as a destination for
exports, adopting the dollar would decrease exchange rate risk, associated with trade
and investment. Manufacturers and investors would not have to worry about the peso
appreciating or depreciating. However, as exchange rate uncertainty decreases, the
rate of imports from the U.S. increases, which will then place pressure on import-
competing industries, like automobiles and electronics. (LO: 2, Learning Outcome:
To discuss the major exchange rate arrangements that countries use, AACSB:
Dynamics of the Global Economy)

TEACHING TIPS: Carefully review the PowerPoint slides for Chapter Nine and select
those you find most useful for enhancing your lecture and class discussion. For
additional visual summaries of key chapter points, also review the figures, tables,
and maps in the text. Current foreign currency values and other related information
can be found on the Web site http://finance.yahoo.com. Have students visit the site
and report back on its usefulness.

I. INTRODUCTION
An exchange rate represents the number of units of one currency needed to acquire
one unit of another currency. Managers must understand how governments set
exchange rates and what causes them to change so they can make decisions that
anticipate and take those changes into account.

II. THE INTERNATIONAL MONETARY FUND

In 1944, the major allied governments met in Bretton Woods, NH, to discuss post-
war economic needs. One of the results was the establishment of the International
Monetary Fund (IMF).
A. Origin and Objectives
Twenty-nine countries initially signed the IMF agreement, and there were 187
member countries in July 2011. The IMF has four major objectives:
• To ensure stability in the international monetary system
• To promote international monetary cooperation and exchange-rate
stability
• To facilitate balanced growth of international trade
• To provide resources to help countries in balance-of-payments
difficulties or to assist with poverty reduction
1. Bretton Woods and the Principle of Par Value. The Bretton Woods
Agreement established a system of fixed exchange rates under which each
IMF member country set a par value (benchmark) for its currency based on
gold and the U.S. dollar. Par values were later done away with when the
IMF moved toward greater exchange-rate flexibility.
B. The IMF Today
1. The Quota System. When a country joins the IMF, it contributes a
certain sum of money, called a quota, relating to its national income,
monetary reserves, trade balance, and other economic indicators. The quota
then becomes part of a pool of money the IMF can draw on to lend to

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 member countries. At the end of 2010, the total quota held by the IMF was
SDR 476.8 billion (U.S. $750 billion). It also forms the basis for the voting
power of each country, as well as the allocation of its special drawing rights.
2. Assistance Programs. When a member country experiences economic
difficulties, the IMF will negotiate loan criteria designed to help stabilize its
economy. Funds are released in phases, allowing the IMF to monitor
progress before releasing all of the funds.
3. Special Drawing Rights (SDRs). To help increase international
reserves, the IMF created a special drawing right (SDR), an international
reserve asset designed to supplement members’ existing reserves of gold
and foreign exchange. The SDR is used as the IMF’s unit of account (the
unit in which the IMF keeps its records) and for IMF transactions and
operations. The value of the SDR is based on the weighted average of four
currencies. As of January 1, 2011 those weights were: the U.S. dollar
41.9%, the euro 37.4%, the Japanese yen 9.4%, and the British pound
11.3%. Unless the executive board decides otherwise, the weights of each
currency in the valuation basket changes every 5 years, with the next review
taking place in 2015.
C. The Global Financial Crisis and the SDR
The global financial crisis brought huge concerns over global liquidity. The G8
countries responded by injecting billions of dollars into their financial systems
and implementing large stimulus packages. In April 2009, the G8 expanded to
the G20 and voted to allow the IMF to raise $250 billion by issuing SDRs. The
Chinese and Russians argued for an expanded role of the SDR because of its
stability and less variability versus the dollar.
D. Evolution to Floating Exchange Rate
The IMF’s original system was one of fixed exchange rates; the U.S. dollar
remained constant with respect to the value of gold and other currencies
operated within narrow bands of value relative to the dollar.
1. The Smithsonian Agreement. Following President Nixon’s suspension
of the dollar’s convertibility to gold in 1971, the international monetary
system was restructured via the Smithsonian Agreement, which permitted
an 8% devaluation of the U.S. dollar, a revaluation of other currencies, and a
widening of the exchange-rate flexibility bands.
2. The Jamaica Agreement. These measures proved insufficient, however,
and in 1976 the Jamaica Agreement eliminated the use of par values by
abandoning gold as a reserve asset and permitting greater exchange-rate
flexibility.

III. EXCHANGE-RATE ARRANGEMENTS [See Table 9.1 and Map 9.1]

The IMF surveillance and consultation programs are designed to monitor the
exchange-rate policies of member nations to be sure they act openly and responsibly
with respect to their exchange-rate policies. Member countries are permitted to select
and maintain their exchange-rate regimes, but they must communicate those choices
to the IMF. Some countries that use a fixed or pegged exchange rate use an
exchange-rate anchor for their monetary policy, which means that they buy or sell

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foreign exchange at given rates to maintain the value of the currency. In addition,
countries can adopt a monetary policy that uses growth in the money supply, called
the monetary aggregate anchor, a targeted rate of inflation, or something else that
they feel is important.
A. Three Choices: Hard Peg, Soft Peg, or Floating
1. Hard Peg
a. Dollarization is the use of the dollar with no domestic legal tender.
b. Some nations use the dollar in addition to creating domestic legal tender.
Currency boards may issue domestic currency anchored to a foreign
currency.
2. Soft Peg
a. There are several types, but a majority of countries have a conventional
peg arrangement in which a country pegs its currency to another
currency or basket of currencies and allows exchange rates to vary plus
or minus 1 percent from that value.
3. Floating Arrangement
a. Floating currencies change according to market forces but may be
subject to market intervention.
b. Free-floating currencies are subject to intervention only in exceptional
circumstances.
B. The Euro The currency of the European Monetary System
1. The European Monetary System and the European Monetary
Union. The creation of the euro had its roots in the European Monetary
System (EMS), begun in 1979. The EMS was set up as a means of creating
exchange-rate stability within the European Community. Members’
currencies were linked through a parity grid. As the fluctuations in
exchange rates narrowed, the EMS was replaced with the Exchange Rate
Mechanism (ERM). In 1999, the European Monetary Union (EMU)
came into being, creating the euro as the common currency of all EMU
member nations. The euro is administered by the European Central Bank
(ECB). Having a common currency eliminates exchange rate risk among
member nations and greatly reduces the cost of cross-border transactions.
Despite these advantages, three of the original 15 members of the European
Union have opted not to join the euro zone. New applicants to the euro
zone must meet the following criteria to be accepted to the EMU:
• Annual government deficit must not exceed 3 percent of GDP.
• Total outstanding government debt must not exceed 60 percent of GDP.
• Rate of inflation must remain within 1.5 percent of the three best
performing EU countries.
• Average nominal long-term interest rate must be within 2 percent of the
average rate in the three countries with the lowest inflation rates.
• Exchange rate stability must be maintained, meaning that for at least
two years, the country concerned has kept within the “normal”
fluctuation margins of the European Exchange Rate Mechanism.
As of 2009, 16 of the 28 member states of the EU were using the euro.

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 2. Pluses and Minuses of the Conversion. While the move to the euro
has been smoother than predicted, the largest currency conversion of all
time has both pluses and minuses. Many companies believe the euro
increases price transparency and eliminates foreign exchange risk;
however, not all member states use the currency, especially the newer
member states. Recent financial volatility has caused an interesting dance
between the value of the euro and the dollar.

POINT—COUNTERPOINT: Should Africa Develop a Common Currency?

POINT: The success of the euro shows the benefits that a common currency can bring to
close geographical and economic partner countries. Africa, with deep economic and
political problems, stands to benefit greatly from a common currency. Such a move
would hasten economic integration leading to an increase in market size, greater
economies of scale, increased trade, and lower transaction costs. The foundation for a
common currency already exists in three regional monetary unions and five existing
regional economic communities. By combining into one large African economic union,
these groups could form a Central Bank and establish a common monetary policy, forcing
institutions in each African nation to improve and insulating monetary policy from
political pressures.

COUNTERPOINT: There is no way that the countries of Africa will ever establish a
common currency, due to a flawed and inadequate institutional framework. Political
pressures in many African countries are too intense to allow the separation of monetary
policy from political expediency. Countries in the region will be very reluctant, or
completely unwilling, to give up monetary sovereignty. Transportation problems within
Africa also make it much more difficult to transfer goods within the region than it is in
Europe. The establishment of the euro in the EU took years of work despite a very
favorable political climate, strong institutional framework, and very cooperative relations
among member states. None of these factors exist in Africa, making the task of
developing a common currency nearly unimaginable. Further strengthening and
expansion of the existing regional monetary unions is the only viable path toward a single
African currency in the long-term future.

IV. DETERMINING EXCHANGE RATES

Exchange-rate regimes are either fixed or floating, with fixed rates varying in terms
of just how fixed they are and floating rates varying with respect to just how much
they are allowed to float.
A. Nonintervention: Currency in a Floating-Rate World
Floating-rate regimes are those whose currencies respond to the conditions of
supply and demand. Technically, an independent floating currency is one that
floats freely, unhampered by any form of government intervention. Equilibrium
exchange rates are achieved when supply equals demand [See Fig 9.2].
B. Intervention: Currency in a Fixed-Rate or Managed Floating-Rate
World

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 In a managed fixed exchange-rate system, a nation’s central bank intervenes in
the foreign-exchange market in order to influence the currency’s relative price.
To buy foreign currencies, it must have sufficient reserves on hand. When
economic policies and market intervention don’t work, a country may be forced
to either revalue or devalue its currency.
C. The Role of Central Banks
Each country has a central bank responsible for the policies affecting the value
of its currency. The central bank in the United States is the Federal Reserve
System, i.e., the Fed, a system of 12 regional banks. The New York Fed,
representing both the Fed and the U.S. Treasury, is responsible for intervening
in foreign-exchange markets to achieve dollar exchange-rate policy objectives.
The New York Fed also acts as the primary contact with other foreign central
banks. The euro is administered by the European Central Bank which, although
independent of all EU institutions and governments, works with the governors of
Europe’s various central banks to establish monetary policy and manage the
exchange-rate system.
1. Central Bank Reserve Assets. Central bank reserve assets are kept in
three forms: gold, foreign-exchange reserves, and IMF-related assets.
Central banks are primarily concerned with liquidity, in order to ensure they
have the cash and flexibility needed to protect their countries’ currencies.
2. How Central Banks Intervene in the Market. Selling U.S. dollars for
foreign currency puts downward pressure on the dollar’s value; buying U.S.
dollars for foreign currency puts upward pressure on the dollar’s value.
Depending on market conditions, a central bank may:
• coordinate its actions with other central banks or go it alone
• aggressively enter the market to change attitudes about its views
and policies
• call for reassuring action to calm markets
• intervene to reverse, resist, or support a market trend
• be very visible or very discrete
• operate openly or indirectly through brokers
a. Case: The U.S. Dollar and the Japanese Yen. The Federal
Reserve could intervene in the foreign-exchange market in order to
affect the price of the Japanese yen, relative to the U.S. dollar, by using
foreign reserves.
b. Different Attitudes to Intervention. Government policies change
over time, depending on economic conditions and the attitude of the
prevailing administration concerning intervention in the foreign-
exchange market.
c. Challenges with Intervention. In general, the United States
disapproves of foreign currency intervention, based on the belief that it
is very difficult, if not impossible, for intervention to have a lasting
impact on the currency’s value.
d. Revisiting the BIS. The Bank for International Settlements (BIS)
in Basel, Switzerland, acts as the central bankers’ central bank and
serves as a gathering place where central bankers meet to discuss

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 monetary cooperation. Although just 56 central banks are shareholders
in the BIS, it regularly deals with some 140 central banks worldwide.
D. Black Markets
The less flexible a country’s exchange-rate system, the more likely there will be
a black market, i.e., a foreign-exchange market that lies outside the official
market. Black markets are underground markets where prices are based on
supply and demand; the adoption of floating rates eliminates the need for their
existence.
E. Foreign Exchange Convertibility and Controls
Some countries with fixed exchange rates control access to their currencies.
Fully convertible currencies are those that the government allows both residents
and nonresidents to purchase in unlimited amounts. Hard currencies are
currencies that are fully convertible. Soft (or weak) currencies are not fully
convertible and tend to be the currencies of developing nations. Most countries
today have nonresident, or external, convertibility, meaning that foreigners can
convert their currency into the local currency and can convert back into their
currency as well.
1. Controlling Convertibility. Governments sometimes place restrictions
on currencies such as licenses that are required of importers and exporters
that fix exchange rates at an official price. Some countries employ multiple
exchange rates, where different exchange rates are set for different types of
transactions, and others use advance import deposits, which require a
deposit with the central bank for as long as one year interest-free.
Governments may also limit the amount of exchange through quality
controls, which limit the amount of foreign currency that can be used in a
specific transaction.
F. Exchange Rates and Purchasing Power Parity
The theory of purchasing-power parity (PPP) states that the prices of tradable
goods, when expressed in a common currency, will tend to equalize across
countries as a result of exchange-rate changes. Put another way, the theory
claims a change in the comparative rates of inflation in two countries necessarily
causes a change in their relative exchange rates in order to keep prices fairly
similar. An interesting illustration of this theory is the “Big Mac Index.” While
purchasing-power parity may be a reasonably good long-term indicator of
exchange-rate movements, it is less accurate in the short run because it is
difficult to determine an appropriate basket of commodities for comparison
purposes, profit margins vary according to the strength of competition, different
tax rates will influence prices differently, and the theory falsely assumes no
barriers to trade exist and transportation costs are zero.
G. Exchange Rates and Interest Rates
Although inflation is the most important long-run influence on exchange rates,
interest rates are also important.
1. The Fisher Effect. While the Fisher Effect theory links inflation and
interest rates, the International Fisher Effect (IFE) theory links interest
rates and exchange rates. The Fisher Effect theory states a country’s
nominal interest rate r (the actual monetary interest rate earned on an

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 investment) is determined by the real interest rate R (the nominal rate less
inflation) and the inflation rate i as follows:

(1 + r) = (1 + R)(1 + i) or r = (1 + R)(1 + i) - 1

Because the real interest rate should be the same in every country, the
country with the higher interest rate should have higher inflation. Thus,
when inflation rates are the same, investors will likely place their money in
countries with higher interest rates in order to get a higher real return.
2. The International Fisher Effect. The International Fisher Effect
implies the currency of the country with the lower interest rate will
strengthen in the future, i.e., the interest-rate differential is an unbiased
predictor of future changes in the spot exchange rate. The country with the
higher interest rate (and higher inflation) should have the weaker currency.
In the short run, however, and during periods of price instability, a country
that raises its interest rate is likely to attract capital and see its currency rise
in value due to increased demand.
H. Other Factors in Exchange-Rate Determination
Confidence. When things are turbulent, people want to hold currencies that are
considered safe. During the toughest times of the economic crisis, the dollar
continued to be a safe haven. Once markets started to recover, money flowed
into euros and into emerging markets.
Information. Release of information can dramatically influence currency
values. This includes formal sources, such as Bloomberg and government
officials, and informal sources like blogs.

V. FORECASTING EXCHANGE-RATE MOVEMENTS

Managers must be able to formulate at least a general idea of the timing, magnitude,
and direction of exchange-rate movements.
A. Fundamental and Technical Forecasting
While fundamental forecasting uses trends regarding fundamental economic
variables to predict future exchange rates, technical forecasting uses past trends
in exchange-rate movements to spot future trends.
1. Dealing with Biases. Smart managers develop their own exchange-rate
forecasts and then use the fundamental and technical forecasts of outside
experts to corroborate their analyses.
2. Timing, Direction, and Magnitude. Forecasting includes predicting the
timing, direction, and magnitude of exchange-rate movements. For countries
whose currencies are not freely floating, the timing is often a political
decision, and not so easy to predict. Predicting the direction is easier than
predicting the magnitude. The problem with attempting to predict the value
of a freely floating currency is that you never really know what will happen
to its value.
B. Fundamental Factors to Monitor
When forecasting exchange-rate movements, key variables to monitor include:
• the institutional setting (the extent and nature of government intervention)

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 • fundamental analysis (PPP rates, balance-of-payments levels, the level of
foreign-exchange reserves, macroeconomic data, fiscal and monetary
policies, etc.)
• confidence factors
• circumstances
• technical analysis (market trends and expectations)

VI. BUSINESS IMPLICATIONS OF EXCHANGE-RATE CHANGES

Exchange-rate fluctuations can affect all areas of a company’s operations.
A. Marketing Decisions
Exchange-rate changes can affect demand for a firm’s products, both at home
and abroad. For instance, the strengthening of a country’s currency could create
price competitiveness problems for exporters; on the other hand, importers
would favor that situation.
B. Production Decisions
Firms may choose to locate production operations in a country whose currency
is weak because initial investment there is relatively inexpensive; it could also
be a good base for exporting the firm’s output. Exchange-rate differentials
contribute to this situation across industrialized nations, as well from
industrialized to developing nations.
C. Financial Decisions
Exchange-rate fluctuations can affect financial decisions in the areas of sourcing
funds (both debt and equity), the cross-border remittance of funds, and the
reporting of financial results.

LOOKING TO THE FUTURE:

Changes in the Relative Strength of the U.S. Dollar, the Euro, the Yen and
the Yuan

The trend toward greater flexibility in exchange-rate regimes will surely extend well into
the future. The euro will continue to strengthen and claim market share from the U.S.
dollar as a prime reserve asset, just as Europe’s transition economies will progress in
their moves toward floating exchange-rate regimes. Regional trading relationships will
also encourage Latin American governments to move still closer toward dollarization, or
at least some form of regional monetary union. Likewise, the U.S. dollar should continue
to be the benchmark currency in Asia, because so many countries there (including China)
rely on the U.S. market as an export destination. The wild card in Asia is the Chinese
yuan. China decided to de-link the yuan to dollar peg in 2005 and widened the trading
band in 2007. Further changes will likely have to be made in order to avoid a major trade
war with Europe and the United States. Although one of the most widely traded
currencies in the world, the Japanese yen remains specific to the Japanese economy. The
inability of the Japanese economy to reform and open up will keep the yen from wielding
the same kind of influence as the dollar and the euro.

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 CLOSING CASE: Welcome to the World of Sony – Unless the Yen Keeps
Rising

This case reviews the impact of the yen on Japan’s Sony. In Sony’s early years (1946-
1970), they had the luxury of operating with a weak yen. They also received support
from the government and expanded rapidly. This era was followed by the First Endaka
(“high yen”). This period (1970-1993) saw the yen very strong against the dollar due to a
weak U.S. economy, the Persian Gulf War, a rise in interest rates in Japan, and lack of
agreement on the condition of the yen among the G8. A Second Endaka hit in1995.
Japanese companies were having trouble remaining competitive and cut costs to do so.
The Japanese economy was in recession and the Bank of Japan dropped interest rates,
which reduced the value of the yen. Although Sony continued to innovate during these
decades, competition from Korean companies, like Samsung and LG, heated up. During
the economic crisis, the yen became a safe-haven currency. Sony continues to be
geographically diversified and take advantage of production outside of Japan. With the
strong yen, Sony’s financial statements were negatively impacted and competition
continued. Sony has lots of strengths but continues to face challenges.

Questions

9-3 What were the major factors that led to the drop in Sony’s exports from Japan?

The strong yen caused Sony’s products to be more costly in the world market. When
the interest rates were higher in the U.S., investors moved money out of Japan into
dollars. The strong yen impacted all exports from Japan but made imports cheaper.
Sony responded by moving production to other countries and reducing costs. (LO: 5,
Learning Outcome: To show how managers try to forecast exchange-rate
movements, AACSB: Dynamics of the Global Economy)

9-4 In what other ways has the strong yen affected Sony’s bottom line? What would be
the effect of a weak yen?

A weak yen would have the reverse effect and make Sony’s products more price
competitive on the international market. Sony’s need to translate dollars or euros
into yen drags down net assets and earnings, reducing Sony’s consolidated results.
When Sony’s foreign operations remit dividends back to Japan, they are worth less
when converted to yen. (LO: 6, Learning Outcome: To explain how exchange-rate
movements influence business decisions, AACSB: Analytical Skills)

9-5 Given the instability in the currency markets, why do you think it is important for
Sony to manufacture more products in the United States and Europe and to also buy
more from suppliers in other countries in Asia?

When Sony operates in markets where they manufacture, they not only can reduce
transportation costs but operate in the same currency. This strategy not only reduces
costs but improves margin. Other Asian suppliers also help the bottom line by

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 sourcing components at a cheaper cost. This will be particularly important as Sony
faces tough competition from lower-priced competitors such as Samsung. (LO: 5,
Learning Outcome: To show how managers try to forecast exchange-rate
movements, AACSB: Analytical Skills)

9-6 What are the major forces that affected the Japanese yen over the years? What
factors do you think are important to monitor as you try to forecast what will happen
to the value of the yen in the future?

The world economy, particularly the U.S. economy, impacts the strength or
weakness of the yen. The period between 1970 and 1993 saw the yen very strong
against the dollar due to a weak U.S. economy, the Persian Gulf War, a rise in
interest rates in Japan and lack of agreement on the condition of the yen among the
G8. Also, internal fears of inflation and government intervention have a direct
impact on the value of the yen. Initially, during the economic crisis, the yen became
a safe-haven currency which benefited the exchange against the euro. Investors also
left the emerging markets and returned to Japan, giving strength to the yen.
Economic recovery is still very slow and many did not see improvement until the
second half of 2010. The yen is still one of the major currencies globally and will
remain so in the foreseeable future. (LO: 4, Learning Outcome: To identify the
major determinants of exchange rates, AACSB: Dynamics of the Global Economy)

ADDITIONAL EXERCISES: Exchange-Rate Determination

Exercise 9.1. In the early 1990s, the Canadian and U.S. dollars were close to par. At
the end of June 2003, the Canadian dollar was worth about U.S. $0.7374. By March
2006, the Canadian dollar was worth about U.S. $.8635. Ask students to discuss the
reasons they believe the Canadian dollar lost so much ground against its American
counterpart between 1990 and 2003. Be sure they raise factors such as the
implementation of the North American Free Trade Agreement and the separatist
movement in Quebec. Now, ask them why the Canadian dollar strengthened against
the U.S. dollar from 2003 to 2006. Finally, note the importance of U.S. trade to the
Canadian economy and ask students if they think Canada should consider
“Americanizing” (pegging) its dollar to its neighbor’s. Why or why not? (LO: 2,
Learning Outcome: To discuss the major exchange-rate arrangements that countries
use, AACSB: Dynamics of the Global Economy)

Exercise 9.2. Use the IMF International Financial Statistics to identify countries
that use the SDR as a basis for the value of their currencies and those that use the
euro. Then engage the students in a discussion as to why certain countries have
chosen to use the SDR while others have chosen the euro. In what ways are the SDR
and the euro similar? In what ways are they different? (LO: 1, Learning Outcome:
To describe the International Monetary Fund and its role in the determination of
exchange rates, AACSB: Multicultural and Diversity Understanding)

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Solution Manual for International Business, 15/E 15th Edition : 0133457230

Exercise 9.3. Historically, the International Monetary Fund has prescribed strict
monetary policies and reduced government spending for developing countries that
sought aid in dealing with currency crises. Ask students to debate the wisdom of the
IMF’s approach. Do they believe it was effective? Then ask the students to suggest
ways in which the IMF might change its approach in the future. Be sure they
consider the implications of their suggestions for international businesses. (LO: 1,
Learning Outcome: To describe the International Monetary Fund and its role in the
determination of exchange rates, AACSB: Communication Abilities)

Exercise 9.4. Have students look up Big Mac prices in Table 9.2. Which is the most
expensive country in which to buy a Big Mac? Which is the least expensive? What
factors other than currency overvaluation or undervaluation might contribute to these
differences? Based on the theory of purchasing power parity, what is likely to
happen to these currencies against the dollar in the next few years? (LO: 6, Learning
Outcome: To explain how exchange-rate movements influence business decisions,
AACSB: Dynamics of the Global Economy)

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