Global Business 4th Edition Peng Solutions Manual

GLOBAL Business 4th Edition peng
Solutions Manual
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Chapter 7: Dealing with Foreign Exchange
Chapter 7
Dealing with Foreign Exchange
Learning Objectives
After studying this chapter, students will be able to accomplish the following objectives:
1. List the factors that determine foreign exchange rates.
2. Articulate and explain the steps in the evolution of the international monetary
system.
3. Identify strategic responses firms can take to deal with foreign exchange
movements.
4. Identify three things you need to know about currency when doing business
internationally.
Chapter Overview
Chapter 7, Dealing with Foreign Exchange, begins by explaining why the value of
currencies are so important in the global economy. The chapter defines appreciation and
depreciation, and it then turns to discuss the factors that determine foreign exchange
rates, including relative price differences, purchasing power parity, interest rates, money
supply, productivity, balance of payments, exchange rate policies, and investor
psychology. Many important concepts are covered in these sections, including balance of
payments, floating and fixed exchange rate policies, and the bandwagon effect. The
chapter’s second section explores the evolution of the international monetary system
from the gold standard of 1870 to 1914, to the Bretton Woods system of 1944 to 1973, to
the post-Bretton Woods system of 1973 to the present. One of the most enduring legacies
of the Bretton Woods system—the International Monetary Fund is then discussed.
Finally, the chapter looks at strategic monetary responses employed by financial and
nonfinancial companies alike.
Opening Case Discussion Guide
The All-Mighty Dollar
While critics in an influential Economist (2015) report argue that the dominance of the
dollar in the face of fading U.S. economic supremacy is “unsustainable,” its would-be
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contenders are in a worse shape. The newest darling, the yuan, is on the lips of many
bankers from Hong Kong to London. But it is an underachiever.
As early as 1872, the U.S. economy became larger than Britain’s. But it took 70 years
(including two World Wars) for the dollar to displace the pound as the reigning
international currency. So, what are the two lessons from history? First, a country that
does not grow its economy cannot continue to provide adequate liquidity to the global
economy indefinitely. Second, the process will take a very long time.
At present, thanks to the economic weaknesses in the rest of the world and the strengths
of the U.S. economy, the dollar recently enjoyed the rise to a 14-year high against a
basket of six major currencies. In summary, a strong dollar was bad for U.S. growth,
potentially threatening 400,000 jobs. The all-naughty dollar might wash away a lot of
President Donald Trump’s job-creation efforts.
Lesson Plan for Lecture
Brief Outline and Suggested PowerPoint Slides
Learning Objectives PowerPoint Slides

Learning Objectives Overview 2: Learning Outcomes
LO1 3: Foreign Exchange Rate

List the factors that determine foreign 4: Exhibit 7.3: What Determines Foreign
exchange rates. Exchange Rates?
5: Supply and Demand of Foreign
Exchange
6: Relative Price Differences
7: Interest Rates and Money Supply
8: Productivity and Balance of Payments
9: Exchange Rate Policies
10: Floating Exchange Rate Policy
11: Fixed Rate Policy
12: Investor Psychology
LO2 13: History of the International Monetary

Articulate and explain the steps in the System - Eras
evolution of the international monetary 14: The Gold Standard (1870–1914)
system. 15: The Bretton Woods System (1944–
1973)
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16: The Post-Bretton Woods System

(1973–Present)
17: International Monetary Fund (IMF)
LO3 18–21: Strategic Responses of Financial

Identify strategic responses firms can take Companies
to deal with foreign exchange movements. 22: Outcome of Integrated Nature of the
Foreign Exchange Market
23: Strategic Responses for Nonfinancial
Companies
LO4 24: Exhibit 7.5: Implications for Action

Identify three things you need to know
about currency when doing business
internationally.
Debate 25: Debate: International Monetary Fund

(IMF) versus New Development Bank
(NDB) and Asian Infrastructure Investment
Bank (AIIB)
Key Terms 26–27: Key Terms
Summary 28–29: Summary
Chapter Outline
LO1: List the factors that determine foreign exchange rates.
1. Key Concepts
A foreign exchange rate is the price of one currency in terms of another. This section
identifies six factors that determine foreign exchange rates: (1) basic supply and
demand, (2) relative price differences and purchasing power parity, (3) interest rates
and money supply, (4) productivity and balance of payments, (5) exchange rate
policies, and (6) investor psychology.
2. Key Terms
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• Appreciation: An increase in the value of the currency

• Balance of payments (BOP): A country’s international transaction statement,
which includes merchandise trade, service trade, and capital movement
• Bandwagon effect: The effect of investors moving in the same direction at the
same time, like a herd
• Capital flight: A phenomenon in which a large number of individuals and
companies exchange domestic currencies for a foreign currency
• Clean (free) float: A pure market solution to determine exchange rates
• Depreciation: A loss in the value of the currency
• Dirty (managed) float: Using selective government intervention to determine
exchange rates
• Fixed exchange rate policy: A government policy to set the exchange rate of a
currency relative to other currencies
• Foreign exchange rate: The price of one currency in terms of another
• Floating (flexible) exchange rate policy: A government policy to let demand
and supply conditions determine exchange rates
• Target exchange rate (crawling band): Specified upper or lower bounds
within which an exchange rate is allowed to fluctuate
3. Discussion Exercise
While individuals often attribute movements in the exchange rate to purely economic
reasons, investor psychology can produce dramatic swings as well. To illustrate this
point, lead the students through a game. The game begins with the instructor handing
out different amounts of money in various currencies (these can be copied or could
even be pieces of paper with a denomination written on it) to the students. The
instructor should then present a table of the exchange rates between the various
currencies, explaining that the rates will change periodically. Then, invite the
students to sell the currencies that they have and to buy others. The objective of this
game is to end up with the most money. At random points in the game, the instructor
may make changes to the exchange rate table, sometimes small and at other times
dramatic. Given these changes, some students may choose to trade as much as
possible to take advantage of the exchange rate changes, while other students may
choose to hang on to what they have to avoid being hurt by potential changes in the
future.
At the game’s conclusion, have students consider and discuss how changes to the
exchange rate affected their attitude toward the currencies that they held, and the
currencies that they wanted. How does the psychological factor bring about changes
to the supply and demand of currencies? How did their mindset influence the actions
5
that they took in the class’ currency exchange market?
LO2: Articulate and explain the steps in the evolution of the international monetary
system.
1. Key Concepts
The history of the international monetary system (IMF) is divided into three eras: the
gold standard, the Bretton Woods system, and the post-Bretton Woods system. The
IMF can be viewed as a lender of last resort to help member countries out of
financial difficulty.
2. Key Terms
• Bretton Woods system: A system in which all currencies were pegged at a

fixed rate to the U.S. dollar
• Common denominator: A currency or commodity to which the value of all
currencies are pegged
• Gold standard: A system in which the value of most major currencies was
maintained by fixing their prices in terms of gold
• International Monetary Fund (IMF): An international organization that was
established to promote international monetary cooperation, exchange stability,
and orderly exchange arrangements
• Post-Bretton Woods system: A system of flexible exchange rate regimes with
no official common denominator
• Quota: 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
LO3: Identify strategic responses firms can take to deal with foreign exchange
movements.
1. Key Concepts
One of the leading strategic goals for financial companies is to profit from the
foreign exchange market. The foreign exchange market is where individuals, firms,
governments, and banks buy and sell currencies of other countries. There are three
primary types of foreign exchange transactions: spot transactions, forward
transactions, and swaps. How do nonfinancial companies cope with the potential
losses they may incur due to fluctuations in the foreign exchange market, broadly
6
known as currency risks? There are three primary strategies: (1) invoicing in their
own currencies, (2) currency hedging (as discussed above), and (3) strategic hedging.
2. Key Terms
• Bid rate: The price at which a bank is willing to buy a currency

• Currency hedging: A transaction that protects traders and investors from
exposure to the fluctuations of the spot rate
• Currency risk: The potential for loss associated with fluctuations in the
foreign exchange market
• Currency swap: A foreign exchange transaction between two firms in which
one currency is converted into another at Time 1, with an agreement to revert it
back to the original currency at a specified Time 2 in the future
• Foreign exchange market: The market where individuals, firms,
governments, and banks buy and sell currencies of other countries
• Forward discount: A condition under which the forward rate of one currency
relative to another currency is higher than the spot rate
• Forward premium: A condition under which the forward rate of one currency
relative to another currency is lower than the spot rate
• Forward transaction: A foreign exchange transaction in which participants
buy and sell currencies now for future delivery
• Offer rate: The price at which a bank is willing to sell a currency
• Spot transaction: The classic single-shot exchange of one currency for
another
• Spread: The difference between the offer price and the bid price
• Strategic hedging: 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
3. Discussion Exercise
Non-financial companies that deal with exchange rates have two strategic choices to
safeguard against currency risks: currency hedging and strategic hedging. The former
involves the use of forward transactions, which necessitates some expectations or
forecasts of future rates. Strategic hedging, meanwhile, entails the spreading out of a
firm’s activities in a number of different currency zones in order to offset losses in
any one currency zone. While currency hedging can largely be performed by a small
group of experts, strategic hedging requires communication across various divisions,
including marketing, sourcing, production, and finance.
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Ask each student to imagine that he or she is an executive of a manufacturing firm

that receives supplies from 18 different countries and sells products to 24 countries.
The student’s/executive’s success or failure is determined by the exchange rates,
which cause frequent fluctuations in the price of supplies and the sale price of
manufactured goods. Considering both the pros and cons of currency hedging and
strategic hedging, which strategy would students opt for? How would they justify
this decision to other executives and to shareholders?
LO4: Identify three things you need to know about currency when doing business
internationally.
1. Key Concepts
First, a successful manager must understand that fostering foreign exchange literacy
is a must. Second, risk analysis of any country must include an analysis of its
currency risks. Third, a currency risk management strategy is necessary—via
invoicing in one’s own currency, currency hedging, or strategic hedging.
Debate: Ethical Dilemma/Emerging Markets
International Monetary Fund versus New Development Bank and Asian

Infrastructure Investment Bank
1. Key Concepts
Critics argue that the IMF’s lending may facilitate moral hazard, which means
recklessness when people and organizations (including governments) do not have to
face the full consequences of their actions. A second criticism centers on the IMF’s
lack of accountability. A third and perhaps most challenging criticism is that the
IMF’s “one-size-fits-all” strategy—otherwise known as the “bitter medicine”—may
be inappropriate. However, the momentum of the criticisms, the severity of the
global crisis, and the desire to better serve the international community have
facilitated a series of IMF reforms since 2009. The IMF 2.0 has become three times
bigger—leaders in the G20 Summit in London in 2009 agreed to enhance the IMF’s
funding from $250 billion to $750 billion.
In July 2014 at the sixth BRICS summit in Fortaleza, Brazil, BRICS countries—
consisting of Brazil, Russia, India, China, and South Africa—launched a New
Development Bank (NDB) as an alternative to the IMF. In addition, in 2015, China
took the lead to launch a new Asian Infrastructure Investment Bank (AIIB) with 50
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founding member countries. Not only did all other BRICS countries sign up, most
Asian developing countries also joined. How the NDB and the AIIB can coordinate
the internal interests among diverse members and manage tricky external
relationships with the IMF, the World Bank, and the United States remains to be
seen.
Closing Case Discussion Guide
Bellini Do Brasil’s Foreign Exchange Challenges
Danilo Bellini, owner and CEO of Bellini do Brasil, and his export manager, Carlo di
Toni both set on complaining about the political and economic situation. After more than
a decade of high inflation, low growth, and debt default, the Brazilian government
introduced a new currency, the real (R$), in 1994. José Ignácio Lula da Silva’s
government gained the confidence of the international financial markets.
During the 2003 crisis, the Central Bank’s reference nominal interest rates topped 26%.
Even at the beginning of 2017, nominal interest rates were around 13% and real interest
rates close to 8%, one of the highest worldwide. After paying back its last IMF loan in
2005, the country obtained the investment grade rating in 2008. Billions of U.S. dollars
poured into the country since then. Things markedly changed since 2013 when the
commodity price boom came to an end. Brazil, being the third largest iron ore producer
worldwide after China and Australia, seriously suffered from the collapse of the iron ore
price thanks to the Chinese slowdown.
After Rousseff was reelected in October 2014 by a narrow margin, she quickly fell into
disgrace with approval ratings falling to as low as 13% in 2016. In parallel, Brazilian
prosecutors and judges uncovered a hitherto unseen corruption scheme, which dragged
the national oil company Petrobras and major construction companies, such as
Odebrecht, Camargo Correa, and Andrade Gutierrez, into the abyss.
As if the economic and political crisis and the ensuing foreign exchange pressures were
not enough, other problems, colloquially summarized as “Custo Brasil” (“Brazil cost”),
gave Carlo and Danilo headaches. The government increased minimum wages from R$
200 in 2002 to R$ 880 in 2016. Worse, taxes levied on interstate business transactions
within Brazil make it often cheaper to import than to buy from suppliers located in
another state.
Bellini do Brasil was founded by descendants of Italian immigrants who populated the
Gaucho Highlands region in South Brazil in the second half of the 19th century. Bellini
9
recognized that the more lucrative export markets would only be reachable by focusing
on upscale furniture.
However, things changed unexpectedly. Not only did the commodity price boom come to
an end, but Brazil also suffered from a deep domestic political and economic crisis,
which led to one of the worst economic performances among emerging economies.
Although exports would generally benefit from currency devaluations, noted Carlo,
recent data from the Brazilian furniture industry showed rather a mixed picture (Exhibit
7.8). Firmly believing that there must be a way to save their company, Danilo and Carlo
discussed possible coping strategies to get out of this trap.
Video Case
Watch “Interpret Numbers with Care” by Sir Peter Middleton of Camelot.
1. Sir Peter Middleton quoted an instructor who wanted everyone to be above average.
What is the problem with everyone being above average? Middleton then indicated
that actually everyone was above average except for one person. How was that
possible?
A “mean average” involves adding up the scores of all the students and dividing by
the number of students. Thus, it would be impossible for everyone to do better than
everyone. However, if one person did lower than all the rest, that person brings
down the average and raises the average for the others.
2. Middleton argues that almost everything you do is affected by numbers. Show how
numbers are related to each major heading of this chapter.
Students’ answers may vary. The key component of the answer is the thought put
into the explanation of foreign exchange rates and strategic responses to foreign
exchange movements.
3. According to Middleton, one could produce six versions of a balance sheet or a

profit-and-loss statement. If you have had an accounting class, show how one could
produce two versions of either of those financial statements. If you have never had
an accounting class, use what you learned about currency exchange rates to show
how those changes could affect what is reported as profit.
Those who have had an accounting class will show how valuation of inventories
used during a period of time or the extent to which an expenditure is treated as an
10
expense or investment will affect the balance sheet and income statement. Those
who focus on the currency market may point out that as currencies change in value
to each other, the prices of goods from a given country will be affected. This affects
sales and profits.
4. Middleton recommended that one ask how a number would look if things were
different. One way to do that is to not simply compare performance in Period B to
Period A but to compare actual performance in Period B to what was forecast for
Period B. For example, suppose your firm’s exports drop by 10%, which would
appear to be bad. How might that be good?
If exports might otherwise have dropped by 50% but a brilliant strategy kept the
drop to only 10% that would be good.
5. Numbers can be misleading according to Middleton. That could be true in the

currency market. For example, when the value of the dollar increases, many people
would feel that is a good thing. How might it be bad?
The increase in value would make exports more expensive to overseas buyers and
thus hurt the sales of some firms.
Additional Discussion Questions

(From Prep Cards)
Critical Discussion Questions
1. Suppose that one U.S. dollar equals 0.7778 euro in New York and one dollar equals
0.7775 euro in Paris. How can foreign exchange traders in New York and Paris
profit from these exchange rates?
Arbitrageurs profit by buying low in one market and selling high in another.
However, as they dump more of a currency into a higher priced market, they are
increasing the supply of that currency in that market. 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. Should China revalue the yuan against the dollar? If so, what impact might this
have on: (1) U.S. balance of payments, (2) Chinese balance of payments, (3)
relative competitiveness of Mexico and Thailand, (4) firms such as Walmart, and
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(5) U.S. and Chinese retail consumers?
Students’ answers will vary. If China revalues the yuan against the dollar, the U.S.
balance of payments would improve and the Chinese balance of payments would
decline. The relative competitiveness of any country with its currency tied to the
dollar is also likely to improve. Chinese retail consumers would gain profit, while
Walmart and U.S. consumers would lose.
Review Questions
1. What are the five major factors that influence foreign exchange rates?
The basic dynamic of supply and demand for a currency is affected by the
following five factors: (1) relative price differences (the impact of purchasing
power parity), (2) interest rates and monetary supply (interest rates of a country will
affect the demand for a currency, and monetary policies of a country will affect the
supply of a currency), (3) productivity and the balance of payments (productivity
affects the cost of a country’s goods and that cost will impact exports, which in turn
affects the balance of payments), (4) exchange rate policies (a currency which can
be freely exchanged will be more desirable than one which cannot), and (5)
investor psychology (positive or negative expectations will affect the extent to
which a currency is desirable).
2. What are the differences between a floating exchange rate policy and a fixed
exchange rate policy?
A floating (or flexible) exchange rate policy includes the willingness of a

government to let demand and supply conditions determine the exchange rate. A
fixed exchange rate policy includes fixing the exchange rate of a currency relative
to other currencies.
3. Describe the IMF’s roles, responsibilities, and challenges.
The International Monetary Fund (IMF) is 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
the adjustments to the balance of payments. While an IMF loan provides short-term
financial resources, it also comes with strings attached, including long-term policy
reforms that recipient countries must undertake to receive their loans.
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4. Describe the three primary types of foreign exchange transactions made by

financial companies.
There are three primary types of foreign exchange transactions.

• Spot transactions are the classic single-shot exchange of one currency for
another.
• A forward transaction is a foreign exchange transaction in which participants
buy and sell currencies now for future delivery, typically in 30, 90, or 180
days after the date of the transaction.
• A currency swap is a foreign exchange transaction in which one currency is
converted into another at Time 1, with an agreement to revert it back to the
original currency at a specific Time 2 in the future.
5. Why is the strength of the U.S. dollar important to the rest of the world?
The rest of the world holds so many U.S. dollars that most countries fear the capital
loss they would suffer if the dollar fell too deep. Additionally, many countries
prefer to keep the value of their currencies down to promote exports.
6. How would you describe the theory of purchasing power parity (PPP)?
Purchasing power parity is a theory that suggests that in the absence of trade
barriers (such as tariffs), the price for identical products sold in different countries
must be the same.
7. What is the relationship between a country’s current account balance and its
currency?
A country experiencing a current account surplus will see its currency appreciate.
Conversely, a country experiencing a current account deficit will see its currency
depreciate.
8. How is the phenomenon of capital flight an example of the bandwagon effect or

herd mentality?
Capital flight is a phenomenon in which a large number of individuals and

companies exchange domestic currencies for a foreign currency. The bandwagon
effect is the result of investors moving as a herd in the same direction at the same
time.
13
9. Why did the gold standard evolve to the Bretton Woods system? Then, why did the
Bretton Woods system evolve to the present post-Bretton Woods system?
The gold standard provided predictability but placed a focus on economic

adjustments and exports, which were difficult to maintain during wartime. Thus,
toward the end of the Second World War, the Bretton Woods system was created in
which currencies were pegged to the dollar. However, it was difficult to maintain
those pegged rates. As a result, under the post-Bretton Woods system, flexible rates
became more common.
10. Name and describe three ways nonfinancial companies can cope with currency
risks.
The three primary strategies for coping with currency risks are given below.
• By invoicing in their own currency, firms can find some protection from
unfavorable foreign exchange movements.
• Currency hedging is a transaction that protects traders and investors from
exposure to the fluctuations of the spot rate.
• Strategic hedging involves 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.
11. Which do you think is a better policy to adopt: a floating exchange rate or a fixed
rate?
This is a question in which the student’s thought process and the ability to clearly
articulate are more important than the answer.
12. Devise your own example of a way a firm might engage in currency hedging.
Currency hedging involves a transaction that protects traders and investors from
exposure to the fluctuations of the spot rate. The example given by the student is
not as important as the extent to which the student demonstrates thought in
providing the answer.
13. What concepts must a savvy manager understand about currencies to do

international business successfully?
First, foreign exchange literacy must be fostered. Second, a risk analysis of any
14
country must include its currency risks. Finally, a country’s high currency risks do
not necessarily suggest that the country needs to be totally avoided. Instead, it calls
for a prudent currency risk management strategy via currency hedging, strategic
hedging, or both.
14. What skills might a manager need to devise strategies for managing currency risk?
To devise strategies for managing currency risk, managers need to develop useful
skills that include currency hedging, strategic hedging, or both.

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GLOBAL Business 4th Edition peng

Opening Case Discussion Guide

The All-Mighty Dollar

Lesson Plan for Lecture

Brief Outline and Suggested PowerPoint Slides

Learning Objectives PowerPoint Slides

LO1 3: Foreign Exchange Rate

LO2 13: History of the International Monetary

16: The Post-Bretton Woods System

LO3 18–21: Strategic Responses of Financial

LO4 24: Exhibit 7.5: Implications for Action

Debate 25: Debate: International Monetary Fund

Key Terms 26–27: Key Terms

Summary 28–29: Summary

LO1: List the factors that determine foreign exchange rates.

• Appreciation: An increase in the value of the currency

that they took in the class’ currency exchange market?

• Bretton Woods system: A system in which all currencies were pegged at a

• Bid rate: The price at which a bank is willing to buy a currency

Ask each student to imagine that he or she is an executive of a manufacturing firm

Debate: Ethical Dilemma/Emerging Markets

International Monetary Fund versus New Development Bank and Asian

Closing Case Discussion Guide

Bellini Do Brasil’s Foreign Exchange Challenges

Watch “Interpret Numbers with Care” by Sir Peter Middleton of Camelot.

3. According to Middleton, one could produce six versions of a balance sheet or a

5. Numbers can be misleading according to Middleton. That could be true in the

Additional Discussion Questions

Critical Discussion Questions

(5) U.S. and Chinese retail consumers?

A floating (or flexible) exchange rate policy includes the willingness of a

3. Describe the IMF’s roles, responsibilities, and challenges.

The International Monetary Fund (IMF) is an international organization that was

4. Describe the three primary types of foreign exchange transactions made by

There are three primary types of foreign exchange transactions.

8. How is the phenomenon of capital flight an example of the bandwagon effect or

Capital flight is a phenomenon in which a large number of individuals and

The gold standard provided predictability but placed a focus on economic

13. What concepts must a savvy manager understand about currencies to do

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