1. More Winter ahead…

2. Trade, FDI, and the Economy offset by capital surplus F U.S. trade deficit – offset by capital surplus reduces U.S. imports F U.S. attracts FDI – reduces U.S. imports Cash $$ T-bills, assets

3. Foreign Currency F What is it? F Why does it change? F Risk for international managers F How to manage risk

4. Linkage Between Currencies World Market for Euros World Market for Dollars Price = $ / € Price = € / $ S D S D $1.30 / € €.77 / $ Same “market”…different perspective.

5. Trade, FDI, and the Economy trade deficit F Increase demand for Japanese computers – trade deficit inflationary F Increase demand for computer inputs (components, labor, etc.) – inflationary appreciates F Increase demand for Yen – appreciates decreases demand for Japanese computers F Stronger Yen increases U.S. prices – decreases demand for Japanese computers Computers Cash $$

6. German Market for BMWs Price in Euros € 100,000 S D

7. Global Market for BMWs: Americans want to import BMWs Price in Euros € 100,000 S D D’ € 110,000

8. World Market for Euros Price in Dollars $0.77 / € S D

9. World Market for D-Marks: Americans need to convert Dollars to Euros Price = $ / € $0.77 / € S D D’ $0.74 / €

10. Linkage Between Currencies World Market for Euros World Market for Dollars Price = $ / € Price = € / $ S D S D $0.77/ €€ 1.30/$

11. Linkage Between Currencies World Market for Euros World Market for Dollars Price = $ / € Price = € / $ S D S D € 1.30/$ D’ S’ $0.77/ € $0.74/ € € 1.35/$

12. Other Forces Causing Change F Foreign Direct Investment F Foreign Portfolio Investment – MNCs – Government Debt Instruments F Currency Arbitrage and Speculation F Governmental Intervention – Official and Unofficial “pegs” – International Agreements (e.g., G-7, the Euro) – Posturing (e.g., “talking” the dollar down)

13. Index of Swiss Franc vs. Dollar 1990 = 100 19901980 2000

14. Depreciating Peso

15. The Big Mac Index www.economist.com

16. Short-term F/X Management F Currency Hedges – Forward Contracts – Options – Negotiation of Ratcheted Pricing Schedule F Adjustment of Prices and Target Profits – Lower foreign prices to keep market share when home currency appreciates … lowers profit margin – Raise foreign prices to keep profit margins when home currency depreciates … less price competitive

17. Today: US Dealer to Import BMWs F Sales Contract: – Quantity: 100 BMW 750s – Price: € 100,000 each – Payment: Due in 3 months F Value of Sales Contract = – € 10.0 million – Spot Rate = $1.30 / € – $13.0 million

18. In Three Months: Payment is Due Uncovered Transaction F Euro appreciates – New spot rate = $1.35 / € – € 10.0 million F Adjusted Value of Sales Contract – “Risk penalty” = $0.05 per € traded – $13.5 million F US Dealer’s Loss = $500,000

19. Today: US Dealer to Import BMWs Hedged Transaction F Sales Contract: – Quantity: 100 BMW 535s – Price: € 100,000 each – Payment: Due in 3 months F Value of Sales Contract = – € 10 million – at 90-day Forward Rate = $1.305 / € – “Insurance premium” = $0.005 per € traded – $13.05 million

20. In Three Months: Payment is Due Hedged Transaction F Euro appreciates – New spot rate = $ 1.35 / € (Doesn’t matter!!!) – € 10 million F Adjusted Value of Sales Contract – Locked-in Forward Rate = $ 1.305 / € – $13.05 million F Cost of Hedge (insurance premium) = $50,000

21. In Three Months: Payment is Due Hedged Transaction F Euro Depreciates – New spot rate = $ 1.25 / € – € 10 million F Adjusted Value of Sales Contract – Locked-in Forward Rate = $ 1.305 / € (Spot better!!) – $12.5 million F Currency Windfall - Cost of Hedge = $450,000

22. Medium-Term F/X Management F Balance sheet hedge – Match foreign assets with same level of foreign liabilities in same currency F Cash flow hedge – Match foreign A/P with A/R in same currency

23. Long-Term F/X Management F Shift sourcing and procurement F Shift production F Cut costs / improve productivity