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Introduction Midterm Grades Executive Summary Due Today

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1 Introduction Midterm Grades Executive Summary Due Today
Chapter 8: Regional Economic Integration Case Study: Hyundai and Kia The “Trade Game” Chapter 9: The Foreign Exchange Market

2 Midterm Results High Score 120 (3 Students) Low Score 73
Best Study Sheet(s) Keith Lee (Web Retail) Julia Van Rosendael (Beryna)

3 Best Diamond(s) Davey Gant (Global Green) Shadia Damra ( PCTE)
Joseph Cornwell (PCTE) Douglas Bell (Web Retail) Keith Lee (Web Retail) Juan Manzanera (Web Retail) Sarthak Gandhi (Web Retail) Andres Echeverri (PCTE) Harpreet Kang ( PCTE) Vikram Bajaj (PCTE) Aayush Singhania (Global Green) Jorge Hernandez (Global Green) Akash Mathran (Paper 2 Paper) Philipp Krispin (Beryna) Livia Machado (Beryna) Julia Van Rosendael (Beryna) Preben Johannessen (Unirate) Mohammed Ahmed (Unirate) Gurmat Sahni (Unirate)

4 Example: Children’s Book: U.S. Market
Demand Conditions Government Chance Culture: Importance of reading to children Preference for picture books Popularity of Gifts (holidays, birthdays, etc.) Strong IP Protection Michelle Obama advocates Children’s literacy Government cut Reading Program (provided 4.4M children w/ Free books) Firm Strategy, Structure, & Rivalry Related & Supporting Industries Universities, publishers, artists, Technological innovation (printing & electronic) Many Authors, Fierce Competition Entrepreneurship Factor Conditions Literacy rates Size of the population Image source: Google images search “diamond”

5 Chapter 8: Regional Economic Integration
Wendy Jeffus Harvard Summer School 5

6 Introduction 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.

7 India - Malaysia 06/30/11 - New Delhi: The India-Malaysia Comprehensive Economic Cooperation Agreement (Ceca), which was inked earlier this year, will come into effect on July 1, 2011. The Ceca envisions liberalization of trade in goods, trade in services, investments and other areas of economic cooperation. Trade between the two countries reached $10 billion in , an increase of 26% from the previous year.

8 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 Association (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 Community of Nations (Bolivia, Colombia, Ecuador, & Peru) Common external tariffs 5 – 20% Common market 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

9 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

10 Example: EU Trade Agreements

11 Case for Integration Pros Economic Arguments Political Arguments Cons
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 the 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 Cons 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)

12 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.

13 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

14 Image Source: http://europa.eu/about-eu/countries/index_en.htm
EU Membership Image Source:

15 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, Iceland, Macedonia, Montenegro and Turkey.

16 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

17 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

18 Most Active Regional Trade Blocs

19 In the news… July 2, United States has decided to remove Bolivia from the Andean Trade Preference Act, a bill that allows many goods from Colombia, Bolivia, Ecuador, and Peru to enter into the United States duty free. The idea behind the act is that providing tariff free access to the U.S. market will help convince farmers to stop growing coca in favor of another commodity. Bolivia was removed because it is not doing enough to reduce the cultivation of coca. The U.S. Trade Representative to Bolivia said there has been "explicit acceptance and encouragement of coca production at the highest levels of the Bolivian government." Coca is seen as a cultural crop in Bolivia, where it is used for numerous reasons other than cocaine (such as religious ceremonies and as a mild sedative). Image Bolivia Coca tea (google images) CocoBlast Image:

20 Implications for Managers
Opportunities: Creation of single markets Protected markets, now open Lower costs doing business in a 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 For your final project: discover what trade agreements are relevant for the country you have selected.

21 Take a Break… Read the Handouts
Hyundai and Kia team if you haven’t done so, load your presentations on the desktop, grab a drink, meet your classmates… see you in 10 min. After the case presentation I will select groups for the “trade game” Image source:

22 Case Study Hyundai and Kia
Present a 5-10min (timed) assessment of the case (answer case questions) All group members must participate.

23 Wendy Jeffus Harvard Summer School
The Trade Game Wendy Jeffus Harvard Summer School 23

24 Assignments Tier I $12,500 Tier I $26,500* Tier II $27,500*
Sojung (& Sojung’s Friend) Douglas Tier I $26,500* Luis Shadia Tier II $27,500* Sophie Philipp Preben Davey Tier II (somewhere between $0 and $45K) Keith Helena Andres Rafael Tier II $26,500 Livia Lasse Aayush Juan Carlos Tier III (Somewhere between $0 and $45K) Azamat Joseph Berre Julia Mohammed Jorge Sarthak Tier III $0 Jonathan Nakul Vikram Akash Dominic Jolly Power Brokers Harpreet & Divya Bankers Radhika &Alessandro Chief Economists Yu & Pong *Winning countries (congrats)

25 The Game is Extended to 9pm!
(By the clock on the wall) Less than 15 seconds….Is the END of the game.

26 The Bankers will pay you in cash for the shapes
The Bankers will pay you in cash for the shapes. You will need this cash to provide for the subsistence of your people (at $500 per person per year). You may also use this cash to purchase additional capital, raw materials, labor, and environmental tokens. Meet your production quota - by paying the Chief Economist $500 for each citizen of your country. If you do not have enough money, then some of your people will starve, and DIE! Trade Simulation Starting Output Prices (at least 3 inches each; higher price for red shapes) Small Triangle $500 Circle $500 Half-Moon with circle cut out $1,000 Large Triangle with Half-moon cut out $1,500 Parallelogram with Square cut out $1,500 Power Brokers’ Price List Pencil $3,000 Colored Paper (2 sheets) $3,000 Labor (per person) $4,000 Red Paper (1 full sheet) $10,000 Ruler $10,000 Scissors $12,000

27 Game OVER!

28 Designing Negotiation Strategies
Organizing to influence – creating, staffing, funding, and directing institutions in ways that influence the trade negotiation process. Selecting the forum – identifying the most promising forum in which to pursue one’s objectives and then ensuring that negotiations take place there. Shaping the agenda – adding or removing issues from the agenda, dividing the larger agenda into modules for parallel negotiations, and establishing some high-level principles to govern the process. Building coalitions – identifying potential winning and blocking coalitions and then devising plans for building supportive coalitions and breaking or forestalling opposing ones. Leveraging linkages – linking and de-linking issues or sets of negotiations in order to create and claim value. Playing the frame game – crafting a favorable framing of “the problem” and “the options” Creating momentum – channeling the flow of the negotiations process in promising directions by establishing appropriate stages to take advantage of action forcing events.

29 9: The Foreign Exchange Market
Wendy Jeffus Harvard Summer School 29

30 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)

31 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

32 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

33 FX Quotations Be careful reading FX quotes, know which currency is first. ¥/$ Source:

34 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

35 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). 7/13/11 Financial Times: Toyota shaken by quake and strong yen 7/5/11 USA Today: Volkswagen’s New Plant in Tennessee

36 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”

37 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 or other transaction 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)

38 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

39 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 29.88BHT/USD. Is the baht over or under valued vs. the dollar? Calculate (implied – actual) / actual. – / = 318% The baht is overvalued by 318% vs. the dollar.

40 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.

41 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%.

42 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:

43 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:

44 Memories of your class…
Submitted by BC Student (Costa Rica) 2009

45 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

46 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)

47 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

48 Technical Analysis Where is the dollar headed versus the yuan?

49 (Accounting) exposure (Economic) Operating exposure
Exhibit 8.1 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

50 Example: Transaction Exposure
Suppose that CHC Helicopters of Canada[1] has billed British Petroleum (BP) for services provided to BP’s sites on the North Sea. CHC’s invoice is for £1 million, due in three months. When CHC Helicopters receives £1 million three months from now, it will convert the British pounds into Canadian dollars at the spot rate. Imagine the exchange rate at time 0 = 1GBP/1CAD What are three things that can happen to the British pound over the next three months? The GBP goes… 0.5GBP/1CAD 1GBP/2CAD up C$ 2,000,000 1GPB/1CAD No where C$ 1,000,000 1.5GBP/1CAD (1GBP/0.667CAD) down C$ ,667 [1] A “world leader in supply logistics to offshore oil rigs” Photo source:

51 (becomes A/R for the seller)
The Life Span of a Transaction Exposure Time and Events CHC offers services to BP for £1M CHC provides services and bills BP £1M BP accepts bid for £1M t1 t2 t3 t4 Seller quotes a price to buyer (in verbal or written form) Buyer places firm order with seller at price offered at time t1 Seller ships product (or performs service) and bills buyer (becomes A/R for the seller) Buyer settles A/P with cash in amount of currency quoted at time t1 Quotation Exposure Backlog Exposure Billing Exposure t = 3 months Spot Rate (unknown) t = 0 Spot Rate (known) Time between quoting a price and reaching a contractual sale Time it takes to fill the order after contract is signed Time it takes to get paid in cash after A/R is issued Source: Modified from Multinational Financial Management, 11th edition, Ch 8, Exhibit 8.3

52 Example: Transaction Exposure
Suppose that CHC Helicopters of Canada[1] has billed British Petroleum (BP) for services provided to BP’s sites on the North Sea. CHC’s invoice is for £1 million, due in three months. When CHC Helicopters receives £1 million three months from now, it will convert the British pounds into Canadian dollars at the spot rate. Core Issue: The future spot rate cannot be known in advance. Consequently, in terms of the CAD, the value of the settlement is uncertain. If CHC Helicopter does nothing to address this uncertainty, it is effectively speculating on the future course of the exchange rate. Doing nothing is as if CHC is willing to take a bet that the British pound will appreciate against the Canadian dollar. [1] A “world leader in supply logistics to offshore oil rigs” Photo source:

53 Risk-sharing Risk-sharing is a contractual arrangement in which the buyer and seller agree to “share” or split currency movement impacts. Example: Ford purchases from Mazda in Japanese yen at the current spot rate as long as the spot rate is between ¥115/$ and ¥125/$. If the spot rate falls outside of this range, Ford and Mazda will share the difference equally. ¥115 ¥125 Mazda (Japan) Ford (U.S.) parts cash Photo source: “Eclipse Spider”

54 Risk-sharing: Example
Ford purchases from Mazda in Japanese yen at the current spot rate as long as the spot rate is between ¥115/$ and ¥125/$ -- and if the spot rate falls outside of this range, Ford and Mazda will share the difference equally. …So if on the date of invoice for a ¥25M payment, the spot rate is ¥110/$, then Mazda would agree to accept the following amount from Ford: ¥110/$ ¥115 ¥125 Mazda (Japan) Ford (U.S.) Note that this movement is in Mazda’s favor but it didn’t cost Ford as much as it could have (Ford saved $5,050)…

55 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 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 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.

56 Why Hedge? Risk aversion.
Maybe you would prefer a sure $10 million over a 50/50 chance at $20 million. Focus on the business of the company rather than “currency speculation” which makes available cash more volatile and takes resources away from the core business.

57 Davey… Imagine you were asked to pay $1,000,000 on Friday July 15th…
…but you forgot and turned off your computer Did you turn it back on and do the trade… …or go home and wait to do the trade on Monday?

58 Were you fired or promoted?
On Friday July 15th the exchange rate between the S. African rand was 6.88… On Monday July 18th the exchange rate was 6.97… I hope you turned your computer back on!

59 Livia… Imagine you were asked to pay $1,000,000 on Friday July 15th…
…but you forgot and turned off your computer Did you turn it back on and do the trade… …or go home and wait to do the trade on Monday?

60 Were you fired or promoted?
On Friday July 15th the exchange rate between the Brazilian real was 1.57… On Monday July 18th the exchange rate was 1.58… I hope you turned your computer back on!

61 Mohammed… Imagine you were asked to pay $1,000,000 on Friday July 15th… …but you forgot and turned off your computer Did you turn it back on and do the trade… …or go home and wait to do the trade on Monday?

62 Were you fired or promoted?
On Friday July 15th the exchange rate between the Egyptian pound was … On Monday July 18th the exchange rate was … I hope you waited until Monday!

63 Hedging Pros & Cons Arguments Against Hedging
Shareholders are much more capable of diversifying currency risk than the management of the firm Currency risk management does not increase the expected cash flows of the firm Management often conducts hedging activities that benefit management at the expense of the shareholders (agency conflict) Managers cannot outguess the market Arguments Supporting Hedging Reducing the risk of future cash flows improves the planning capability of the firm …and the likelihood that the firm’s cash flows will fall below a necessary minimum (the point of financial distress) Management has a comparative advantage over the individual shareholder in knowing the actual currency risk of the firm Management is in better position to take advantage of disequilibrium conditions in the market

64 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

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 For your final projects: know the currency, determine if it is fixed or floating, report whether it is expected to strengthen or depreciate, and discuss the impact on your investment.


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