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Exchange Rates Research




;III. International;Environmental Forces;11;11. Financial Forces;The McGrawHill;Companies, 2005;Financial Forces;Internationales;Business;Los Negcios Internacionais;Business;ationales Gli Affari Internazionali;ternationales;nternationales Geschft;Business;os negocios internacionales;Gli Affari Internazionali;faires Internationales;Bridgeman Art Library;Gli Affari Internazionali Affaires Internationales;London/Superstock;s Internationales;A currency;Whats the;Los Negciosjoke:rubles equalsexchange rate between the British pound, the U.S. dollar and the Russian ruble?;Internacionais;One pound of;a U.S. dollar.;nales Geschft;Los Negcios Internacionais;Business;nationales Gli Affari Internazionali;Brad Templeton,;BallMcCullochFrantz;GeringerMinor;International Business;10th Edition;III. International;Environmental Forces;The McGrawHill;Companies, 2005;11. Financial Forces;Gli Affari Internazionali Affaires;Los negocios internacionales;Internationales;Internationales Geschft Los Negcios InternacionaisBusiness;Gli Affari Intern;Negcios Internacionais;Los negocios internacionales;Affaires Internationales;Business;Affaires Internationale;Business;CONCEPT PREVIEWS;After reading this chapter, you should be able to;U.S. Consumers Credited;with Saving the World;from Recession;realize that money can be madeand lostin the;foreign exchange (Fx) markets;understand Fx quotations, including cross rates;recognize currency exchange risks;understand currency exchange controls;The U.S. consumers have been like Atlas recently, carrying the;understand how financial forces such as balance of;world on its shoulders. So suggests Christopher Swann in a repayments, tariffs, taxes, inflation, fiscal and monecent article in the Financial Times (of London). The spending of;tary policies, and differing accounting practices afAmericans has been relentless, compared to that of Europeans;fect business;and Asians, despite serious stock market dips, rising unemexplain sovereign debt, its causes, and some of its;ployment, terrorism, and war. A wide range of economists sugpossible solutions;gests that this spending has been an important factor in;averting a deep world recession.;recognize that a new small business in a developing;U.S. consumers have increased their spending in every;country might be a better credit risk than the govquarter from the end of 1991 to the present. In fact, after disernment in a developing country;counting inflation, consumer spending rose by 55 percent. This;is compared to a 23 percent increase in the euro zone and a 16;percent increase in Japan.;Can this marathon of consumption continue? That is the question, the Financial Times suggests, for economists now. The answer lies in the U.S. labor market, whose growth has been sluggish, even in a growing economy. Earnings growth in the year leading up to January 2004 was at only 2 percent, with an inflation rate at 1.9;during the same period. Job creation rates have also been low.;The U.S. government appears committed to averting a recession. The Federal Reserve has been active, the;most proactive of the worlds central banks. Tax cuts have also been fortunately timed. They led to a 6.9 percent;increase in consumption in the third quarter of 2003. According to Nariman Behravesh, chief economist at Global;Insight, an economic consultancy, Policymakers have been shoveling money into peoples pockets in an effort to;keep them spending. Auto companies have also gone to the market with great deals that give incentives to buy.;Despite the negative economic indicators, the housing markets rising value has given Americans a sense of;wealth, and equity-based loans have given consumers a way to access some of their equity without selling. The;cash raised through these equity-based loans is estimated at $775 billion for last year, 2003. Credit has been democratized, observes Brian Nottage, an economist at He points out that there is a very relaxed attitude toward credit, with the young and people with low incomes able to leverage against their future earnings.;Bankruptcy is also far less stigmatized in the United States than in Europe. Ten years ago, nine households in 1,000;declared bankruptcy. The rate now is 15 in every 1,000.;Source: Christopher Swann, Carefree Spenders Take Care of World Economy, Financial Times, February 10, 2004, p. 7.;325;BallMcCullochFrantz;GeringerMinor;International Business;10th Edition;sovereign debt;Debt of the government of a sovereign;nation;III. International;Environmental Forces;11. Financial Forces;The McGrawHill;Companies, 2005;The uncontrollable financial forces that we will discuss include: foreign currency exchange;risks, national balances of payment, taxation, tariffs, national monetary and fiscal policies;inflation, and national business accounting rules. Uncontrollable means that these financial;forces originate outside the business enterprise. It does not mean that the financial management of a company is helpless in the face of these uncontrollable financial forces.;We will look at what causes exchange rates to change and at how governments sometimes intervene in foreign exchange markets. We will emphasize the importance for management of remaining aware of balance-of-payments developments, exchange rate forecasts;inflation forecasts, government fiscal and monetary policies, and other financial forces. And;at the end of the chapter, we will look at sovereign debt.;Fluctuating Currency Values;In Chapters 4 and 5, we spoke of the European Monetary System, which has created a European central bank and a single currency (the euro), and we learned there is powerful opposition in the three non-euro-zone EU countries (Denmark, Sweden, United Kingdom) to;giving up their own currencies as well as yielding their sovereignty to the powers of the EU;central bank. After a slow start, the euro has been successful.;Outside the EU, there are no comparable efforts by countries to tie major currency values to each other or to integrate monetary systems. Most currencies in the world are free to;fluctuate against each other. You will recall that the Bretton Woods conference (discussed in;Chapter 5) established fixed exchange rates. That system was eliminated in 1971 and replaced;with freely floating exchange rates. Although central banks occasionally intervene in the foreign exchange markets by buying and selling large amounts of a currency, for the most part;major currencies fluctuate freely against each other. These fluctuations may be quite large.;Financial managers must understand how to protect against losses or optimize gains from;such fluctuations. Another level of currency exchange risk is encountered when a nation suspends or limits convertibility of its currency, and managers must try to minimize or avoid;losses resulting from large holdings of inconvertible and otherwise less useful currencies.;In the United States, the symbol $ generally refers to U.S. dollars. One must be careful;as the $ symbol is also used elsewhere in the world to denote local currencies. For example;Australia, Canada, and New Zealand call the local currency the dollar and use the $ symbol;to refer to the local currency, as do Singapore, Taiwan, and Zimbabwe. The same is true in;Hong Kong. And Mexico, which calls its currency the peso, uses the $ symbol to denote the;Mexican peso.;When you want to convert one currency into another currency, you might first look for;the value of the currency you have in terms of the one you want. You can find international;currency exchange quotations in business publications such as The Wall Street Journal and;the Financial Times and in the business section of most major newspapers. Xenon Laboratories, Inc., has developed what it calls the Universal Currency Converter, which allows you to;see exchange rates on the Internet at;Foreign Exchange Quotations;Foreign exchange quotationsthe price of one currency expressed in terms of anothercan;be confusing until you have examined how they are reported. In the worlds currency exchange markets, the U.S. dollar (US$) is the common unit being exchanged for other currencies. Recent research shows that from 1998 to 2001, the U.S. dollar was on one side of;around 90 percent of the foreign exchange transactions.1 Even if a holder of Japanese yen ();wants British pounds (), the trade, particularly if it involves a large amount, usually will be;to buy US$s with the and then to buy s with the US$s. The reasons for this procedure are;historical and practical.;The international monetary system established at Bretton Woods just before the end of;World War II set the value of the US$ in terms of gold at $35 per ounce. The values of all the;other major currencies were then stated in terms of the US$. For example, the yen was worth;326;International Business: The Challenge of Global Competition;BallMcCullochFrantz;GeringerMinor;International Business;10th Edition;III. International;Environmental Forces;11. Financial Forces;0.28 of a U.S. cent, the French franc (Ff) was worth 18 cents, the German mark (DM) was;worth 27 cents, and the British pound () was worth $2.40. In other words, the US$ was established as the keystone currency at the center of the worlds monetary system. Bretton;Woods selected the US$ as the cornerstone because the US$ was viewed as the strongest;most stable currency and the United States economy was in the best position to lead the rest;of the world out of the economic problems caused by World War II. (At the time of Bretton;Woods in 1945, Frances official currency was the franc and Germanys was the mark. Both;countries now use the euro as their official currency.);The practical reasons for the continuing central position of the US$ involve the functions;it performs in the world. It is the main central reserve asset of many countries. It is the most;used vehicle currency and intervention currency.;Liberia, Panama, and El Salvador use the US$ as their official currency, and Israel uses;it as a parallel currency to the shekel. It has been a preferred medium of exchange and store;of value in Poland and many other countries in Eastern Europe and elsewhere. (Store of value;means that people view the US$ as a good currency to hold to protect their assets. The US$;is viewed as a better store of value than are many currencies because of the desire to protect;assets from erosion due to instability of other currencies.) Ecuador, for example, in the year;2000, adopted the US$ as its currency. After a six-month transition period, the US$ replaced;the local Ecuadorian currency, the sucre. The decision by the Ecuadorian government to dollarize the Ecuadorian economy came as a surprise to many people both within Ecuador and;abroad, even though Ecuador had experienced recession and inflation. In 1999, the sucre lost;two-thirds of its value and the economy shrank by 7.5 percent. These economic problems;convinced the Ecuadorian government to replace the sucre with the US$.2 Even though many;in Ecuador lament the loss of the local currency, most recognize that acceptance of the dollar was necessary to ensure financial security.;The US$ is in demand worldwide for several reasons, including its safe haven aspect;and its universal acceptance in most countries. Even if U.S. interest rates and investment opportunities were less attractive, many would still feel that money is safe in American securities or property. Inflation in the United States has been brought to a low level, and the country;political risk is low. It is seen as less likely than others to be invaded or to have its government collapse. One problem with universal use of U.S. dollars is the increased opportunity;for counterfeiting. This is especially true in certain countries.;At an April 2004 congressional hearing, Secret Service Deputy Assistant Director Bruce;Townsend, who has responsibility for investigations of counterfeiting and other financial;crimes, testified that U.S. and other law enforcement agencies seized about $63 million in;counterfeit U.S. currency in 2003. Approximately $10.7 million of this was seized in the;United States, while more than $31 million was seized in Colombia.3 Investigations of counterfeiting used to be a part of the Treasury Department and were moved to the Department of;Homeland Security in March 2003.;Although Colombia is the single largest producer of counterfeit U.S. currency, cooperation between U.S. and Colombian authorities has been successful. Townsend reported a 37;percent reduction in Colombian-produced counterfeit currency passed in the United States;($15.3 million passed in 2002, $9.6 million in 2003). Townsend also cited Bulgaria as one of;the countries where counterfeiting is on the increase.;To appreciate the scope of the potential problem, it may help to know that around $670;billion in genuine U.S. currency is currently in circulation in the United States and an amount;as much as two-thirds of that, known as Eurodollars, is circulated overseas, according to the;same Secret Service report.;The McGrawHill;Companies, 2005;central reserve;asset;Asset, usually;currency, held by a;governments central;bank;vehicle currency;A currency used as a;vehicle for international trade or;investment;intervention;currency;A currency used by a;country to intervene in;the foreign currency;exchange markets;(e.g., using some of its;U.S. dollar reserve to;buyand thus;strengthenits own;currency);safe haven;In reference to the U.S.;dollar, a political;concept based on the;belief that the United;States is less likely;than most countries to;have communist;government or to be;subjected to a military;coup or revolution;Exchange Rates;Figure 11.1 is the listing of currency trading from The Wall Street Journal for the two business days preceding Tuesday, August 3, 2004. The top part of Figure 11.1 is Key Currency;Cross Rates, which is discussed below. The other part of Figure 11.1 is Exchange Rates.;You will notice in Figure 11.1 that there is no entry for the 12 individual euro-zone countries;(Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, and Spain) as they all use the euro as their official currency.;Financial Forces;327;BallMcCullochFrantz;GeringerMinor;International Business;10th Edition;FIGURE;11.1;III. International;Environmental Forces;The McGrawHill;Companies, 2005;11. Financial Forces;Foreign Exchange Quotations;Key Currency Cross Rates;Late New York Trading Monday, August 2, 2004;Dollar;Pound;SFranc;Peso;Yen;CdnDir;1.3319;110.68;11.3999;1.2784;.54700;.83120...;Canada;Japan;Mexico;Switzerland;U.K.;Euro;U.S.;Euro;1.6024;133.16;13.7152;1.5381;.6581...;1.2031;2.4349;202.34;20.840;2.3371...;1.5195;1.8281;1.0418;86.574;8.9170...;.4279;.65015;.78220;.116874;9.709...;.11215;.04798;.07291;.08772;.01203...;.10300;.01155;.00494;.00751;.00904...;83.099;8.5591;.9599;.41070;.62405;.75080;Source: Reuters;Exchange Rates;August 2, 2004;The foreign exchange mid-range rates below apply to trading;among banks in amounts of $1 million and more, as quoted at;4 p.m. Eastern time by Reuters and other sources. Retail;transactions provide fewer units of foreign currency per dollar.;Country;Argentina (Peso)-y;Australia (Dollar);Bahrain (Dinar);Brazil (Real);Canada (Dollar);1-month forward;3-months forward;6-months forward;Chile (Peso);China (Renminbi);Colombia (Peso);Czech. Rep. (Koruna);Commercial rate;Denmark (Krone);Ecuador (US Dollar);Egypt (Pound)-y;Hong Kong (Dollar);Hungary (Forint);India (Rupee);Indonesia (Rupiah);Israel (Shekel);Japan (Yen);1-month forward;3-months forward;6-months forward;Jordan (Dinar);Kuwait (Dinar);Lebanon (Pound);Malaysia (Ringgit)-b;Malta (Lira);Mexico (Peso);Floating rate;U.S. $ EQUIVALENT;Mon;Fri;.3348;.3355;.7044;.7020;2.6524;2.6525;.3282;.3292;.7508;.7523;.7504;.7520;.7499;.7514;.7492;.7507;.001558.001553;.1208;.1208;.0003837.0003827;CURRENCY;PER U.S. $;Mon;Fri;2.9869;2.9806;1.4196;1.4245;.3770;.3770;3.0469;3.0377;1.3319;1.3293;1.3326;1.3298;1.3335;1.3308;1.3348;1.3321;641.85;643.92;8.2781;8.2781;2606.20 2613.01;.03802;.03796;.1618;.1617;1.0000;1.0000;.1612;.1610;.1282;.1282;.004821.004843;.02161;.02157;.0001094.0001094;.2212;.2215;.009035.008993;.009048.009005;.009074.009032;.009124.009082;1.4104;1.4104;3.3920;3.3929;.0006606.0006605;.2632;.2632;2.8354;2.8321;26.302;6.1805;1.0000;6.2050;7.8003;2.07.43;46.275;9141;4.5208;110.68;110.52;110.21;109.60;.7090;.2948;1513.78;3.7994;.3527;26.344;6.1843;1.0000;6.2116;7.8003;206.48;46.361;9141;4.5147;111.20;111.05;110.72;110.11;.7090;.2947;1514.00;3.7994;.3531;11.3999;11.4155;.0877;.0876;U.S. $ EQUIVALENT;Country;Mon;Fri;New Zealand (Dollar);.6420;.6357;Norway (Krone);.1425;.1425;Pakistan (Rupee);.01710;.01713;Peru (new Sol);.2934;.2926;Philippines (Peso);.01791;.01786;Poland (Zloty);.2737;.2750;Russia (Ruble)-a;.03432;.03436;Saudi Arabia (Riyal);.2666;.2667;Singapore (Dollar);.5827;.5819;Slovak Rep. (Koruna).03000;.02998;South Africa (Rand);.1579;.1596;South Korea (Won).0008587.0008573;Sweden (Krona);.1305;.1303;Switzerland (Franc);.7822;.7806;1-month forward;.7829;.7814;3-months forward;.7844;.7829;6-months forward;.7869;.7853;Taiwan (Dollar);.02946;.02942;Thailand (Baht);.02420;.02421;Turkey (Lira);.00000068.00000068;U.K. (Pound);1.8281;1.8211;1-month forward;1.8226;1.8160;3-months forward;1.8133;1.8064;6-months forward;1.7998;1.7930;United Arab (Dirham);.2723;.2723;Uruguay (Peso);Financial;.03400;.03400;Venezuela (Bolivar);.000521.000521;SDR;Euro;1.4609;1.2031;1.4578;1.2024;CURRENCY;PER U.S. $;Mon;Fri;1.5576;1.5731;7.0175;7.0175;58.480;58.377;3.4083;3.4176;55.835;55.991;3.6536;3.6364;29.138;29.104;3.7509;3.7495;1.7161;1.7185;33.333;33.356;6.3331;6.2657;1164.55 1166.45;7.6628;7.6746;1.2784;1.2811;1.2773;1.2798;1.2749;1.2773;1.2708;1.2734;33.944;33.991;41.322;41.305;1470588 1470588;.5470;.5491;.5487;.5507;.5515;.5536;.5556;.5577;3.6724;3.6724;29.412;1919.39;29.412;1919.39;.6845;.8312;.6860;.8317;Special Drawing Rights (SDR) are based on exchange rates for the;U.S., British, and Japanese currencies. Source: International Monetary Fund.;a-Russian Central Bank rate. b-Government rate. y-Floating rate.;Source: From The Wall Street Journal, August 3, 2004. Copyright 2004 by Dow Jones & Co., Inc. Reproduced with permission of Dow Jones & Co.;Inc. via Copyright Clearance Center.;The Exchange Rates part of Figure 11.1 shows the US$ equivalent rate and the currency;per US$ rate. The US$ equivalent rate is the cost in U.S. dollars of one unit of another currency. For example, Figure 11.1 (Exchange Rates) shows that the price (indicated as the US$;equivalent rate) of Switzerlands currency, the franc, on Monday, August 2, 2004, was.7822.;This means that one Swiss franc cost US$.7822, or about 78 cents. For another example, look;at the Japanese yen, which is quoted at.009035. Each yen costs that fraction of a dollar, less;than one cent. This does not mean that prices are inexpensive in Japan. In fact, quite the con328;International Business: The Challenge of Global Competition;BallMcCullochFrantz;GeringerMinor;International Business;10th Edition;III. International;Environmental Forces;11. Financial Forces;The McGrawHill;Companies, 2005;trary, Japan is an expensive market for dollar-based consumers. An example of a currency;that costs more than a U.S. dollar is the British pound listed under U.K., at $1.828, meaning;one pound can be purchased for $1.83.;We have looked at the cost of foreign currency in U.S. dollars. The currency per US$;rate, on the other hand, is the price of one U.S. dollar in another currency. The currency per;US$ rate of the Australian dollar for Monday, August 2, 2004, was 1.4196. That means one;US$ cost about 1.42 Australian dollars.;Depending on what transaction is occurring, it may be necessary to convert from the US$;equivalent rate to the currency per US$ rate. By using the reciprocal of the US$ equivalent;rate, one can reach the currency per US$ rate, and vice versa;1;= currency per US$ rate;US$ equivalent rate;1;= US$ equivalent rate;currency per US$ rate;There is more to be learned from reading the exchange rates quotes. Using the Exchange;Rates of Figure 11.1, you will see that exchange rates for the preceding Friday are also given.;Comparing the two prices tells you whether the currency is weakening or strengthening.;Spot Rates The spot rate is the exchange rate between two currencies for their immediate trade for delivery within two days. The rate on the same line as the name of the country;is the spot rate. You will note in the Exchange Rates in Figure 11.1 that the spot rate for Swiss;francs was.7822 for Monday.;Forward Rates The forward rate is the cost today for a commitment to buy or sell an;agreed amount of a currency at a fixed, future date. The commitment is a forward contract;and for frequently traded currencies such contracts are usually available on a 30-, 60-, 90-;or 180-day basis. You may be able to negotiate with banks for different time periods or for;contracts in other currencies.;In the Exchange Rates in Figure 11.1, look under Switzerland and refer to the Swiss;franc one-month forward rate quotation. For Monday, August 2, 2004, it was.7829. Compare that rate with the spot rate of.7822, and you will see that it would cost more in US$ to;buy a Swiss franc for delivery in one month than for delivery today. The Swiss franc is said;to be trading at a premium in the one-month forward market. Look then at the three-month;and six-month rate quotations, and you see that on Monday, the Swiss franc cost.7844 and;.7869, respectively, for three-month and six-month delivery. These prices are also more expensive, or stronger, and so the Swiss franc is trading at a premium in all the reported forward periods. Conversely, if a currencys forward rate quotes are less expensive, or weaker;than the spot rate, the currency is said to be trading at a discount in the forward markets.;Whether there is a premium or a discount and its size depend on the expectations of the;world financial community, businesses, individuals, and governments about what the future;will bring. These expectations factor in such considerations as supply and demand forecasts;for the two currencies, relative inflation in the two countries, relative productivity and unit;labor cost changes, expected election results or other political developments, and expected;government fiscal, monetary, and currency exchange market actions.;spot rate;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;trading at a premium;When a currencys;forward rate quotes;are stronger than spot;trading at a discount;When a currencys;forward rate quotes;are weaker than spot;So Many Yen, So Few Pounds;Look again at the Exchange Rates in Figure 11.1, and you will see that it took about 111 yen;to buy 1 US$, whereas less than 1 pound was enough for a dollar. Glancing up and down the;column, you find that an Indonesian rupiah holder would need over 9,141 rupiahs for US$1;and that holders of each of the other currencies quoted require a different number. It might;seem that the fewer units of a currency required to buy a dollar, the harder or better that;currency is compared to the others, but as we have seen before, that is not necessarily correct. (Look at Japan, for example.) Outside of controlled economies, supply and demand;forces in the foreign exchange markets for the most part today set the price of currencies. As;Financial Forces;329;BallMcCullochFrantz;GeringerMinor;International Business;10th Edition;relevance;for managers;III. International;Environmental Forces;11. Financial Forces;The McGrawHill;Companies, 2005;mentioned before, in 1945, currencies of the worlds major trading countries were set in value;relative to the US$. Those exchange rates were the rates in the markets at that time. Since;then, and particularly since 1973, the relative values of currencies and the ease of their convertibility have been set by the market forces, which are influenced by many factors including trade policies of governments, monetary and fiscal policies such as decisions on taxation;and interest rates, and by uncontrollable forces including world events, inflation, and unemployment. 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 of money by;governments. What kinds of taxes at what rates? On what and in what amounts does the government spend money?;Values of currencies in terms of each other do not remain fixed, but change, sometimes;rapidly, as the currencies are traded in the worlds financial centers. What happens in the;Tokyo foreign exchange market affects the London and New York markets.;An international traveler will need currencies for use in the countries in which that traveler is visiting. Often credit cards and automatic teller machine (ATM) cards can be used instead of the local currency. Use of credit cards can be expensive, though, as credit card;companies generally charge a foreign transaction fee that can be as high as 2 or 3 percent of;the total amount of the purchase.;Bid and Ask Prices When travelers or businesses contact a bank or an exchange agency;to buy or sell a currency, they find a bid price and an asked price. The bid is the lower and it;is the dealers offer to buy from you. The quotation for the Swiss franc may be.78 bid and;.82 asked. If the customer has francs to sell, the bank or agency is biddingoffering78;cents (U.S. pennies) for each franc. If the customer wants to buy francs, the bank or agency;is asking 82 cents, a higher price. The difference provides a margin for the bank or agency.;The rates listed in financial publications, such as those shown in The Wall Street Journal (Figure 11.1), are for customers buying large quantities, usually US$1 million or more. The rates;charged to small customers are much less favorable to the customer. Banks intend to make a;profit in currency transactions.;Remember that when discussing exchange rates, we need to be clear about what currency;we are using and what currency (a commodity) we are buying. Again, novices sometimes;mix up their perspectives, which is easy to do because the terms used to describe market fluctuations are mirror images (hard and soft, strong and weak, dear and cheap).;Cross Rates;cross rates;Currency exchange;rates directly between;non-US$ currencies;usually determined by;comparing the US$;exchange rates of the;other currencies;relevance;for managers;330;In addition to the US$, currencies of other developed countries are also important in world;transactions and are becoming more important. This is particularly true of the Japanese yen;() and the EU euro (a). Many expect the euro to become as frequently used as the dollar.;Although most large currency exchanges go through the US$, it is possible to find exchange;rates for trading directly between non-US$ currencies. These rates are called cross rates. See;the Key Currency Cross Rates in Figure 11.1 for an example of the quotes for cross rates from;The Wall Street Journal.;Fluctuating Exchange Rates Create Risk;When your activities involve more than one country, usually you must deal with more than;one currency. For example, a U.S. company exporting to Switzerland will, in most cases;want to receive US$s. If credit is involved, payment is not made when the goods are delivered, and one of the parties will have a currency exchange risk. If the Swiss importer agrees;to pay Swiss francs, then the U.S. exporter bears a risk that the value of the Swiss franc will;fall and thus the Swiss francs will buy fewer US$s when received than they would have at;the earlier goods delivery date. On the other hand, if the Swiss importer agrees to pay in US$;at a future time, then the importer bears that risk (see Figure 11.2.);Company financial managers have strategies for dealing with this type of risk, presented;in Chapter 20. Another potential hazard for a company is that a country in which it has assets may institute currency exchange controls.;International Business: The Challenge of Global Competition;BallMcCullochFrantz;GeringerMinor;International Business;10th Edition;FIGURE;11.2;III. International;Environmental Forces;The McGrawHill;Companies, 2005;11. Financial Forces;Currency Exchange Risk;February 1;Suppose;Goods delivery date exchange rate;August 1;US$1 = 1.78 Swiss francs;Whichever party bore the currency exchange risk, neither gained or lost.;Payment date exchange rate;US$1 = 1.78 Swiss francs;Suppose;US$1 = 1.78 Swiss francs;Whichever party bore the currency exchange risk lost. It now requires;1.80 Swiss francs to buy the US$1, which could have been bought for;1.78 Swiss francs at the time the goods were delivered.;US$1 = 1.80 Swiss francs;Suppose;US$1 = 1.78 Swiss francs;Whichever party bore the currency exchange risk gained. It now requires;only 1.76 Swiss francs to buy the US$1, which would have cost 1.78 Swiss;francs at the time the goods were delivered.;US$1 = 1.76 Swiss francs;Note: Parties agree to payment in US$.;Are Foreign Exchange Markets Truly Competitive?;Foreign currency markets come under criticism for their lack of competition. An article in;The Wall Street Journal stated, Currency trading is the largest and least regulated market in;the world, a Wild West of global capitalism where more than $1.2 trillion changes hands each;day. Unlike major stock and commodities markets, the foreign-exchange market, or FX, operates with virtually no government or regulatory oversight.4;Currency Exchange Controls;Currency exchange controls limit or prohibit the legal use of a countrys currency in international transactions. Typically, the value of the currency is arbitrarily fixed at a rate higher;than its value in the free market, and it is decreed that all purchases or sales of other currencies be made through a government agency. A black market inevitably springs up, but it is of;little use to a finance manager, who wants to abide by the laws of a country in which the company is operating. In addition, the black market is rarely able to accommodate transactions;of the size involved in a multinational business.;Thus, the company must pay more than the free market rate if the government grants;permission to buy foreign currency. If permission is not granted or if the cost of foreign;currency is uneconomically high, the blocked currency can be used only within the country. This usually presents problems of finding suitable products and investments within the;country. When faced with blocked currency in the former Soviet Union, Pepsi once bought;an oil tanker in Russia and filled it with vodka, all paid for with blocked currency and all;for export.;Official rates for currencies are considered currency exchange controls. When you see;the notation official rate next to a currency rate quotation, you know that the country has;currency exchange controls. The currency exchange controls discussed here are a result of;some governmental action.;People will go to remarkable extremes to get blocked money out of exchange-controlled;countries. In New Delhi, the local manager of a major international airline gave a case of;Scotch to a government official. Shortly thereafter, the agency for which that official worked;granted the airline permission to use blocked rupees to buy almost US$20 million and transfer them to the airlines home country. This was an extreme method of converting blocked;currencies to convertible currencies. It was also illegal. Most financial managers do not resort to such methods, but they can take legal steps to protect their firms from the adverse effects of currency exchange controls.;Financial Forces;currency exchange;controls;Government controls;that limit the legal;uses of a currency in;international transactions;331;BallMcCullochFrantz;GeringerMinor;International Business;10th Edition;III. International;Environmental Forces;11. Financial Forces;The McGrawHill;Companies, 2005;Employees wait for customers at a currency exchange, licensed by the Bank of Bangladesh, in Dhaka. Some countries;set official rates for currency and decree that all purchases or sales of other currencies be made through a;government agency.;Shawkat Khan/AFP/Getty Images;relevance;for managers;Controls differ greatly from country to country and even within a country, depending on;the type of transaction. In general, the relatively rich developed countries have few or no currency exchange controls. They are a minority of the worlds countries, though, and th


Paper#32634 | Written in 18-Jul-2015

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