Transcript Slide 1
This chapter covers:
11
•The foreign
exchange markets
•Foreign exchange
quotations
Financial Forces
•Currency exchange
risks
•Currency exchange
controls
•How financial forces
affect business
•Sovereign debt
•Small business in a
developing country
International Business
by Ball, McCulloch, Frantz,
Geringer, and Minor
McGraw-Hill/Irwin
Copyright © 2006 The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
Realize that money is made, and lost, in the foreign
exchange markets
Understand foreign exchange quotations, including
cross rates
Recognize currency exchange risks
Understand currency exchange controls
Understand financial forces that affect business
Explain sovereign debt, its causes, and its solutions
Recognize the role of small business in a
developing country
11-2
Uncontrollable Financial Forces
Foreign Currency Exchange
Risks
National Balances of
Payment
Taxation
Tariffs
National monetary and fiscal
policies
Inflation
National business
accounting rules
11-4
Fluctuating Currency Values
Most currencies in the world are free to fluctuate
against each other
Fluctuations may be quite large
Financial managers must understand how to protect
against losses or optimize gains
Another risk is encountered when a national
suspends or limits convertibility of its currency
International currency exchange quotes can be
found in business publications
11-5
Foreign Exchange Quotations
In the world’s currency exchange markets
the U.S. dollar is the common unit being
exchanged for other currencies
Reasons for the continued central position of the
U.S. dollar include that the U.S. dollar
is the main central reserve asset of many countries
is the most used vehicle currency and intervention
currency
is in great demand worldwide as a result of its safe
haven aspect and its universal acceptance
11-6
Foreign Exchange Quotations
Exchange Rates
By using the reciprocal of the US$ equivalent rate, the
currency per US$ rate can be reached and vice versa.
1
US$ equivalent rate = currency per US$ rate
1
currency per US$ rate = US$ equivalent rate
11-7
Exchange Rates
Spot rates
The exchange rate
between two currencies
for delivery within two
business days
Forward rate
The exchange rate
between two currencies
for delivery in the future.
Commonly 30, 60, 90,
or 180 days
11-8
Exchange Rates
Trading at a premium
When a currency’s forward rate quotes are
stronger than spot
Trading at a discount
When a currency’s forward rate quotes are
weaker than spot
Premium or a discount depends on the expectations
of the world financial community, businesses,
individuals, and governments about what the future
will bring
11-9
Exchange Rates
Cross Rates
Currency exchange
rates directly
between non-U.S.
dollar currencies
Use of the Japanese yen
and European euro is
increasing
11-10
Currency Exchange Controls
Government controls that
limit the legal uses of a
currency in international
transactions
Value of currency is
arbitrarily fixed at a rate
higher than its market value
If you see “official rate” next
to a currency rate quotation,
that country has currency
exchange controls in place
11-11
A black market typically
surfaces as a result of
currency exchange controls
However, this type of
currency exchange
transaction is illegal
The black market is
rarely able to
accommodate
transactions of the size
involved in a
multinational business
Balance of Payments (BOP)
The state of a nation’s BOP can tell about the state of that
country’s economy.
If the BOP is slipping into deficit
the government is probably considering one or more
market or nonmarket measures to correct or suppress that
deficit
Currency devaluation or restrictive monetary or fiscal
policies to induce deflation are likely
Currency or trade controls may be near
11-12
BOP
If BOP slipping into deficit
Companies may want to
start shopping for export
incentives
Export incentives include
tax breaks, lower-cost
financing, foreign aid,
and other government
related incentives to
make exporting easier
and more profitable
11-13
Taxation
Tariffs and duties used
interchangeably
Taxes on imported goods
Important for business to
minimize them
Many tariffs have been
lowered or abolished
world wide
If a business can lower
taxes, it can lower prices
to customers
11-14
Taxation in different
countries
Income tax is generally
the biggest revenue
earner for governments
Other types of taxes
include
sales or value-added
taxes on goods or
services
capital gains taxes,
property taxes, and
social security
Inflation
Inflation’s Effects on Interest Rates
The inflation rate determines the real cost of
borrowing
Real interest rates are found by subtracting
inflation from the nominal interest rates
11-15
When borrowed money is repaid in the
future after inflation, it is worth that much
less to the lender
Inflation
Monetary and Fiscal Policies
Affect Inflation
Monetary policies
control the amount of
money in circulation,
whether it is growing,
and, if so, at what pace
Fiscal policies
address the collecting and
spending on money by
governments
11-16
Inflation and the International Company
High inflation rates
Encourage borrowing because the loan will be repaid with
cheaper money
Bring high interest rates
Discourage lending
Make capital expenditure planning more difficult
Cause the cost of goods and services to rise
Tend to cause BOP deficits
Could lead to more restrictive fiscal or monetary policies,
currency controls, export incentives, and import obstacles
11-17
Accounting Practices
11-18
Vary widely from country to
country
Must use host country’s
practices then translate into
home country practices
U.S. uses Financial Accounting
Standards Board
Establishes GAAP
Rule based
Rest of the world follows
International Accounting
Standards Board
Principle based
Countries Went Bust
The sovereign debt crisis surfaced during the 1980s
Poland’s sovereign debt crisis occurred in 1981
The sovereign debt crisis for Mexico, Brazil,
Argentina, and others occurred in 1982 and later
IMF took lead in resolving these crises, BIS made
bridge loans in the interim
The immediate causes of the growing country debts
were the jumps in oil prices
11-19
Debt Problem Solutions
Short-Term Solutions
Rescheduling of debts
that countries were
unable to pay as they
came due
Renegotiations are
becoming more difficult
BIS, commercial banks,
11-20
and central banks are
reluctant to come up with
more money
IMF’s resources are
limited
Long-Term Solutions
The Baker Plan
Market-oriented
strategies to encourage
growth and bring
inflation under control
The Brady Plan
Private banks with
money backed by
funds from IMF,
World Bank, and
developed country
governments
Debt Problem Solutions
The three mechanisms of the Brady debt relief
1) The exchange of old debt for new at a discount
2) The exchange of old debt for new at a lower
interest rate
3) The buying back of debt from creditor banks at
a discount
This mechanism has resulted in debtor countries
buying their own debt and retiring it
11-21
Debt Problem Solutions
The Paris Club, which is a
group of Western creditor
governments
forgave half of Poland’s
debt ($17.5 billion)
The U.S. forgave the
Egyptian debt
as an expression of
thanks for Egypt’s
support in the war
against Iraq
11-22
The World Bank, the IMF,
and the Paris Club
approved a plan to relieve
the massive debt load of
some of the world’s most
heavily indebted poor
countries (HIPC)
Assistance can be
defended on a
humanitarian basis
Most of these countries
are in sub-Saharan Africa
United States in Debt
Net negative international investment position
is the difference between the value of overseas assets owned by
Americans and the value of U.S. assets owned by foreigners
Differences in U.S. debt
11-23
First, over $300 billion of the U.S. foreign-owned assets are
obligations of the U.S. Treasury or U.S. corporations traded daily
in world financial markets
Second, U.S. foreign assets are often measured at book value
which results in an estimated undervaluation of up to $200 billion
Third U.S. assets abroad reportedly earn more in interest and
dividend per dollar of investment than foreign holdings earn in
America
Fourth, It is denominated in U.S. dollars
Sample Rates Bid vs. Offer
AUD/USD
BID
0.6979
OFFER
0.6989
EUR/CHF
1.5447
1.5457
EUR/CZK
31.3150
31.4150
EUR/DKK
7.4375
7.4395
EUR/GBP
0.67940
0.68040
EUR/JPY
133.68
133.78
EUR/USD
1.21830
1.21930
GBP/CHF
2.27150
2.27350
GBP/JPY
196.57
11-24
196.77
Australian Currency
11-25
U.S. BOP 2002
Category
Receipts
Payments
Net
I. Current Account
A. Merchandise Account
(Exports/Imports)
848,678
-1,224,417
-375,739
B. Income Account
(Rents, Interest, Profits)
352,866
-367,658
-14,792
C. Transfers
-54,136
Current Account Balance
-444,667
II. Capital Account
A. Foreign Investment in the U.S.
1,024,218
B. U.S. Investment Abroad
C. Statistical Discrepancy
Capital Account Balance
III. Balancing Account
(Official Reserve Transfers)
Source: Economic Report of the President 2002
-580,952
1,401
444,667
0
U.S. Inflation Rates per CPI & RPI
11-27
Retail Price Index
Consumer Price Index
List of 41 highly indebted
poor countries
Angola
Benin
Bolivia
Burkina Faso
Burundi
Cameroon
Central African Republic
Chad
Congo
Congo, Dem Rep.
Côte d'Ivoire
Ethiopia
The Gambia
Ghana
Guinea
Guinea-Bissau
Guyana
Honduras
Kenya
Lao PDR
Liberia
Madagascar
Malawi
Mali
Mauritania
Mozambique
Myanmar
Nicaragua
Niger
Rwanda
Sierra Leone
São Tomé Principe
Senegal
Somalia
Sudan
Tanzania
Togo
Uganda
Vietnam
Yemen, Rep. of
Zambia