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M ODULE IV FACTORS AFFECTING B USINESS E NVIRONMENT

R OLE OF G OVERNMENT IN B USINESS E NVIRONMENT

Promoter, Caretaker and Regulator


Policy to promote and protect SSIs Efforts to revive sick units

Development of Indian Multinationals


Uninterrupted inflow of foreign capital, technology and expertise

Promote and maintain ecological balancing and sustainable growth philosophy in business environment

R OLE OF G OVERNMENT IN B USINESS E NVIRONMENT


Promote social role of business in country Infrastructural facilities to develop the economy Appropriate legal system for industrial growth and development Industrial policy for a balanced industrial and economic growth

Industrial licensing policy with minimum restriction and maximum inducement for investment and growth
Trade and export-import policy

C ULTURAL , E CONOMIC , P OLITICAL , L EGAL , E COLOGICAL , AND T ECHNOLOGICAL ENVIRONMENT I TS I NFLUENCE ON B USINESS

C ULTURAL E NVIRONMENT

Society

Business

C ULTURE : W HAT

IS IT ??

Culture is the art and other manifestations of human intellectual achievement regarded collectively;

it is the customs, civilization, and achievement of a particular time or people; is it the way of life of a particular society or group.

Culture is the knowledge, beliefs, art, law, morals, customs, and other capabilities of one group, distinguishing it from other groups

C ULTURAL E NVIRONMENT D EFINITION

It is the class structure of society.


It depends upon many factors:

Occupation of the people Education of the people Income level Social status Mobility Attitude towards living and work Social relationship Attitude towards business

C ULTURE

It broadly means how the members of the society behave and interact with each other in the society, as well as outside society It includes

Values Norms Customs Ethics Goals Other accepted behavioral patterns

R ELIGION T HE B ASIS OF C ULTURAL S TRUCTURE

For many years, religion has been the basis of cultural structure in the society. Business was also influenced by the dogmas of church. In the Middle Ages, the Catholic Church believed that business was evil. However, the outlook has changed with the passage of time.

C ULTURE

IN I NDIA

Hinduism has been the behind-the-scenes force in the society.


Other religious groups have also asserted themselves in the political spheres. Such groups include

Muslims Christians Sikhs Parsis, etc.

C ASTE S YSTEM

C ASTE S YSTEM

The upper castes had an advantage over the lower castes in terms of cultural structure.
The situation didnt change even during the British rule. After the independence, the Government adopted reservation policy. Under this policy, the Government intends to nullify the disadvantage that the lower castes suffered before independence. Because of such a system, an entrepreneur cant employ a person of his choice to increase the productivity of the business.

R OLE OF W OMEN IN B USINESS

Earlier, joint family structure was prevalent in India. During that period, the women were confined to managing home and looking after the family. However, with the break-ups of joint families, now women have started taking bigger role in businesses occupying places of profit.

R URAL /U RBAN D IVIDE

The rural and urban cultures differ in terms of


Education Upbringing Outlook Aspiration of people

Attitude of people
Ambition of people

C ULTURE AND I NTERNATIONAL B USINESS

Culture is very important to the practice of international business.


Culture impacts the way strategic moves are presented. Culture influences decisions. Culture is the lens through which motivation occurs. Management, decision making, and negotiations are all influenced through culture. Culture influences nearly all business functions from accounting to finance to production to service.

C ULTURE AND THE L IABILITY OF F OREIGN - NESS

Culture is a key ingredient in the liability of foreign-ness . Culture is what makes international business practice difficult or easy, depending on how similar or different cultures are. Culture is both divisive and unifying.

C ULTURE DOES NOT EXPLAIN


EVERYTHING

While culture is very important to our understanding of international business, it does not explain everything that is different from one place to another. While culture explains some, other things like corporate strategy, structure, governmental policy, and economics also help to explain success or failure in international business.

C ORRELATES OF C ULTURE : O VERVIEW

Culture is correlated with other variables that vary cross-nationally, like language and religion. It is useful to remember that culture often cuts across religious, linguistic, and national borders. Religious, linguistic and national boundaries also often cut across cultures too.

C ORRELATES OF C ULTURE : L ANGUAGE

Language is the means by which we communicate verbally. We use it for socialization and for communicating how values and norms are expressed and understood. According to the records, there are approximately 20 different language families that cut across national borders. Not only are words different, but also syntax and usages are also quite different between language families.

C ORRELATES OF C ULTURE : V ERBAL AND N ONVERBAL L ANGUAGE

It is important to remember, that for language to be truly useful to business people,

they must understand the uses, distances, gestures and interpretations that accompany verbal communication.

Without this broader understanding, cross cultural communication can quickly go away.

C ULTURE -A ESTHETICS

Aesthetics pertain to a culture's sense of beauty and good taste, and is expressed in arts, drama, music, folklore, dance and the like.
Aesthetics are of special interest to the international business executives for these govern the norms of beauty in a society and are helpful in correctly interpreting meanings of various methods of artistic expressions, colors, shapes, forms and symbols in a particular culture. Colors, for instance, mean different things to different people. The color of mourning is black in the United States, but it is white in the Far East. Green is restful color to Americans, but it is disliked by people in Malaysia where it connotes illness and death.

C ULTURE -A ESTHETICS

Symbols also need to be interpreted correctly. Seven, for instance, signifies good luck in the United States but just opposite in Singapore, Ghana and Kenya. Use of number four should be avoided in Japan because it is pronounced as 'shi' which in Japanese means death. Sensitivity to the aesthetics of a society and their symbolic expressions can greatly help in avoiding socially embarrassing situations and correctly designing the products and messages.

C ULTURE -E DUCATION

Education is generally understood as formal schooling.


However, it is better to adopt a broader perspective and define education as any process, formal or informal, through which one learns skills, ideas and attitudes. Education is important as it affects not only the education levels but also the development of mental faculties and various skills. In general, educated people have been found to be more sophisticated, discriminating and receptive to new products and ideas.

C ULTURE -E DUCATION

Availability of educated manpower like skilled labor, technicians and professionals is also dependent on the country's education level. Media to be used by a company for promoting its products and services are also dependent on education level prevailing in the country. The conventional forms of printed communications, for instance, do not work in countries where literacy rates are low.

C ULTURE -R ELIGIONS AND S UPERSTITIONS

Religions are a major determinant of moral and ethical values and influence people's attitudes, habits and outlook on life which are reflected in their work habits and consumption patterns.
Dr. Ernest Dichter observed: "In puritanical cultures, it is customary to think of cleanliness as being next to godliness. But in Catholic and Latin American countries, to fool too much with one's body to overindulge in bathing or toiletries, has the opposite meaning. It is that type of behavior which is considered immoral and improper".

There are numerous religions and faiths in the world, with prominent ones being : Animism, Buddhism, Christianity, Hinduism, Islam and Shinto. Each one has its own morals and codes of conduct.

C ULTURE -R ELIGIONS AND S UPERSTITIONS

A working knowledge of the religions prevalent in the target markets helps in understanding people's work habits, underlying motivations and consumption behaviors.
Equally important are the superstitions of the people in a society.

People's beliefs in astrology, hand reading, ghosts, lucky days and places are integral part of certain cultures.
In some countries, single storey houses are preferred because it is considered bad to have another's foot on ones head. Location of a building and its architecture in many Asian countries is governed by the principles of 'vastushastra' and Feng Shui rather than purely geographical and economic considerations.

C ULTURE -ATTITUDES AND VALUES


Besides religions and superstitions, one must be cognizant of attitudes, values and beliefs prevalent in a society.
These attitudes and values may relate to consumption level, material possessions, risk taking and change. 'What is important and desirable' differs from society to society and is largely governed by the attitudes and values existing in a society. Americans in general are more receptive to change and risk taking, but people in many societies are averse to change and risk taking. They prefer doing what is traditional and safe. New products are not accepted unless these have the approval of local chiefs or religious leaders.

C ULTURE -T ECHNOLOGY

Technology includes the ways and means applied in making of material goods. It is technical know-how in possession of the people of a society. Choice of technology has its repercussions on the size of investment, scale of operations as well as type and number of workers to be employed. Technology transfer has been a highly controversial issue in the past. Because of supply of obsolete or inappropriate technology, many developing countries have laid down stringent rules and regulations concerning technology imports and payments. Since transfer of new technology is often riddled with workers' resistance to change and public criticisms, multinational corporations generally have suitable action plans to counter such opposition.

C ULTURE -M ATERIAL C ULTURE

According to Ball and McCulloch, material culture refers to all manmade objects and its study is concerned with how man makes things and who makes what and why.

While the question 'how? relates to technology, other questions 'who', 'what' and 'why' are part of economics.
These elements influence the level of demand as well as types and quality of goods in demand, and consumption pattern in a society.

C ULTURE -M ATERIAL C ULTURE

Business implications of material culture of a society are obviously many.


The goods and services that are acceptable in one market may not be acceptable in another market because of differences in material cultures of two societies. For example, sophisticated electronic appliances widely in demand in the technologically and economically advanced Western countries may not find a market in the less developed countries of Asia, Africa or Latin America.

E CONOMIC E NVIRONMENT

Among all the uncontrollable, economic environment is perhaps the most important factor.
An analysis of economic environment enables a firm to know how big is the market and what its nature is. Answers to these questions in turn determine whether a firm should enter a given foreign market, and if yes, what strategies it should use to successfully run its business operations.

E CONOMIC E NVIRONMENT

Economic Development: Economic development is directly related to the development of marketing in a country.
Countries characterized by high levels of economic development not only have high demand for a variety of products, but also have better infrastructure and more developed marketing systems. Competition is also high in these countries.

In the less developed countries, on the other hand, not only demand is low, but infrastructure is also poor. It, therefore, becomes quite difficult and more expensive to do business in such nations.

E CONOMIC E NVIRONMENT

Income: Income is an important indicator of the country's level of development and also its market size. Gross national product (GNP) and per capita income are among the major measures of income. While sales of most of the industrial goods and capital equipment generally co-relate with GNP, demand for consumer products depends on per capita income. Though per capita income is a useful measure, it is not a full-proof measure of the country's development and prosperity. What is more relevant is the distribution of income.

While in the developed countries income distribution is relatively more even, it is highly skewed in the developing countries. Since only a small portion of the population accounts for 60 to 70 percent of the country's GNP and the rest are poor in the developing countries, market for high priced product and non-essential products is limited only to select rich people.

E CONOMIC E NVIRONMENT

Besides income, one should acquire information about the sectoral distribution of the GNP as it is an important determinant of kinds of goods in demand in a foreign country.
If the majority of a country's GNP comes from agriculture, it implies that the country is agriculture based and it shall have a good demand for agricultural inputs such as seeds, fertilizers, pesticides and agricultural machinery and tools.

An industrial nation with relatively higher dependence on manufacturing, on the other hand, shall have a good market for raw materials, plant and machinery, and also for a variety of consumer durables and non-durables.

E CONOMIC E NVIRONMENT

Expenditure Pattern: Data on expenditure patterns are useful in judging as to how the money is spent on different item and which products receive more weightage. Infrastructure: Infrastructure is another vital dimension of the country's economic environment and is directly related to the country's economic development.

E CONOMIC E NVIRONMENT

Infrastructure refers to various social overheads such as transportation, telecommunications, commercial and financial services like advertising, marketing research, various media, warehousing, insurance, distribution, credit and banking facilities. Absence of adequate infrastructure not only hinders country's development but also affects firms' costs and capacity to reach various market segments.
Companies find it difficult to co-ordinate and control their business in countries with poor communication systems.

P OLITICAL E NVIRONMENT

Political forces has a large influence over the nature of business, programs and projects to be undertaken for the development of the country.

These political forces can be classified as


Long term forces Quick changes

Regional factors

POLITICAL ENVIRONMENT

It is rightly said that a foreign business firm operates only as a guest and at the convenience of the host country government.
The government reserves the right of allowing a foreign firm to operate in the country as well as laying down the manner in which a foreign firm can conduct business. To gain an insight into a foreign country's political environment, one needs to analyze factors such as current form of government and political party system, role of government in the economy, political encouragement to foreign firms, political stability, and political risks to business.

POLITICAL ENVIRONMENT
Form of Government and Political Party System:

Government in a foreign country can be either parliamentary or absolutist.


While the parliamentary type of government is run by people's representatives selected from time to time, the absolutist government assumes the form of absolute monarchies or dictatorships, and only a select few make policies. In the case of parliamentary government, one needs to know whether it is a single party system or multiparty government system.

Single party government is considered to be more stable than the multiparty government.
However, multiparty system brings in checks and balances to authoritarianism of single party system.

POLITICAL ENVIRONMENT
Political Ideology and Role of Government:

Besides political party system, one must have knowledge about the political ideology and government attitudes toward foreign business and investment. In addition to regulatory role, government itself can be directly involved in business. In such cases, government enterprises emerge as dominant players in the market and pose tough competition to the foreign firms. Even supplying goods and services to the agencies is not hassle free. Because of monopsonic power of the government organizations, it becomes quite arduous to negotiate prices and other terms with them.

POLITICAL ENVIRONMENT
Political Stability:

Stability of the government and government policies are a major concern for the international firm. Since business decisions, these days involve huge investments and are irreversible, what the foreign firms look in for is politically stable countries. Political instability can result from either change in the type of government, a shift in political parties that form the government or change in the government policies without change in the government or shifts in political parties.

POLITICAL ENVIRONMENT
Political Risk:

Political risk which is defined as the vulnerability of a project to the political acts of a sovereign government is a big threat to foreign business.

The political acts leading to political risks can range from confiscation, expropriation, nationalization, domestication to restrictions on transfer of finds.
Confiscation occurs when a foreign investment is taken over by a government without any compensation.

POLITICAL ENVIRONMENT
Political Risk:

Expropriation takes place when the government takes over foreign investment but some compensation is paid. The compensation may or may not equate with the market value of a firm. Nationalization affects the entire industry rather than a single company, and involves transferring ownership of the confiscated or expropriated business to a national firm or government entity.

POLITICAL ENVIRONMENT
Political Risk:

Domestication is a mild form of intervention and involves transfer of control of foreign investment to national ownership to bring the firm's activities in line with national interest. It differs from expropriation in the sense that it is gradual encroachment of the freedom of operation of a foreign operator.
Domestication can be either firm initiated, government initiated or predetermined. Whereas firm initiated and predetermined domestication entail low levels of risk, government initiated domestication is quite risky and is ranked equal with expropriation in risk.

POLITICAL ENVIRONMENT
Political Risk:

Another type of risk relates to a temporary or permanent blocking of finds.


Unlike other kinds of risks, a business firm under blockage of funds owns the funds and property rights but it cannot remit the funds or earnings back to home country. This was a common problem faced by Indians during Idi Amin's rule in Uganda. Although the government did not formally make any announcements regarding takeover of property, it became almost impossible for the firms to repatriate their earnings in any form. No doubt black money market operations may exist in any country, it is difficult for such operations to handle large scale of funds involved.

POLITICAL ENVIRONMENT
Political Risk:

International firms need a proactive approach to deal with political risks. An effective management of risks calls for recognizing the existence of various kinds of political risks and their consequences, and developing appropriate plans and policies to deal with such risks.

LEGAL ENVIRONMENT

Every business firm operates within the jurisdiction of legal system.

This is true of domestic as well as international firms.


But the problem for the international firms is that the laws that they face in their home countries might be different from those encountered in the host countries. Advertising laws in Germany, for instance, are so strict that is it best advised for the international marketer to get himself good legal counsel before framing his advertising strategy. Similarly there exist laws in European countries preventing promotion of products through price discounting. These laws are based on the premise that such practices differentiate buyers.

LEGAL ENVIRONMENT

Different laws exist in different countries not only in the area of marketing mix variables but also for other business decisions like location of plant, level of production, employment of people, raising money from the market, accounting and taxation, property rights including immovable property and patent and trade marks, cancellation of agreements.

LEGAL ENVIRONMENT

Besides directly influencing firm's business operations, laws affect the environment within which a firm operates in the foreign country. Thus while one country may promote competition within its markets through its legal system, another country might try to protect its industry and thereby restrain competition.

In the United States, for instance, anti-trust legislation influences all mergers, takeovers, and business practices which are in restraint of trade. Court's verdicts in this respect are governed by paragraph one of Sherman Act.
Gillette, for example, was prevented from taking over Braun A.G. of Germany which was an electric razor manufacturer on the grounds that it would distort competition.

LEGAL ENVIRONMENT

A major problem with laws in different countries is that the legal systems of the world are not harmonized and are in fact based on contradicting legal philosophies. The legal systems that exist in different countries of the world are antecedents of one of the two legal philosophies ,viz., common law and code law. Common law finds it roots in Britain and is practiced today in the United States, United Kingdom and Canada. The basis of common law is tradition, past practices and past rulings of higher courts who look upon similar problems within the accepted set of laws.

Code law, on the other hand, is based on Roman law and is an all inclusive system of written rules that encompass all eventualities.

LEGAL ENVIRONMENT

One important business implication of the two legal philosophies is that the judgements awarded in the case of a commercial dispute can be radically different.
To illustrate, let us take the interpretation of nonfulfillment of required conditions of a contract under 'act of god'. What constitutes an 'act of god' in code law is not necessarily the same under common law. Thus while strike by workers may be looked upon as an 'act of god' in code law, it will definitely not be a reason for non-fulfillment of the contract under the common law.

LEGAL ENVIRONMENT

In the last few decades, efforts have been made to evolve international laws International laws deal with upholding orders. Originally these laws recognized only nations as entities, but today these laws also incorporate role played by individuals.

LEGAL ENVIRONMENT

International laws may be defined as a set of rules and regulations which the nations consider binding upon themselves. This definition brings out two important characteristics of international law.
1.

One there is absence of the existence of a comprehensive legal system. There is truly no comprehensive body of law because as stated earlier international commercial law is of recent birth. This has had a direct bearing upon the existing administering authorities. As of today, there are only a few international bodies for administering justice. These include International Court of Justice founded in 1946 and the World Court at Hague. Second characteristic of the international law relates to the fact that no nation can be forced into these rules as stated in the phrase 'consider binding upon them'. Since all nations recognize the sovereignty of the legal systems, international judgements are, therefore, based on the premise of good humanity and not on the basis of any particular country's legal system.

2.

LEGAL ENVIRONMENT

In the absence of laws having jurisdiction over sovereign countries, a major problem faced by the international business firms is which country's laws, viz.. host country's or home country's or third country's laws, shall be binding in the case of a dispute. Firms also need to be aware of different modes of the settlement of trade disputes and role of International Chamber of Commerce' Court of Arbitration.

ECOLOGICAL ENVIRONMENT

Ecology refers to the pattern and balance of relationships between plants, animals, people and their environment. Earlier there was hardly any concern for the depletion of resources and pollution of the environment. Smoke stemming from the chimneys and the dust and grime associated with factories were accepted as a necessary price to be paid for the development. But in recent years, the magnitude and nature of the 'pollution overload' have assumed such alarming proportions that pressures have built up all over the world to do something urgently lest the situation gets out of control.

ECOLOGICAL ENVIRONMENT

In almost all the countries, there exist today legislations and codes of conduct to preserve the earth's scarce resources and put a halt to any further deterioration in the environment. Business operations of the international firms are no exceptions and have been brought under such regulations. Very recently, the United States government imposed a ban on exports of marine products from countries including India which did not have special devices fitted into fishing trawlers to free the tortoises trapped during fishing expeditions. Similarly, restrictions have been put on garment exports using cloth processed through the use of AZO dyes. Germany today is perhaps the country with most stringent environmental laws in the world.

ECOLOGICAL ENVIRONMENT

The concept of industrial progress and development has also undergone paradigm shifts. Corporations today are judged in terms of not only financial returns, but also conservation of environmental resources and reduction in pollution levels. Green technologies, green products and green companies are highly valued in today's global market place.

TECHNOLOGICAL ENVIRONMENT

Technological factors sometimes pose serious problems. A firm that unable to cope with technological changes may not be survived. Further, the differing technological environment of different markets or countries may be called for product modifications.

TECHNOLOGICAL ENVIRONMENT

Technology is the most important elements of the macro environment. Technology is the human being innovation and it literally wonder. Technology helps to human being go to moon, travelling the spaceships, other side of the globe with few hours.

Advances in the technologies have facilitated product improvements and introduction of new products and have considerably improved the marketability of the products.
Internet and telecom system is the part of technological development in the world.

These things today changed whole world.


It changes people and business operation. It leads to many new business opportunities apart from the many existing systems.

T ECHNOLOGICAL E NVIRONMENT

Technological environment characteristics are outlined:

The find of technological change

Opportunities are arising out of technological developments.


Risk and uncertain is the major feature of the technological developments. Research and development role to country

T ECHNOLOGICAL E NVIRONMENT
Technologies issues relating with companies are listed below:

Access to the internet communication facilities which is enable to connect large numbers of employees to work from one place/ home to another place in the globe. It helps to business for sales and exchange of goods and services. It provide opportunity to customers with accessing to online shopping through the internet technology.

T ECHNOLOGICAL E NVIRONMENT OF THE C OMPANY

K EY I SSUES OF T ECHNOLOGY

Strategist should know what of type technology used by company?

Strategist should know which type of technologies are used in the companies, business, products and its services?
To know the critical issues in technology and know the operating skills in technology related products and services.

To know the availability of technology to organisation. And also its procedure to get external technology for its operations.
To know the cost of technology, alternative technology, competitors, design structure of the technology and production implementation services of the company. To know the companys business applications that are relating to technology. Technology helps the business for formulation of strategy, implementation of strategy and control of the company performance.

M OTIVES FOR U SING I NTERNATIONAL F INANCIAL M ARKETS

The markets for real or financial assets are prevented from complete integration by barriers such as tax differentials, tariffs, quotas, labor immobility, communication costs, cultural differences, and financial reporting differences. Yet, these barriers can also create unique opportunities for specific geographic markets that will attract foreign investors.

M OTIVES FOR U SING I NTERNATIONAL F INANCIAL M ARKETS

Investors invest in foreign markets:

to take advantage of favorable economic conditions;

when they expect foreign currencies to appreciate against their own; and
to reap the benefits of international diversification.

M OTIVES FOR U SING I NTERNATIONAL F INANCIAL M ARKETS

Creditors provide credit in foreign markets:


to capitalize on higher foreign interest rates; when they expect foreign currencies to appreciate against their own; and to reap the benefits of international diversification.

M OTIVES FOR U SING I NTERNATIONAL F INANCIAL M ARKETS

Borrowers borrow in foreign markets:


to capitalize on lower foreign interest rates; and when they expect foreign currencies to depreciate against their own.

F OREIGN E XCHANGE M ARKET

The foreign exchange market allows currencies to be exchanged in order to facilitate international trade or financial transactions.

The system for establishing exchange rates has evolved over time.

From 1876 to 1913, each currency was convertible into gold at a specified rate, as dictated by the gold standard.

F OREIGN E XCHANGE M ARKET

This was followed by a period of instability, as World War I began and the Great Depression followed. The 1944 Bretton Woods Agreement called for fixed currency exchange rates. By 1971, the U.S. dollar appeared to be overvalued. The Smithsonian Agreement devalued the U.S. dollar and widened the boundaries for exchange rate fluctuations from 1% to 2%.

F OREIGN E XCHANGE M ARKET

Even then, governments still had difficulties maintaining exchange rates within the stated boundaries. In 1973, the official boundaries for the more widely traded currencies were eliminated and the floating exchange rate system came into effect.

F OREIGN E XCHANGE T RANSACTIONS

There is no specific building or location where traders exchange currencies. Trading also occurs around the clock.

The market for immediate exchange is known as the spot market.


The forward market enables an MNC to lock in the exchange rate at which it will buy or sell a certain quantity of currency on a specified future date.

F OREIGN E XCHANGE T RANSACTIONS

Hundreds of banks facilitate foreign exchange transactions, though the top 20 handle about 50% of the transactions.

At any point in time, arbitrage ensures that exchange rates are similar across banks.
Trading between banks occurs in the interbank market. Within this market, foreign exchange brokerage firms sometimes act as middlemen.

F OREIGN E XCHANGE T RANSACTIONS

The following attributes of banks are important to foreign exchange customers:

competitiveness of quote

special relationship between the bank and its customer


speed of execution

advice about current market conditions


forecasting advice

F OREIGN E XCHANGE T RANSACTIONS

Banks provide foreign exchange services for a fee: the banks bid (buy) quote for a foreign currency will be less than its ask (sell) quote. This is the bid/ask spread. ask rate bid rate
ask rate

bid/ask % spread =

Example:

Suppose bid price for = $1.52, ask price = $1.60.

bid/ask % spread = (1.601.52)/1.60 = 5%

F OREIGN E XCHANGE T RANSACTIONS


The bid/ask spread is normally larger for those
currencies that are less frequently traded.

The spread is also larger for retail transactions than for wholesale transactions between banks or large corporations.

I NTERPRETING F OREIGN E XCHANGE Q UOTATIONS

Exchange rate quotations for widely traded currencies are frequently listed in the news media on a daily basis. Forward rates may be quoted too. The quotations normally reflect the ask prices for large transactions.

I NTERPRETING F OREIGN E XCHANGE Q UOTATIONS

Direct quotations represent the value of a foreign currency in dollars, while indirect quotations represent the number of units of a foreign currency per dollar. Note that exchange rate quotations sometimes include IMFs special drawing rights (SDRs). The same currency may also be used by more than one country.

I NTERPRETING F OREIGN E XCHANGE Q UOTATIONS

A cross exchange rate reflects the amount of one foreign currency per unit of another foreign currency.

Value of 1 unit of currency A in units of currency B= value of currency A in $


value of currency B in $

C URRENCY F UTURES AND O PTIONS M ARKET

A currency futures contract specifies a standard volume of a particular currency to be exchanged on a specific settlement date. Unlike forward contracts however, futures contracts are sold on exchanges. Currency options contracts give the right to buy or sell a specific currency at a specific price within a specific period of time. They are sold on exchanges too.

$ E UROCURRENCY M ARKET

U.S. dollar deposits placed in banks in Europe and other continents are called Eurodollars. In the 1960s and 70s, the Eurodollar market, or what is now referred to as the Eurocurrency market, grew to accommodate increasing international business and to bypass stricter U.S. regulations on banks in the U.S.

$ E UROCURRENCY M ARKET

The Eurocurrency market is made up of several large banks called Eurobanks that accept deposits and provide loans in various currencies.

For example, the Eurocurrency market has historically recycled the oil revenues (petrodollars) from oil-exporting (OPEC) countries to other countries.

$ E UROCURRENCY M ARKET
Although the Eurocurrency market focuses on
large-volume transactions, there are times when no single bank is willing to lend the needed amount.

A syndicate of Eurobanks may then be composed


to underwrite the loans. Front-end management and commitment fees are usually charged for such syndicated Eurocurrency loans.

$ E UROCURRENCY M ARKET

The recent standardization of regulations around the world has promoted the globalization of the banking industry.

In particular, the Single European Act has opened up the European banking industry.
The 1988 Basel Accord signed by G-10 central banks outlined common capital standards, such as the structure of risk weights, for their banking industries.

E UROCURRENCY M ARKET

The Eurocurrency market in Asia is sometimes referred to separately as the Asian dollar market. The primary function of banks in the Asian dollar market is to channel funds from depositors to borrowers. Another function is interbank lending and borrowing.

T HE O RIGINS

OF

O FFSHORE B ANKING

S UPPLY D EMAND

AND FOR

The Eurocurrency market evolved through a combination of forces. The supply and demand for Eurodollars had always been present. The innovation came in the mid-1950s when banks elected to lend these funds within Europe rather than invest them in the U.S. money market. The demand for Eurodollars further multiplied when the Bank of England restricted the external use of sterling in 1957.

B OOST

O NSHORE B ANKING R EGULATIONS


THE

O FFSHORE M ARKET

Under Regulation Q, the Federal Reserve established ceilings on the interest rate that banks could pay on deposits.

To reduce the U.S. capital outflow, more regulations were imposed in the 1960s:

The Interest Equalization Tax (IET) taxes U.S. purchases of foreign securities. The Foreign Credit Restraint Program limits the volume of bank lending with foreigners.

B OOST

O NSHORE B ANKING R EGULATIONS


THE

O FFSHORE M ARKET

However, these regulations only further encouraged borrowers to investigate the Eurocurrency markets.

B OOST

O NSHORE B ANKING R EGULATIONS


THE

O FFSHORE M ARKET

European governments also experimented with capital controls in the 1970s.

Both Germany and Switzerland imposed regulations to try to limit the nonresident demand for their currencies.

Similarly, these regulations helped to promote the non-dollar segments of the Eurocurrency market.

T HE O FFSHORE M ARKETS E NDURE

Even though many of the regulations that initially fostered the market had since been abolished, the Eurocurrency markets have continued to grow and prosper. Today, we describe the innovation that permits the Eurocurrency market to sustain its existence as unbundling - taking the exchange risk of one currency and combining it with the regulatory climate and political risk of another financial center.

G ROWTH

OF THE

E UROCURRENCY M ARKET

As in the onshore markets, funds are deposited, lent, re-deposited, and re-lent in the Eurocurrency market.

The market has grown from essentially zero in 1960 to roughly $9.5 trillion on a gross basis and $5.5 trillion on a net basis in 1999.
The U.S. dollar is the main currency, while Europe is the dominant region for Eurocurrency deposits.

T HE E UROCURRENCY
MARKET

Attractions

Gave opportunity to those who wanted to deposit or borrow dollars (later, other currencies, as well). Lack of government regulations makes the Eurocurrency attractive Banks offer higher interest rates

Drawbacks

Unregulated system could result in loss of deposits Borrowing funds internationally can expose a company to foreign exchange risk

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