1. International Business
Wendy Jeffus
Harvard Summer School

2. Introduction Chapter 8: Regional Economic Integration
Case Study: Boeing vs. Airbus: Two Decades of Trade Disputes
Chapter 9: The Foreign Exchange Market
Trading FX (time permitting)
World Perspective (time permitting)

3. Chapter 8: Regional Economic Integration
Wendy Jeffus
Harvard Summer School 3

4. Introduction Trend - Regional Economic Integration
Regional Trade Agreements –
Agreements among countries in a geographic region to reduce, and ultimately remove, tariff and non-tariff barriers to the free flow of goods, services, and factors of production.
While the move toward regional economic integration is generally seen as a good thing, some observers worry that it will lead to a world in which regional trade blocs compete against each other. In this possible future scenario, free trade will exist within each bloc, but each bloc will protect its market from outside competition with high tariffs. The specter of the EU and NAFTA turning into economic fortresses that shut out foreign producers with high tariff barriers is worrisome to those who believe in unrestricted free trade. If such a situation were to materialize, the resulting decline in trade between blocs could more than offset the gains from free trade within blocs.

5. Levels of Economic Integration
Free trade area
Barriers to trade are removed, but each country determines its own external trade policy
Example: European Free Trade Area (Norway, Iceland, Liechtenstein, & Switzerland)
Basically for industrial goods (i.e. heavy equipment)
Customs union
Internal barriers to trade are removed and a common external trade policy is adopted
Example: Andean Pact (Bolivia, Colombia, Ecuador, & Peru)
Common external tariffs 5 – 20%
Common market
It has no barriers to trade between member countries, includes a common external trade policy, and also allows factors of production to move freely between members.
Example: MERCOSUR (Argentina, Brazil, Paraguay, & Uruguay)
Economic union
Involves the free flow of products and factors of production between member countries and the adoption of a common external trade policy, but it also requires a common currency, harmonization of members’ tax rates, and a common monetary and fiscal policy.
Example: EU (although not all members have adopted the common currency)
Political union
Occurs when a central political apparatus coordinates the economic, social, and foreign policy of the member states
Example: United States

6. Levels of Economic Integration
Figure 9.1, p. 294
Free trade area
Barriers to trade are removed, but each country determines its own external trade policy
Customs union
Internal barriers to trade are removed and a common external trade policy is adopted
Common market
It has no barriers to trade between member countries, includes a common external trade policy, and also allows factors of production to move freely between countries allows factors of production to move freely between members
Economic union
Includes the establishment of a common currency and the harmonization of tax rates
Political union

7. Case for Integration Economic Arguments Political Arguments
Stimulates economic growth in member countries
Increases FDI and world production
Countries specialize in goods and services that can be efficiently produced
Creates additional gains from free trade beyond the international agreements such as GATT and WTO
Political Arguments
Economic interdependence creates incentives for political cooperation
This reduces the potential for violent confrontation
Together, the countries have more economic clout to enhance trade with other countries or trading blocs

8. Impediments to Integration
Integration is hard to achieve and sustain
Nations may benefit but groups within countries may be hurt.
Example: (Canadian & U.S. textile workers)
Potential loss of sovereignty and control over domestic issues (especially for the “economically weaker” members)

9. Trade Creation & Trade Diversion
Economists point out that the benefits of regional integration are determined by the extent of trade creation, as opposed to trade diversion
Trade creation occurs when high cost domestic producers are replaced by low cost producers within the free trade area.
Example: NAFTA/Mexico, EU/Poland
Trade diversion occurs when lower cost external suppliers are replaced by higher cost suppliers within the free trade area.
Example: Britain imported lamb from New Zealand, until the EU imposed the common external tariff. Now Britain imports lamb from France.
Example: Mexico and the US. Lower production cost in Mexico
Poland and EU: Same as above
When tariff are imposed to protect manufacturer within the regional block; eventhough the product is more expensive than that produced abroad
The UK's import of lamb, before Britain joined the EU most lamb imports came from New Zealand, (the cheapest lamb producer), when Britain joined the EU the common external tariff made it more expensive to import lamb from New Zealand than countries inside the union, thus France became the majority exporter of lamb to the UK. Trade was diverted from New Zealand and created between France.

10. Evolution of the European Union
Product of two political factors:
A desire for peace (after the devastation from WWI & WWII)
A desire for strong political & economic position on the world stage
Single European Act:
Sought to create a true single market by abolishing administrative barriers to the free flow of trade and investment between EU countries
Maastricht Treaty:
Took the EU even further along the road the road to economic union by establishing a common currency

11. The Euro Currency Abbr. Rate Austrian schillings (ATS) 13.760300
   Belgian francs
(BEF)
   Dutch gulden
(NLG)
   Finnish markka
(FIM)
   French francs
(FRF)
   German mark
(DEM)
   Irish pounds
(IEP)
   Italian lire
(ITL)
   Luxembourg francs
(LUF)
   Portuguese escudos
(PTE)
   Spanish pesetas
(ESP)
January 1, countries
January 1, Greece - Greek drachma (GRD) exchange rate of
January 1, 2002 old currencies were not accepted (actually you could exchange currency for about 2 months until February 28, 2002)
Eurozone - Austria, Belgium, France, Finland, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain.
The euro is also legal currency in the eurozone overseas territories of French Guiana, Réunion, Saint-Pierre et Miquelon, Guadeloupe, Martinique and Mayotte.
By virtue of some bilateral agreements the European mini states of Monaco, San Marino, and Vatican City mint their own euro coins on behalf of the European Central Bank.
Andorra, Montenegro and Kosovo adapted the foreign euro as their legal currency for movement of capital and payments without participation in the ESCB or the right to mint coins. Andorra is in the process of entering a monetary agreement similar to Monaco, San Marino, and Vatican City.

12. Key Dates EU Membership 1951 - European Coal and Steel Community.
1957- Treaty of Rome establishes the European Community
1993 – Treaty of Maastricht established the European Union
January 1, countries
January 1, Greece - Greek drachma (GRD) exchange rate of
January 1, 2002 old currencies were not accepted
Actually you could exchange currency for about 2 months until February 28, 2002.
Source: Wikipedia.org

13. EU Membership
Source: Wikipedia.org

14. Economic Gains of 1 Currency
Reduced exchange costs
Reduced currency risk
Increased price competition
Major investment and export opportunities for firms within region
Allows firms to optimize mix of resources to reduce overall costs

15. The Single European Act
This act committed member countries to work toward the establishment of a single market by December 31, 1992
The act was born out of:
Frustration among members of the European Community regarding the barriers to the free flow of trade and investment between member countries
A need to harmonize the wide range of technical and legal standards for doing business
Objectives:
Abolish delays and reduces costs of trade bureaucracy
“Mutual recognition” of product standards
Allow foreign low cost suppliers to compete
Lift barriers to banking and insurance competition
Remove restrictions on foreign exchange transactions and trucking

16. The Single European Act
Benefits:
Savings from using only one currency
Easy to compare prices, resulting in lower prices
Forces efficiency
Creates liquid pan-Europe capital market
Increases range of investments for individuals and institutions
As of 2008 Euro strong against the dollar.
Costs:
Countries lose monetary policy control
European Central Bank controls policy for the “Euro zone”
EU is not an “optimal currency area”
Country economies are different
Euro puts the economic cart before the political horse
Strong Euro (2008) makes it harder for Euro zone exporters to sell their goods

17. Enlargement of the European Union
To qualify for EU membership applicants must:
Privatize state assets
Deregulate markets
Restructure industries
Control inflation
Include EU laws into their own systems
Establish stable democratic governments
Respect human rights
Current Candidate Countries: Croatia, Macedonia, and Turkey.

18. NAFTA
The North American Free Trade Agreement (NAFTA) became law January 1, 1994
NAFTA includes the following:
Over 10 year period: tariffs reduced (99% of goods traded)
Removal of most barriers on cross border flow of services
Removal of restrictions on FDI except in certain sectors
Mexican railway and energy
US airline and radio communications
Canadian culture
Protection of intellectual property rights
Applies national environmental standards
Establishment of commission to police violations

19. The Case For & Against NAFTA
Pros
Enlarged and productive regional base
Labor-intensive industries move to Mexico
Mexico gets investment and employment
Increased Mexican income to buy US/Canada goods
Demand for goods increases jobs
Consumers get lower prices
Cons
Loss of jobs to Mexico
Mexican firms have to compete against efficient US/Canada firms
Mexican firms become more efficient
Environmental degradation
Loss of national sovereignty

20. NAFTA Results
Recent surveys indicate that NAFTA’s overall impact has been small but positive
From 1993 to 2004, trade between NAFTA’s partners grew by 250 percent
Canada’s trade with NAFTA partners increased from 70% to more than 80% of all Canadian foreign trade
Mexico’s trade with NAFTA partners increased from 66% to 80% of all Mexican foreign trade
All countries experienced strong productivity growth
The United States has lost 110,000 jobs per year due to NAFTA
Many economists dispute this figure because more than 2 million jobs a year were created in the US during the same time period

21. Most Active Regional Trade Blocs

22. The Andean Community Bolivia, Colombia, Ecuador, Peru, Venezuela
Nearly failed. Rejuvenated in 1990
Changed from FTA to customs union in 1992
Still has many political and economic problems
Bolivia, Chile, Ecuador, Colombia, and Peru signed an agreement in 1969 to create the Andean Pact
The Andean Pact was largely based on the EU model, but was far less successful at achieving its stated goals
By the mid-1980s, the Andean Pact had all but collapsed and had failed to achieve any of its stated objectives
Nearly failed. Rejuvenated in 1990 in the Galapagos Declaration
Five current members include Bolivia, Ecuador, Peru, Colombia, and Venezuela
Objectives included the establishment of a free trade area by 1992, a customs union by 1994, and common market by 1995
Operates as a customs union currently

23. Mercosur 1988: Argentina, Brazil. 1990: Paraguay, Uruguay
1995: Agreed to move toward a full customs union
Trade quadrupled between
Has significant trade diversion issues
Revival in 2003 by Brazil’s president to be modeled after EU with common currency and elected parliament
2006: Venezuela
Originated in 1988 as a free trade pact between Brazil and Argentina
The pact expanded in March 1990 to include Paraguay and Uruguay
These countries have:
A combined population of 200 million
An average annual growth rate of 3.5% for GDP
MERCOSUR countries have significant trade diversion issues

24. Other Associations Central American Common Market CARICOM
1960s: Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua.
Collapsed in 1969
CARICOM
1973: English-speaking Caribbean countries
1991: Failed for third time to establish common external tariff
Free Trade Area of the Americas
Two stumbling blocks include intellectual property rights and reductions in agriculture subsidies

25. ASEAN Countries Association of Southeast Asian Nations Created in 1967
Objective to achieve free trade between member countries and achieve cooperation in their industrial
Brunei, China, Indonesia, Laos, Malaysia, the Philippines, Myanmar, Singapore, Thailand, and Vietnam
Progress limited by Asian financial crisis of the 90’s
Map 9.3, p. 314

26. APEC Countries ‘Promote a sense of community’ 18 members
Asia Pacific Economic Cooperation
Founded in 1990 to ‘promote open trade and practical economic cooperation
‘Promote a sense of community’
18 members
50% of world’s GNP
40% of global trade
Despite slow progress, if successful, could become the world’s largest free trade area
Map 9.4, p. 315

27. African Union
Many of these groups have been dormant for years. Significant political turmoil in several African nations has persistently impeded any meaningful progress. Also, deep suspicion of free trade exists in several African countries. The argument most frequently heard is that because these countries have less developed and less diversified economies, they need to be “protected” by tariff barriers from unfair foreign competition. Given the prevalence of this argument, it has been hard to establish free trade areas or customs unions.
The only African state that is not a member of the African Union is Morocco, which left the AU's predecessor, the Organisation of African Unity (OAU), in 1984.
Source: Wikipedia.org

28. Implications for Managers
Opportunities:
Creation of single markets
Protected markets, now open
Lower costs doing business in single market
Threats:
Differences in culture and competitive practices make realizing economies of scale difficult
More price competition
Outside firms shut out of market
EU intervention in M&A

29. Global Peace Index

30. Case Study Boeing vs. Airbus: Two Decades of Trade Disputes
Present a 5-10min (timed) assessment of the case (answer case questions)
All group members must participate.

31. 9: The Foreign Exchange Market
Wendy Jeffus
Harvard Summer School 31

32. Definitions Foreign exchange market Exchange rate
A market for converting the currency of one country into the currency of another.
Exchange rate
The rate at which one currency is converted into another
Foreign exchange risk
The risk that arises from changes in exchange rates
Spot exchange rate
Rate at which a dealer converts one currency into another currency on a particular day
Forward exchange rate
An exchange rate governing future transactions (can be used to reduce foreign exchange risk)

33. The FX Market The following participants operate within the FX market:
The FX Market
The following participants operate within the FX market:
Individuals (investors and tourists)
Speculators and arbitragers
Governments (central banks and treasuries)
Brokers and dealers
Businesses
Payments for exports & purchases from foreign suppliers
Foreign income (licensing, royalty payments, etc.)
Investment/Speculation/Hedging activities

34. FX Rates and Quotations
FX Rates and Quotations
Most foreign exchange transactions involve the US dollar.
Professional dealers and brokers may state foreign exchange quotations in one of two ways:
European Terms - the exchange rate between the US dollar and Japanese yen is stated in European terms by the WSJ below ¥106/$
American Terms - the exchange rate between US dollars and the Japanese yen can also be stated in American terms $0094/¥.
FT vs. WSJ

35. FX Market Foreign Exchange Market (FX Market)
World’s largest financial market ($2.5 trillion average daily turnover)
Open 24 hours a day, 6 days a week
Sunday at 5pm (EST) to Friday 4:30pm (EST)
Sydney & Tokyo
west to Hong Kong & Singapore
to Bahrain
to Frankfurt, Zurich, & London
to New York to Chicago to San Francisco & LA

36. Currency Hedging
Volkswagen, Europe’s largest carmaker, reported a 95% drop in Q4’03 profits.
Two causes stood out:
The unprecedented rise in the value of the Euro against the dollar
Volkswagen’s decision to only hedge 30% of its foreign currency exposure as opposed to the 70% it had traditionally hedged.
Example:
Suppose the Jetta costs €14,000 to manufacture & ship from Germany to the U.S. where it sells for $15,000.
If the exchange rate is $1 = €1, VW earns €1,000 on the sale.
If the dollar depreciates to $1.25 = €1 (or $1 = 0.80€) the $15,000 price will only convert to €12,000.
In other words, VW would lose €2,000 on every Jetta sold!
For Volkswagen, which made cars in Germany and exported them to the United States, the fall in the value of the dollar against the euro during 2003 was devastating. To understand what happened, consider a Volkswagen Jetta built in Germany for export to the United States. The Jetta costs m14,000 to make in Germany and ship to a dealer in the United States, where it sells for $15,000. With the exchange rate standing at around m1 $1.00, the $15,000 earned from the sale of a Jetta in the U.S. could be converted into m15,000, giving Volkswagen a profit of m1,000 on every Jetta sold. But if the exchange rate changes during the year, ending up at m1 $1.25 as it did during 2003, each dollar of revenue will now buy only m0.80 (m1/$1.25 m0.80), and Volkswagen is squeezed. At an exchange rate of m1 $1.25, the $15,000 Volkswagen gets for the Jetta is now only worth m12,000 when converted back into euros, meaning the company will lose m2,000 on every Jetta sold (when the exchange rate is m1 $1.25, $15,000/1.25 m12,000).

37. Currency Hedging CEO Jeff Bezos promised a profit in 2001.
In Q4’01 Amazon reported an operating profit of $59M and a net income of $5M.
But what was the quality of earnings?.. i.e. Where did the earnings arise from?
Operations?
A one time sale of assets?
The company had a one time foreign currency gain of $16M in Q4!

38. Hedging Fuel
In 2001, LUV substantially increased its hedging strategy.
In 2004, more than 80% of its fuel needs were hedged at a price of $24 a barrel.
Without this hedge, Q1’04 profit of $26M would have been a loss of $8M!
Both AMR and CAL reported losses in Q1’04!
Why didn’t these airlines hedge fuel costs?
Hedging requires credit lines or cash which has been in short supply to airlines.
The airline industry attracts executives that like to take risks.
Photo Source: wikipedia.org

39. Exchange Rate Determination
Economic Theories of Exchange Rate Determination:
Exchange rates are determined by the demand and supply of one currency relative to the demand and supply of another
Law of One Price
Purchasing Power Parity (PPP)
Money supply and price inflation
Investor psychology and “Bandwagon” effects
Note: For additional information on exchange rates see:
Exchange Rate Determination (A) and (B) under “International Finance”

40. Law of One Price
In competitive markets, identical products sold in different countries should sell for the same price when their price is expressed in terms of the same currency.
Assumptions:
No transportation costs
No barriers to trade
Tradable goods
Example: If the euro/dollar exchange rate is 0.78EUR/USD.
A jacket selling for $50 in New York should retail for €39.24 in Paris ($50 x 0.78EUR/USD = €39.24)

41. Example 1 You can rent a compact car in Washington, D.C. for $31.99
You can rent a compact car in Bangkok, Thailand for BHT
Therefore the exchange rate should be = BHT/31.99USD = BHT/USD
Source: Avis.com

42. PPP & The Law of One Price
The implied exchange rate based on the absolute theory of PPP is BHT/31.99USD = BHT/USD
But the actual exchange rate today is 32.81BHT/USD.
Is the baht over or under valued vs. the dollar?
Calculate (implied – actual) / actual.
– / = 281%
The baht is overvalued by 281% vs. the dollar.

43. Example 2
You can enjoy a chocolate lunch for $30 per person at the Langham hotel in Boston.
You can enjoy a chocolate lunch for 250 AED per person at the Burj Al Arab hotel in Dubai.
Therefore the exchange rate should be 8.33AED/USD.

44. PPP & The Law of One Price
Given this information, the exchange rate should be 8.33AED/USD.
The actual exchange rate today is AED/USD.
Is the UAE Dirham over or under valued?
Calculate (implied – actual) / actual.
/ = 126%
The UAE Dirham is overvalued by 126%.

45. Example 3 You can stay at a Hilton in Boston for $152.96 per night
You can stay at a Hilton in Athens, Greece for € per night

46. PPP & The Law of One Price
Given this information, the exchange rate be between the USD and the EUR should be 251EUR/152.96USD = 1.64EUR/USD
The actual exchange rate today is EUR/USD.
Is the euro over or under valued?
Calculate (implied - actual) / actual.
/ = 120%
The euro is overvalued by 120%.

47. The Big Mac Hamburger Standard
The Economist developed the Big Mac Standard to track PPP:
Assuming that the Big Mac is identical in all countries, it serves as a comparison point as to whether or not currencies are trading at market prices.
A Big Mac in Switzerland costs Sfr6.30 while the same Big Mac in the US costs $2.54.
The implied PPP of this exchange rate is:

48. The Big Mac Hamburger Standard
However, on the date of the survey, the actual exchange rate was Sfr1.73/$, therefore the Swiss franc is overvalued by:

49. Big Mac Index
The Economist's Big Mac index is based on the theory of purchasing-power parity.
The cheapest burger is in China, where it costs $1.30, compared with an average American price of $3.15. This implies that the yuan is 69% undervalued.
3.15/1.30 = 2.46
Actual rate on 01/09 =
2.46/8.06 – 1 = -69%

50. Latte Index
The Economist asked: what can the price of Starbucks coffee—now served in as many as 32 countries—tell us about exchange rates?
The theory of purchasing-power parity (PPP) says that, in the long run, exchange rates should move towards levels that equalize the prices of a basket of goods and services in different countries—ie, a dollar should buy the same amount of stuff everywhere.
By coincidence, the average price of a Starbucks tall latte in America is the same as the average price of a Big Mac, $2.80. By dividing the local currency price in each country by the dollar price we can calculate dollar PPPs. Comparing these with actual exchange rates is one test of whether a currency is undervalued or overvalued.
Our tall-latte index tells broadly the same story as the Big Mac index for most main currencies (see table; see article). Economic trouble is surely brewing in Europe: the euro (based on the average price of €2.93—$3.70—in member countries where Starbucks operates) is about 30% overvalued against the dollar. Sterling is 17% too strong. By both measures, the Swiss franc is the world's most overvalued currency. The Canadian, Australian and New Zealand dollars are still undervalued against the dollar despite their recent climb.
Where the two measures differ is in Asia. The burger index says the yen is 12% undervalued against the dollar; on the coffee standard, however, it is 13% overvalued. More startling is the Chinese yuan: it is 56% undervalued according to the Big Mac, but spot on its dollar PPP according to our Starbucks index. If so, American manufacturers have no grounds to complain about the yuan. The pricing differences probably reflect different competition in the markets for the two products.
Many readers will find burgernomics and lattenomics hard to swallow. Both are flawed as measures of PPP, because they are distorted by differences in the cost of non-tradables such as rents. Yet they are surely a more fun way to understand exchange rates than textbooks. Many readers ask why we don't we use the price of The Economist around the globe. Unlike the Big Mac or a tall latte, The Economist is not produced locally in lots of countries, so distribution accounts for a large chunk of its cost. Burgers and coffee are therefore likelier to give some clues about currencies.
Source: “Burgers or beans?” Jan 15th The Economist A new theory is percolating through the foreign-exchange markets

51. Rumors have it there are 2 local beers: Gazelle Flag
Example Senegal
Rumors have it there are 2 local beers:
Gazelle
Flag
Flag sells for CFA 300.
CFA 300 is the price in local currency [1]
The spot rate was CFA Franc = 1 South African Rand, so the price in rand = 3.10 [2]
Implied PPP = 3.10/2.30 = 1.35 [3]
1.35/96.80 = 1.39%, which means the CFA franc was over valued by 1.35% versus the rand.
Egypt:
Mauritius
Photo Source: Modified from
CFA stands for Communauté financière d'Afrique ("Financial Community of Africa").
(CFA price is as of 3/13/99)

52. Interest Rates & Exchange Rates
Theory says that interest rates reflect expectations about future exchange rates.
Fisher Effect
International Fisher Effect

53. Fisher Effect Fisher Effect
A country’s “nominal” interest rate (i) is the sum of the required “real” rate of interest (r) and the expected rate of inflation over the period for which the funds are to be lent (I).
i = r + I

54. International Fisher Effect
International Fisher Effect (IFE)
For any two countries the spot exchange rate (S) should change in an equal amount but in the opposite direction to the difference in nominal interest rates (i) between the two countries.
(S1 – S2)/S2 x 100 = i$ - iDM

55. Insuring against FX Risk
Forward exchanges occur when two parties agree to exchange currency and execute the deal at some specific date in the future
Exchange rates governing such future transactions are referred to as forward exchange rates
For most major currencies, forward exchange rates are quoted for 30 days, 90 days, and 180 days into the future
When a firm enters into a forward exchange contract, it is taking out insurance against the possibility that future exchange rate movements will make a transaction unprofitable by the time that transaction has been executed

56. Investor Psychology & Bandwagon Effects
Evidence suggests that neither PPP nor the International Fisher Effect are good at explaining short term movements in exchange rates
Explanation may be investor psychology and the bandwagon effect
Investor Psychology
Example: if the market is bullish on the dollar, then the dollar is likely to strengthen versus other currencies.
Bandwagon Effect
Examples: Investors sell their positions to get out of a falling asset.

57. Exchange Rate Forecasting
Individuals that believe in the efficient market theory believe that prices reflect all available public information
Forward rates should be unbiased predictors of future spot rates
Individuals that feel there is an inefficient market believe that prices do not reflect all available information
Forward exchange rates will not be the best possible predictor of future spot exchange rates
If this is true, it may be worthwhile for international businesses to invest in forecasting services
Approaches to Forecasting
Fundamental analysis
Draws on economic theory to construct sophisticated econometric models for predicting exchange rate movements
Technical analysis
Uses price and volume data to determine trends

58. Technical Analysis
Where is the dollar headed versus the yuan?

59. Technical Analysis
Where is the dollar headed versus the yuan?

60. Currency Convertibility
In some countries the ability to convert currency is restricted by the government.
Government restrictions can include
A restriction on residents’ ability to convert the domestic currency into a foreign currency
Restricting domestic businesses’ ability to take foreign currency out of the country
Governments will limit or restrict convertibility for a number of reasons that include:
Preserving foreign exchange reserves
A fear that free convertibility will lead to a run on their foreign exchange reserves – known as capital flight

61. Barter
Barter (or Countertrade) is when companies trade goods and services rather than entering foreign exchange markets or paying cash.
The Economist adds that “[Barter] is often popular when the quality of money is low or uncertain, perhaps because of high inflation or counterfeiting, or when people are asset-rich but cash-poor, or when taxation or extortion by criminals is high.”

62. Barter (Continued) It’s a huge industry!
In fact, the International Reciprocal Trade Association ( estimates that the annual value of barter trade by North American Companies is approximately $10B…
…and that over a half a million firms will use the services of commercial barter companies this year.

63. Examples General Motors swapped locomotives for tea in Sri Lanka.
Coca Cola has traded for Korean toothpick frills and Bulgarian forklifts.
In the Balkans, McDonnell Douglas accepted crystal software, cutting tools, leather coats and canned hams--yes, canned hams--as partial payments for jet aircraft!
Source:

64. How many Chickens is a Fighter Jet Worth?
Thai economists are trying to work out the answer as the Government is hoping to barter chickens and rice to pay for everything from military aircraft to subway trains.
When the Prime Minister opened the bidding for Thailand's Bt1.7 trillion public works program, he said his Government was interested in alternative "financing mechanisms" — namely, bartering.
The highlight of the new projects is an expansion of the public transport system, expected to cost Bt550 billion. The Defense Ministry also wants to barter for fighter jets it is considering buying from Russia, Sweden or the US.
The Government believes that bartering for such big-ticket items would help keep the country's foreign debt ratio below 50 per cent of gross domestic product.
The scheme envisions trading farm goods already in government stocks, such as surplus rice, instead of using cash for at least part of the payment to foreign companies.
A barter trade committee has been created to assess the bids for the public works projects and negotiate how much chicken, rice or tapioca could be used to finance the deal.
Some foreign companies are skeptical.
French engineering conglomerate Alstom, doubted whether barter was the best payment option. "A company like us, we don't do barter, we sell trains. We cannot sell chickens," said Nazir Rizk, who heads the Thai subsidiary.

65. Implications for Managers
It is critical that international businesses understand the influence of exchange rates on the profitability of trade and investment deals
Adverse changes in exchange rates can make apparently profitable deals unprofitable

66. (Accounting) exposure (Economic) Operating exposure
Conceptual Comparison of Transaction, Operating and Accounting Foreign Exchange Exposure
Moment in time when
exchange rate changes
Translation
(Accounting) exposure
(Economic) Operating exposure
Changes in reported owners’ equity
in consolidated financial statements
caused by a change in exchange rates
Change in expected future cash flows
arising from an unexpected change in
exchange rates
Transaction exposure
Impact of settling outstanding obligations entered into before change
in exchange rates but to be settled after change in exchange rates
Time

67. Reducing FX Exposure Reducing Translation and Transaction Exposure
These tactics are primarily designed to protect short-term cash flows from adverse changes in exchange rates
Firms can use a lead strategy
An attempt to collect foreign currency receivables when a foreign currency is expected to depreciate
Expect foreign depreciation: Collect Early
Paying foreign currency payables before they are due when a currency is expected to appreciate
Expect foreign appreciation: Pay Early
Firms can use a lag strategy
An attempt to delay the collection of foreign currency receivables if that currency is expected to appreciate
Expect foreign appreciation: Collect Late
Delay paying foreign currency payables if the currency is expected to depreciate
Expect foreign depreciation: Pay Late
A number of tactics can help firms minimize their transaction and translation exposure.

68. Reducing Economic Exposure
Reducing economic exposure requires strategic choices that go beyond the realm of financial management
The key to reducing economic exposure is to distribute the firm’s productive assets to various locations so the firm’s long-term financial well-being is not severely affected by adverse changes in exchange rates

69. Other Steps Central control of exposure
to protect resources efficiently and ensure that each subunit adopts the correct mix of tactics and strategies
Forecasts of future exchange rate movements
Establish good reporting systems & monthly FX exposure reports.
so the central finance function can regularly monitor the firm’s exposure positions.
The firm needs to develop a mechanism for ensuring it maintains an appropriate mix of tactics and strategies for minimizing its foreign exchange exposure. Although there is no universal agreement as to the components of this mechanism, a number of common themes stand out.

70. Project Topics – Due Next Class
Final Project Topics Due Next Class:
1 slide 2 minutes 3 copies (include each team member’s name)
Figure 7.6, p. 256