International Business Environments & Operations

International Business Environments & Operations
15e, Global Edition Daniels ● Radebaugh ● Sullivan International Business Environments and Operations 15e, Global Edition by Daniels, Radebaugh, and Sullivan

23 January 2018: Our company is ordering Euro 1 million worth of manufacturing raw materials from a distributor in The Netherlands, to be delivered in January 2019, payable now or on the delivery date. (Our vendor’s analysis probably set the price for acceptable profit regardless of when we pay. Check Spot Rate: Jan 23, :42 UTC

Spot and Futures Rates Jan 23, 2018 16:42 UTC Russian Ruble 1.00 RUB
Russian Ruble 1.00 RUB Rubles to Euro Jan 2019 Futures Exchange Jan 2019

Alternatives Payment now: R 144 210 000,00
Payment in a year using futures contract: R ,00. Paying now is R ,00 less than paying a year from now.

Alternatives Sberbank will pay 10,52% on a 1 year deposit.
10,52% x R ,00 = R ,00

Alternatives By investing R ,00 in new and upgraded production facilities and marketing, our company can increase profits from sales revenue. If sales revenue is R ,00 per annum, and our profit is 15% per annum, what percent increase in sales would we need to realize from this investment to equal the return from the savings deposit at Sberbank?

Alternatives Our annual profits are 15,000,000.00 ₽.
An investment of R ,00 R would need to double annual profits to match the interest income from the savings deposit.

Alternatives Your solution and justify:

Factors that Influence Exchange Rates
Chapter 9 Factors that Influence Exchange Rates Chapter 9: Factors that Influence Exchange Rates

Definition: Central Bank
Central Bank: a Government-established monopoly institution given privileged control over the production and distribution of money and credit. In modern economies, the central bank is usually responsible for the formulation of monetary policy and the regulation of member banks. Read more: Central Bank

Definition: Monetary Policy
Monetary policy consists of the actions of a central bank, currency board or other regulatory committee that determine the size and rate of growth of the money supply in a nation-state, which in turn affects interest rates.

How does your local bank obtain foreign currency?
The interbank market is the top-level foreign exchange market where banks exchange different currencies. The banks can either deal with one another directly, or through electronic brokering platforms. The Electronic Broking Services (EBS) in the UK, and Thomson Reuters EIKON are the two competitors in the electronic brokering platform business and together connect over 1000 banks.

As the currencies of most developed countries have floating exchange rates, these currencies do not have fixed values but, rather values that fluctuate relative to other currencies—The brokering systems provide spot and futures information on exchange rates in near-real-time.

The interbank market is an important segment of the foreign exchange market. It is a wholesale market through which most currency transactions are channeled. It is mainly used for trading among bankers.

The three main constituents of the interbank market are: the spot market the forward market SWIFT (Society for World-Wide Interbank Financial Telecommunications)

The interbank market is unregulated and decentralized. There is no specific location or exchange where these currency transactions take place. However, foreign currency options are regulated in a number of countries and trade on a number of different derivatives exchanges. The Central Banks in many countries publish closing spot prices on a daily basis.

RISK: Russian hackers steal $10 million from ATMs through Interbank networks
11 December 2017 A newly-discovered hacking group had managed to steal potentially millions of dollars from US, UK, and Russian banks in the past two years, researchers claim. The group, dubbed MoneyTaker, has successfully managed to attack over 20 financial institutions, banks, software vendors, and law firms worldwide through the Interbank network systems.

Chapter Learning Objectives
Describe the International Monetary Fund and its role in the determination of exchange rates Discuss the major exchange-rate arrangements that countries use Explain the European Monetary System and how the euro became the currency of the euro zone Identify the major determinants of exchange rates Show how managers try to forecast exchange-rate movements Explain how exchange-rate movements influence business decisions The Learning Objectives for this chapter are To describe the International Monetary Fund and its role in the determination of exchange rates To discuss the major exchange-rate arrangements that countries use To explain how the European Monetary System works and how the euro became the currency of the euro zone To identify the major determinants of exchange rates To show how managers try to forecast exchange-rate movements To explain how exchange rate movements influence business decisions

Definition: Monetary Policy
Money supply is maintained through actions such as modifying the interest rate, buying or selling government bonds, and changing the amount of money banks are required to keep as bank reserves. Usually a central bank is in charge of monetary policy Read more: Monetary Policy

Definitions: Reserve Currency
Reserve currency: A reserve currency is currency held by central banks and other major financial institutions as a means to pay off international debt obligations, or to influence their domestic exchange rate. A large percentage of commodities, such as gold and oil, are priced in the reserve currency, causing other countries to hold this currency to pay for these goods.

Definitions: Reserve Currency
Holding currency reserves minimizes exchange rate risk, as the purchasing nation will not have to exchange their currency for the current reserve currency in order to make a purchase. Since 1944, the U.S. dollar has been the primary reserve currency used by other countries. Read more: Reserve Currency

Definitions Financial Instrument: definition from Investopedia.com:

Introduction Learning Objective: Describe the International Monetary
Fund and its role in the determination of exchange rates Learning Objective : To describe the International Monetary Fund and its role in the determination of exchange rates.

The International Monetary Fund
1:23 minutes The goals of the International Monetary Fund (IMF) are to ensure stability in the international monetary system promote international monetary cooperation and exchange-rate stability facilitate the balanced growth of international trade provide resources to help members in balance-of-payments difficulties or to assist with poverty reduction The IMF, which was created in 1945, was formed to promote exchange rate stability and facilitate the international flow of currencies. The IMF monitors the global economy and also the economies of individual nations and provides recommendations as needed. Most recently, the IMF has been involved in the crisis in Greece for example.

Bretton Woods Agreement: Some History
What is the 'Bretton Woods Agreement' The Bretton Woods Agreement is the landmark system for monetary and exchange rate management established in 1944. It was developed at the United Nations Monetary and Financial Conference held in Bretton Woods, New Hampshire, USA, from July 1 to July 22, 1944

The Bretton Woods Agreement
Delegates from 44 countries met to create a new international monetary system. The main goals of the meeting of the 730 delegates were to ensure a foreign exchange rate system, prevent competitive devaluations and promote economic growth.

Preparation for this event took two years. The primary designers of the system were John Maynard Keynes, of the United Kingdom, and Harry Dexter White, the chief international economist of the U.S. Treasury Department.

Keynes’ plan was to establish a global central bank called the Clearing Union. White’s plan limited the powers and resources of each country. In the end, the adopted plan took ideals from both, leaning more toward White’s plan. Creation of Two New Institutions

Creation of the International Monetary Fund. The IMF was created to monitor exchange rates and lend reserve currencies to nations. It was formally introduced in December 1945 when 29 members signed the Articles of Agreement.

The Bretton Woods Agreement also created the World Bank Group, Set up to provide financial assistance for countries during the reconstruction post World War phase.

End of Bretton Woods Agreement The Bretton Woods Agreement was dissolved between 1968 and 1973. An overvaluation of the U.S. dollar led to concerns over the exchange rates and tie to the price of gold. President Richard Nixon called for a temporary suspension of the dollar’s convertibility to gold.

End of Bretton Woods Agreement Countries were then free to choose any exchange agreement, except the price of gold. In 1973, foreign governments let currencies float, which put an end to the Bretton Woods system. Read more: Bretton Woods Agreement

The IMF Today The Quota System Assistance Programs
every member contributes a quota Assistance Programs the IMF lends money to ease balance-of-payments difficulties Special drawing rights (SDRs) the IMF’s unit of account The IMF relies on a quota system to generate funds to lend to countries in need. Quotas, which are based on the relative size of a country within the global economy, are important because they influence the voting power of each country. The larger the quota, the higher the voting power. The quota system was reformed in 2010 giving more quota shares to emerging markets. So, while the United States retained its top position, China now holds the number 3 spot, and the BRIC countries are among the largest shareholders in the Fund. Special drawing rights are an international reserve asset given to each country to help increase its reserves. They are also the unit of account in which the IMF keeps its financial records. Currencies making up the SDR basket are the U.S. dollar, the euro, the Japanese yen, and the British pound.

The Latest Global Financial Crisis and the IMF
The global crisis in raised concerns over global liquidity prompted the G20 to inject huge amounts of cash into the IMF Greece’s financial crisis required assistance from the IMF and the EU the IMF required Greece to adopt very unpopular austerity measures The G20, mindful of the global financial crisis, voted to significantly increase reserves available to the IMF to help countries in distress. Greece has been a beneficiary of IMF funds, but continues to be quite unstable. .

Evolution to Floating Exchange Rates
The Smithsonian Agreement: Meeting in December 1971 at the Smithsonian Institution in Washington D.C., the Group of Ten signed the Smithsonian Agreement 8% devaluation of the dollar revaluation of other currencies widening of exchange rate flexibility In the early 1970s, the United States was in trouble. The country’s large balance-of-trade deficit made it difficult to maintain the fixed exchange rate system prompting then President Richard Nixon to abandon the Bretton Woods system in A new system, the Smithsonian Agreement was then established, followed by the Jamaica Agreement in 1976. .

The Jamaica Accords provided greater exchange rate flexibility eliminated the use of par values ratified the end of the Bretton Woods monetary system. changed the "articles of agreement" that the International Monetary Fund (IMF) was founded upon. The agreement was concluded after meetings 7–8 January 1976 at Kingston, Jamaica by a committee of the board of governors of the IMF. In the early 1970s, the United States was in trouble. The country’s large balance-of-trade deficit made it difficult to maintain the fixed exchange rate system prompting then President Richard Nixon to abandon the Bretton Woods system in A new system, the Smithsonian Agreement was then established, followed by the Jamaica Agreement in 1976. .

The Jamaica Accords allowed the price of gold to float with respect to the U.S. dollar and other currencies, albeit within a set of agreed constraints. The accords also made provisions for financial assistance to developing countries representing the Group of 77 member countries to compensate for lost earnings from the export of primary commodities. An amendment was made in 1978 to allow for the creation of Special Drawing Rights, described as "a rather cheap line of credit" for developing countries. In the early 1970s, the United States was in trouble. The country’s large balance-of-trade deficit made it difficult to maintain the fixed exchange rate system prompting then President Richard Nixon to abandon the Bretton Woods system in A new system, the Smithsonian Agreement was then established, followed by the Jamaica Agreement in 1976. .

Exchange Rate Arrangements
Under the Jamaica Agreement countries selected and maintained their own exchange rate arrangements The IMF monitors the exchange rate policies of countries to see if they are acting openly and responsibly The IMF requires countries to identify how they base their exchange rate mechanism. .

Three Choices: Hard Peg, Soft Peg, or Floating
Learning Objective: Discuss the major exchange-rate arrangements that countries use Learning Objective : To discuss the major exchange-rate arrangements that countries use. .

Three Choices: Hard Peg, Soft Peg, or Floating
The IMF classifies currencies into three categories Hard peg value is locked into something and does not change dollarization currency boards Soft peg more flexible than hard peg Chinese Yuan is an example Floating floating or free floating change according to market forces What type of arrangement do countries choose? There are three possibilities: hard peg, soft peg, or floating. Countries can adopt a currency in place of their own. Countries that use the dollar as an exchange arrangement with no separate legal tender are practicing dollarization of the currency. Another option for countries with a hard peg is the currency board. A currency board is an organization generally separate from a country’s central bank. Its responsibility is to issue domestic currency that is typically anchored to a foreign currency. If it does not have deposits on hand in the foreign currency, it cannot issue more domestic currency. Most countries following a soft peg arrangement use a conventional fixed-peg arrangement, whereby a country pegs its currency to another currency or basket of currencies and allows the exchange rate to vary plus or minus one percent from that value. It’s more similar to the original fixed exchange-rate system used by the IMF. Floating regimes include floating systems that change according to market forces but may be subject to market intervention, or freely floating systems where intervention is rare. Because countries can change their systems, it’s important for managers to monitor exchange regimes in each country. .

The Euro Learning Objective:
Explain the European Monetary System and how the euro became the currency of the euro zone Learning Objective : To explain how the European Monetary System works and how the euro became the currency of the euro zone.

The Euro The European Monetary System (EMS)
established to create exchange rate stability within the European Community European Monetary Union (EMU) outlined the criteria for euro applicants the U.K., Sweden, and Denmark opted not to adopt the euro The European Central Bank (ECB) sets monetary policy for the adopters of the euro The EU countries agreed to political and monetary union with the Treaty of Maastricht in As part of this agreement the countries decided to replace individual currencies with a single currency, the euro. The Growth and Stability Pact provides the criteria that must be met to be part of the EMU. It includes measures of deficits, inflation, debt, interest rates, and exchange rate stability. Today, 17 of the 27 EU countries have adopted the euro, and others are working toward meeting the criteria. The new currency required companies to update their systems, but should also provide greater price transparency, and eliminate foreign exchange costs and risks. During the global financial crisis, investors fled to dollars as a safe-haven currency and only returned to euros when they were willing to incur more risk. Currently, the financial crisis in Greece is threatening the future of the euro. Moreover, instability in Spain, Portugal, and Italy could also be problematic. .

Determining Exchange Rates
Learning Objective: Identify the major determinants of exchange rates Learning Objective : To identify the major determinants of exchange rates. .

Currency in a floating rate world demand for a country’s currency is a function of the demand for that country’s goods and services and financial assets In a free float system, currencies are determined by supply and demand without government intervention.

Equilibrium Exchange Rate
The exchange rate at which the supply for a currency meets the demand of the same currency. As foreign exchange rates are affected by a number of factors, the equilibrium exchange rate in turn, are also influenced by its supply and demand. Hence equilibrium is achieved when a currency's demand is equal to its supply. This Figure shows the equilibrium exchange rate in the market and then a movement to a new equilibrium level as the market changes. .

The Equilibrium Exchange Rate and How it Moves This Figure shows the equilibrium exchange rate in the market and then a movement to a new equilibrium level as the market changes. .

Currency in a fixed rate or managed floating rate world Role of central banks reserve assets intervening in the market attitudes toward intervention The Bank for International Settlements (BIS) the central banks’ bank coordinates central bank intervention Fixed exchange rates do not automatically change in value according to supply and demand. Instead, they are regulated by central banks like the Federal Reserve in the United States and the European Central Bank in the EU. While central banks maintain reserve assets in gold, foreign exchange reserves, and IMF-related assets, the vast majority of reserve assets is foreign exchange. Central banks use these reserves as they intervene in markets by buying and selling currency to influence its price. Keep in mind that governments vary in their intervention policies by country and by administration. .

Black Markets A black market closely approximates a price based on supply and demand for a currency instead of a government controlled price Economic activity that takes place outside government-sanctioned channels. Black market transactions usually occur “under the table” to let participants avoid government price controls or taxes. The black market is also the venue where highly controlled substances or products such as drugs and firearms are illegally traded. Black markets can take a toll on an economy, since they are shadow markets where economic activity is not recorded and taxes are not paid. Black markets often exist in countries that strictly regulate and control the convertibility of their currencies. .

Black Markets Read more: Black Market Black markets often exist in countries that strictly regulate and control the convertibility of their currencies. .

Foreign Exchange Convertibility and Controls
Hard currencies: Hard currency is a currency widely accepted around the world as a form of payment for goods and services. A hard currency is expected to remain relatively stable through a short period of time, and to be highly liquid in the forex, or foreign exchange (FX), market. A hard currency generally comes from a nation with a strong economic and political situation. Read more: Hard Currency Fully convertible currencies can be purchased in unlimited amounts by both residents and nonresidents of a country. Hard currencies are usually fully convertible and strong or relatively stable in value compared to other currencies. In contrast, soft currencies aren’t fully convertible. Soft currencies are sometimes called weak currencies. Governments might try to conserve scarce foreign exchange by imposing exchange restrictions. Licensing occurs when a government requires that all foreign exchange transactions be regulated and controlled by it. Governments can also use multiple exchange rate systems to set different rates for different types of transactions. Governments might also demand advance import deposits prior to releasing foreign exchange to pay for imports. Finally, quantity controls can be used to limit the amount of foreign currency that can be used in a specific transaction. .

Foreign Exchange Convertibility and Controls
Hard currencies U.S. dollar, euro, British pound, Japanese yen Soft currencies developing countries Countries can control convertibility through licenses multiple exchange rate systems advance import deposits quantity controls Fully convertible currencies can be purchased in unlimited amounts by both residents and nonresidents of a country. Hard currencies are usually fully convertible and strong or relatively stable in value compared to other currencies. In contrast, soft currencies aren’t fully convertible. Soft currencies are sometimes called weak currencies. Governments might try to conserve scarce foreign exchange by imposing exchange restrictions. Licensing occurs when a government requires that all foreign exchange transactions be regulated and controlled by it. Governments can also use multiple exchange rate systems to set different rates for different types of transactions. Governments might also demand advance import deposits prior to releasing foreign exchange to pay for imports. Finally, quantity controls can be used to limit the amount of foreign currency that can be used in a specific transaction. .

Exchange Rates and Purchasing Power Parity
Purchasing power parity (PPP) a change in relative inflation between two countries must cause a change in exchange rates to keep the prices of goods in the countries fairly similar The Big Mac Index Relative rates of inflation, differences in real rates of inflation, and confidence in the government’s ability to manage the political and economic environment all influence exchange rates. The Big Mac Index can be used to test PPP. The theory suggests that the price of a burger should be the same from country to country after exchange rates. If prices aren’t the same, then the foreign currency is undervalued or overvalued relative to the dollar. Note that if the domestic inflation rate is lower than that in the foreign country, the domestic currency should be stronger than that of the foreign currency. .

Exchange Rates and Interest Rates
The Fisher Effect links inflation and interest rates The International Fisher Effect (IFE) links interest rates and exchange rates Other Factors in Exchange Rate Determination confidence information Interest rate differentials can have an important effect on exchange rates especially in the short term. The Fisher Effect suggests that the nominal interest rate is the real interest rate plus inflation. Because the real interest rate should be the same in every country, the country with the higher interest rate should have higher inflation. According to the International Fisher Effect, the currency of the country with the lower interest rate will strengthen in the future. In other words, interest rate differentials are unbiased predictors of future changes in spot rates. In addition to interest rates and inflation, exchange rates can be affected by confidence and technical factors. .

Fisher Effect The Fisher effect is an economic theory proposed by economist Irving Fisher that describes the relationship between inflation and both real and nominal interest rates. The Fisher effect states that the real interest rate equals to the nominal interest rate minus the expected inflation rate. Therefore, real interest rates fall as inflation increases, unless nominal rates increase at the same rate as inflation. Read more: Fisher Effect

Forecasting Exchange Rate Movements
Learning Objective: Show how managers try to forecast exchange-rate movements Learning Objective : To show how managers try to forecast exchange-rate movements. .

Fundamental and Technical Forecasting
Forecasting exchange rates Fundamental forecasting uses trends in economic variables to predict future rates Technical forecasting uses past trends in exchange rates to spot future trends Biases can skew forecasts Timing, direction, and magnitude of exchange rate movements are important to consider It’s hard to know what will happen to currencies in the future. There are two main approaches to forecasting exchange rates: fundamental forecasting and technical forecasting. Keep in mind that neither approach works well – in fact, all forecasting tends to be imprecise making it difficult for multinationals to develop operating strategies. .

Fundamental Factors to Monitor
The institutional setting Fundamental analyses Confidence factors Circumstances Technical analyses Firms can try to monitor certain fundamental factors as a way to gain some insight as to what might happen with currencies in the future. For freely floating exchange rates, the best predictor of future exchange rates are interest rates for short-term movements, inflation rates for medium-term movements, and current account balances for long-term movements. However, since most currencies are managed at least to some degree, there are other factors to consider as well. Firms should consider the institutional setting and whether, for example, the currency floats or is managed, and how intervention is handled. Fundamental analyses can provide insight as to whether the currency is overvalued or undervalued in terms of PPP. Confidence factors can give some indication about market expectations. It’s also important to consider whether there any national or international events or crises that could impact a currency’s value. Finally, technical analyses can provide information about what trends might be emerging. .

Business Implications of Exchange Rate Changes
Learning Objective: Explain how exchange-rate movements influence business decisions Learning Objective : To explain how exchange rate movements influence business decisions. .

Business Implications of Exchange Rate Changes
Marketing Decisions when the value of a country’s currency rises, exporting becomes more difficult as the product becomes more expensive in foreign markets Production Decisions might locate production in a weak currency country because the initial investment is cheap and it will make a good base for exports Financial Decisions currency rates influence sourcing, cross-border remittance of funds, and the reporting of financial results Why do firms need to bother trying to predict exchange rate changes? Well, they can dramatically affect operating strategies and profits. Exchange rates changes can affect marketing, production, and financial decisions. .

The Future: The Dollar, The Euro, The Yen, The Yuan
Europe the euro should take market share away from the dollar as the prime reserve asset assuming the problems in Greece and other countries are controlled Asia China is moving forward to establish the yuan as a major world currency Latin America emerging market currencies should strengthen as commodity prices recover The dollar, the euro, the yen, and the yuan will all play a role in the global economy in the future. At this point it is difficult to say just what will happen though. The dollar will probably maintain its position as a benchmark currency in the world, especially given that the euro continues to be a question mark given the problems in Greece and some of the other unstable EU countries like Spain, Portugal, Ireland, and Italy. The Japanese yen will probably not have as much power as the dollar or the euro, but remains one of the most widely traded currencies in the world. However, the yuan could become a major currency. While it’s still not floating freely, it’s going through a significant liberalization process, and could become influential in the future. Similarly, the Brazilian real is emerging as a key currency in Latin America. .

The Economist Intelligence Unit Global Forecast - Feb. 2018: 20 minutes

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. .

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