1. INTERNATIONAL MONETORY SYSTEM AND FOREIGN EXCHANGE
WEEK 6
INTERNATIONAL MONETORY SYSTEM AND FOREIGN EXCHANGE

2. LEARNING OBJECTIVES After this topic you should be able to:
1. Track the evolution of the international monetary system
2. Understand foreign exchange
3. identify firms’ strategic responses to deal with foreign exchange movements
4. draw implications for action 2

3. EVOLUTION OF THE INTERNATIONAL MONETARY SYSTEM
Gold standard
1870 and 1914
a system in which the value of most currencies was maintained by fixing their prices in terms of gold, which served as the common denominator
Convert the paper currency into gold 3

4. How currency was converted?
Under gold standard – one US dollar=23.22 grains of pure gold, 480 grains in an ounce, one ounce of gold cost $20.67 (480/23.22
British pound sterling = 113 grains, one ounce of gold cost 4.52 pound (480/113).
From the gold par values , the exchange rate for pound and dollar was 1 pound = $4.87 ($20.67/4.25 pound)

5. Before Gold Standard

8. Bretton Woods system In 1944, World War II to 1973
Establishment of International Monetary Fund (IMF) and the World Bank (promote economic development)
Introduced a system in which all currencies were pegged at a fixed rate to the US dollar.
All countries were to fix the values of their currency in term of gold but not required to exchange their currency for gold
US dollar remained convertible into gold at the price of $35 per ounce.
Problem- any pressure of dollar could weak havoc the system

10. Bretton Wood Agreement

11. The World Bank
Official name – International Bank for Reconstruction and Development (IBRD)
The bank lend money under two schemes-
IBRD scheme (the money is raised through bond sales in the international market and borrowers pay what the bank calls a market rate interest – lower than commercial bank interest
International Development Association (IDA) – loan for poor countries, sources of the loan is from rich countries (USA, UK, Germany and Japan). Borrowers have 50 years to repay at an interest rate of 1 percent a year.

12. International Monetary Fund (IMF)
Established on 1 march 1947
An international organization of 185 member countries established to:
promote international monetary cooperation, exchange stability, and orderly exchange arrangements
foster economic growth and high levels of employment
provide temporary financial assistance to countries to help ease balance of payments adjustment 12

14. IMF roles in overall finance architecture

16. How IMF operate? Based on Quota system
Quota (SDR) is the pool of money that IMF can draw to lend to countries
Determine the voting rights of individual countries
US (17.19%) quota, Japan (6.13%), Germany (5.99), France (4.94) and UK (4.94)

18. Critics of IMF
Inappropriate policies – “one-size-fits-all” approach to macroeconomic policy is inappropriate for many countries
Moral hazard – when people behave recklessly because they know they will be saved if things wrong
Lack of accountability – too powerful, determines microeconomic policies in those countries and yet IMF lack of staff (1000), less expertise to do the job.

19. Floating exchange rate regime
formalized in 1976, system of flexible exchange rate regimes with no official common denominator
Jamaica Agreement – gold was abandoned as a reserve asset, IMF return all gold to members at market proce

20. Floating exchange rate regime
formalized in 1976, system of flexible exchange rate regimes with no official common denominator
Jamaica Agreement – gold was abandoned as a reserve asset, IMF return all gold to members at market proce

21. WHAT IS EXCHANGE RATE?
An exchange rate (also known as the foreign-exchange rate, forex rate or FX rate)
The price of one country's currency expressed in another country's currency
Example - if you are traveling to Thailand the exchange rate for RM  1:10 Bath, this means that for every RM you can buy 10 baths
Theoretically, identical assets should sell at the same price in different countries, because the exchange rate must maintain the inherent value of one currency against the other.

22. Country
Currency
Currency Code
Symbol
Argentina
Pesos
ARS $
Australia
Dollars
AUD
Belgium
Euro
EUR €
Brazil
Reais
BRL R$
Britain (United Kingdom)
Pounds
GBP
Brunei Darussalam
BND
China
Yuan Renminbi
CNY
Denmark
Kroner
DKK kr
England (United Kingdom)
France
Holland (Netherlands)
India
Rupees
INR Rs
Indonesia
Rupiahs
IDR Rp
Malaysia
Ringgits
MYR RM
South Korea
Won
KRW ₩
Switzerland
Francs
CHF
Thailand
Baht
THB ฿
United States of America
USD

24. 24

27. WHY EXCHANGE RATE IS IMPORTANT FOR INTERNATIONAL BUSINESS?
Payment received from exports
Income received from international investment
Payment for purchase of products of services from other countries
spare cash - Short term Investment in money market

28. Currency distribution of global foreign exchange

29. Why US dollar is widely used in international trading?
It’s an investment currency in many capital market
It’s reserve currency use by many central banks
It’s a transaction currency in many international commodities
It’s an invoice currency in many contracts
It’s an intervention currency employed by monetary agencies

30. DETERMINANT OF EXCHANGE RATE
Inflation rate - As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies
Interest Rates - Higher interest rates offer lenders in an economy a higher return relative to other countries. Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise.
Current-Account Deficits - a deficit in the current account shows the country is spending more on foreign trade than it is earning, and that it is borrowing capital from foreign sources to make up the deficit.

31. UK current account - Deficit

34. Public Debt - countries will engage in large-scale deficit financing to pay for public sector projects and governmental funding. While such activity stimulates the domestic economy, nations with large public deficits and debts are less attractive to foreign investors. The reason? A large debt encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future.
Terms of Trade - increasing terms of trade shows greater demand for the country's exports. This, in turn, results in rising revenues from exports, which provides increased demand for the country's currency (and an increase in the currency's value).
Political Stability and Economic Performance
Black markets – people are willing to pay more for US dollars than official rate

35. US Public Debt

37. Law of price
how much of one currency should be pay to receive certain amount of product
Identical product must have identical price in all countries
Helps to determine whether the currency is overvalued or undervalued.
Big-Mac Index – Publish by economist magazine
Use McDonald’s Big Mac as a products to test the law of price
Compare the price of Big Mac in the US with another countries

39. Example:
The average price of Big Mac in the US is $3.58
The cheapest Big Mac was Found in China equivalent $1.83.
The most expensive was in Norway - $7.02
Therefore, according to Big Mac Index – China Yuan was undervalued by 49% (3.58 – 1.83)/3.58 x 100.
Norway currency was overvalued by 96% - (3.58 – 7.02)/3.58 x 100.

40. EXCHANGE RATE ARRANGEMENT
fixed exchange rate policy - Fixing the exchange rate of a currency relative to other currencies- usually US dollar.
Floating (or flexible) exchange rate policy - willingness of a government to let the demand and supply conditions determine exchange rates 40

41. FIXED EXCHANGE RATE Also called pegged exchange rate
When a country pegs its currency to the dollar,
control the value of their currency so that it rises and falls as the dollar does to stabilize the value of a currency
makes trade and investments between the two countries easier and more predictable
Reduce uncertainties for all economic agents in the country. As businesses have the perfect knowledge that the price is fixed and therefore not going to change they can plan ahead in their productions.
Control inflation - to ensure that inflation is kept as low as possible the government is forced to take measurements, to keep businesses competitive in foreign markets.
Reduce speculations in foreign exchange markets.

42. FLEXIBLE/FLOATING RATE
Currency rate is determined by free market forces, rather than being fixed by the government.
determined by the private market through supply and demand.
Often termed "self-correcting", as any differences in supply and demand will automatically be corrected in the market
if demand for a currency is low, its value will decrease, thus making imported goods more expensive and stimulating demand for local goods and services.
is constantly changing.

43. create uncertainty on the international markets
create uncertainty on the international markets. As businesses try to plan for the future it is not easy for the businesses to handle a floating exchange rate which might vary.

44. How companies use Foreign Exchange?
Commercial bills of exchange – use check or called draft through electronic transmission. If the exporter requested the payment to be made after 30 days of delivery of goods the draft is called “sign draft”
Letter of credit
obligate the buyer’s bank to honor a draft presented to it assume payment.
A credit relationship between the importer and the importer’s bank.

45. THE FOREIGN EXCHANGE TRADING PROCESS
US company B
Malaysian Company A
Financial Institution A
Money center Bank
Financial Institution B
Broker
Option/ futures exchange
Broker
Malaysian Ringgit
Dollar

46. BUSINESS IMPLICATIONS OF EXCHANGE-RATE CHANGES
Marketing decisions – strengthening of a country’s currency value could create problems to exporters. Cost of products and services higher that markets
Production decisions – companies might locate production in a weak-currency country because low cost of investment and inexpensive exportation
Financial decisions – can influence the source of financing, cross boarder funds, and reporting financial results

47. GLOBAL FINANCIAL CRISIS AND IMPLICATION
China is trying to increase the importance of Yuan to reduce the importance of US dollar
China is working with several country to allow bilateral Swap in currencies
Unstable economics
Risks in business

48. DISCUSSION
What is the implications of changing value of US dollar to Malaysian companies that involve in import and export of goods from other countries?