Welcome to class of financial forces by Dr. Satyendra Singh University of Winnipeg Canada

Learning Objectives  Foreign exchange (FX) terminology  Foreign exchange rates  Currency fluctuations  Exchange rate forecasting  Currency exchange controls  How financial forces such as tariffs, taxes, inflation and the balance of payments can affect international business Objectives:

Foreign Exchange Terminology  Foreign Exchange Quotation  The price of one currency expressed in terms of another  Reported in the world’s currency exchange markets  Central reserve asset  Asset (currency) held by a government’s central bank  Vehicle currency  Used as a vehicle for international trade or investment  Intervention currency  Used by a country to intervene in the foreign currency exchange markets, often to buy (strengthen) its own currency

Exchange Rates…  Spot rates  The exchange rate between two currencies for delivery within two business days  Forward currency market  Trading market for currency contracts deliverable 30, 60, 90, or 180 days in the future  Forward rate  The exchange rate between two currencies for delivery in the future, usually 30, 60, 90, or 180 days

Exchange Rates…  Trading at a premium  A currency’s forward rate quote is stronger than the spot rate  Trading at a discount  A currency’s forward rate quotes is weaker than the spot rate  Premium or a discount depends on the expectations of the world financial community, businesses, individuals, and governments about what the future will bring

Exchange Rates  Cross Rates  Currency exchange rates for trading directly between non-U.S. dollar currencies  Bid price  Price offered to buy  Ask price  Sales price

Influences of Exchange Rate Fluctuation  Supply and demand of the currency  Interest rates  Inflation  Expectations

Exchange Rate Fluctuation…  Monetary policies  Government policies that control the amount of money in circulation and its growth rate  Fiscal policies  Policies that address the collecting and spending of money by the government  Law of one price  Concept that in an efficient market, like products will have like prices  Arbitrage  The process of buying and selling instantaneously to make profit with no risk

Exchange Rate Fluctuation  Fisher effect  The relationship between real and nominal interest rates: the real interest rate will be the nominal interest rate minus the expected rate of inflation  International Fisher effect  Concept that the interest rate differentials for any two currencies will reflect the expected change in their exchange rates  Purchasing Power Parity (PPP)  Theory that predicts that currency exchange rates between two countries should equal the ratio of the price levels of their commodity baskets

Exchange Rate Forecasting…  Efficient market approach  Assumption that current market prices fully reflect all available relevant information  Random walk hypothesis  Assumption that the unpredictability of factors suggests that the best predictor of tomorrow’s prices is today’s prices

Exchange Rate Forecasting  Fundamental approach  Exchange rate prediction based on econometric models that attempt to capture the variables and their correct relationships  Technical analysis  An approach that analyzes data for trends and then projects these trends forward

Currency Exchange Controls…  Government controls that limit the legal uses of a currency in international transactions  Value of currency is arbitrarily fixed at a rate higher than its market value  If you see “official rate” next to a currency rate quotation, that country has currency exchange controls in place

Currency Exchange Controls  A black market typically surfaces as a result of currency exchange controls  However, this type of currency exchange transaction is illegal  The black market is rarely able to accommodate transactions of the size involved in international business

Tariffs  Tariffs  Taxes, usually on imported goods  May be ad valorem, specific, compound, or variable

Taxation  Income tax Direct tax on personal and corporate income  Value-added tax (VAT) A tax charged on the value added to a good as it moves through production from raw materials to final purchaser  Withholding tax Indirect tax levied on passive income that the corporation would pay out to non residents

Corporate Tax Rates

Inflation  A trend of rising prices  May be caused by demand exceeding supply  May be caused by an increase in the money supply  Measured by consumer price index (CPI)  Basket of consumer goods  Gross domestic product deflator--OECD  Takes into account the prices of intermediate goods and services

Inflation and the International Company..  High inflation rates  Make capital expenditure planning more difficult  Cause the cost of goods and services to rise  Tend to cause BOP deficits  Could lead to more restrictive fiscal or monetary policies, currency controls, export incentives, and import obstacles  Encourage borrowing because the loan will be repaid with cheaper money  Bring high interest rates  Discourage lending  Make capital expenditure planning more difficult

Balance of Payments (BOP)  The state of a nation’s BOP reveals the state of that country’s economy  If the BOP is slipping into deficit  the government is probably considering one or more market or nonmarket measures to correct or suppress that deficit  Currency devaluation or restrictive monetary or fiscal policies to induce deflation are likely  Currency or trade controls may be near