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ChapterChapter

2222

InternationalInternationalBusinessBusiness

FinanceFinance

2005, Pearson Prentice Hall

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International Business FinanceInternational Business Finance

Exchange Rate:Exchange Rate:the price of onethe price of onecurrency in terms of another.currency in terms of another.

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Exchange RatesExchange Rates

Exchange rates affect our economy andExchange rates affect our economy and

each of us because:each of us because:

1) When the1) When the dollar appreciatesdollar

appreciatesstrongstrongdollar)! the dollar becomes moredollar)! the dollar becomes more

"aluable relati"e to other currencies."aluable relati"e to other currencies.

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Exchange RatesExchange Rates

Exchange rates affect our economy andExchange rates affect our economy and

each of us because:each of us because:

1) When the1) When the dollar appreciatesdollar

appreciatesstrongstrongdollar)! the dollar becomes moredollar)! the dollar becomes more

"aluable relati"e to other currencies."aluable relati"e to other currencies.

Foreign products become cheaper to us.Foreign products become cheaper to us.

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Exchange RatesExchange Rates

Exchange rates affect our economy andExchange rates affect our economy and

each of us because:each of us because:

1) When the1) When the dollar appreciatesdollar

appreciatesstrongstrongdollar)! the dollar becomes moredollar)! the dollar becomes more

"aluable relati"e to other currencies."aluable relati"e to other currencies.

Foreign products become cheaper to us.Foreign products become cheaper to us. #.$. products become more expensi"e#.$. products become more expensi"e

o"erseas.o"erseas.

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Exchange RatesExchange Rates

Exchange rates affect our economyExchange rates affect our economy

and each of us because:and each of us because:

%) When the%) When the dollar depreciatesdollar depreciates&ea' dollar)! the dollar falls in&ea' dollar)! the dollar falls in

"alue relati"e to other currencies."alue relati"e to other currencies.

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Exchange RatesExchange Rates

Exchange rates affect our economyExchange rates affect our economy

and each of us because:and each of us because:

%) When the%) When the dollar depreciatesdollar depreciates&ea' dollar)! the dollar falls in&ea' dollar)! the dollar falls in

"alue relati"e to other currencies."alue relati"e to other currencies.

Foreign products become moreForeign products become moreexpensi"e for us.expensi"e for us.

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

Floating Rate 5urrency $ystem:Floating Rate 5urrency $ystem:$ince$ince1-06! the &orld has allo&ed exchange1-06! the &orld has allo&ed exchange

rates to change daily in response torates to change daily in response to

mar'et forces.mar'et forces.Exchange rates are affected by:Exchange rates are affected by:

foreign in"estorsforeign in"estors

speculatorsspeculators

political conditions here and o"erseaspolitical conditions here and o"erseas

inflationinflation

trade policies tariffs and 7uotas) and8trade policies tariffs and 7uotas) and8

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

$upply and 3emand for currencies9$upply and 3emand for currencies9

et;s consider theet;s consider the ( *( * mar'et.mar'et.

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

$upply and 3emand for currencies9$upply and 3emand for currencies9

et;s consider theet;s consider the ( *( * mar'et.mar'et.

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

$upply and 3emand for currencies9$upply and 3emand for currencies9

et;s consider theet;s consider the ( *( * mar'et.mar'et.

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

$uppose the British increase demand for$uppose the British increase demand for#.$. products.#.$. products.

British importers buy the #.$. products toBritish importers buy the #.$. products tosell in England.

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

( *price of

dollars)

$upply of

3ollars

3emand for 3ollars

=uantity of dollars

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

( *price of

dollars)

$upply of

3ollars

3emand for 3ollars

=uantity of dollars

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

>nother example:>nother example:

et;s consider theet;s consider the * *mar'et.mar'et.

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

>nother example:>nother example:

et;s consider theet;s consider the * *mar'et.mar'et.

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

>nother example:>nother example:

et;s consider theet;s consider the * *mar'et.mar'et.

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

$uppose >merican demand for ?apanese$uppose >merican demand for ?apanesecars and stereos increases rapidly.cars and stereos increases rapidly.

>merican importers buy the ?apanese>merican importers buy the ?apanese

products to sell in the #.$.

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

*price of

dollars)

$upply of3ollars

3emand for 3ollars

=uantity of dollars

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What 3etermines Exchange Rates4What 3etermines Exchange Rates4

*price of

dollars)

$upply of3ollars

3emand for 3ollars

=uantity of dollars

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Foreign Exchange @ar'etsForeign Exchange @ar'ets

3ifferent exchange rates are used for different3ifferent exchange rates are used for differenttypes of transactions:types of transactions:

1)1) $pot Exchange @ar'et$pot Exchange @ar'et::deals &ithdeals &ith

currency for immediate deli"ery.currency for immediate deli"ery.

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Foreign Exchange @ar'etsForeign Exchange @ar'ets

%)%) For&ard Exchange @ar'etFor&ard Exchange @ar'et::deals &ith thedeals &ith the

future deli"ery of foreign currency.future deli"ery of foreign currency.

ou can buy or sell currency for futureou can buy or sell currency for future

deli"ery! usually in one! three! or sixdeli"ery! usually in one! three! or six

months.months.

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For&ard @ar'et CedgeFor&ard @ar'et Cedge

Example: ou &ill import &ine from France!Example: ou &ill import &ine from France!

to be deli"ered and paid for in six months.to be deli"ered and paid for in six months.

ou ha"e agreed to a price ofou ha"e agreed to a price of /!/!

francsfrancs. With the spot exchange rate of. With the spot exchange rate of ..

1A/01A/0! this comes to! this comes to *0%!2/*0%!2/..

$uppose the dollar &ea'ens o"er the next six$uppose the dollar &ea'ens o"er the next six

months! and themonths! and the *F exchange rate rises to .%.*F exchange rate rises to .%.

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For&ard @ar'et CedgeFor&ard @ar'et Cedge

ou decide to hedge your ris' &ith aou decide to hedge your ris' &ith afor&ard exchange contract9for&ard exchange contract9

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@oney @ar'et Cedge@oney @ar'et Cedge

For the pre"ious problem! another potentialFor the pre"ious problem! another potentialsolution is the money mar'et hedge.solution is the money mar'et hedge.

1) Borro&1) Borro& *0%!2/*0%!2/from your ban'.from your ban'.

%) Buy the%) Buy the /! francs/! francsno& at the currentno& at the currentspot exchange rate ofspot exchange rate of .1A/0.1A/0) for) for *0%!2/*0%!2/..

6) In"est the6) In"est the /! francs/! francsin interestDbearingin interestDbearing

French securities.French securities.

A)5omplete your transaction after six months.A)5omplete your transaction after six months.

Borro&ing and in"estment rates determine the cost of theBorro&ing and in"estment rates determine the cost of the

hedge.Ghedge.G

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For&ardD$pot 3ifferentialFor&ardD$pot 3ifferential

If theIf the for&ard rate H the spot ratefor&ard rate H the spot rate! the! thefor&ard is trading at afor&ard is trading at a premiumpremium..

If theIf the for&ard rate the spot ratefor&ard rate the spot rate! the! the

for&ard is trading at afor&ard is trading at a discountdiscount..

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For&ardD$pot 3ifferentialFor&ardD$pot 3ifferential

If theIf the for&ard rate H the spot ratefor&ard rate H the spot rate! the! thefor&ard is trading at afor&ard is trading at a premiumpremium..

If theIf the for&ard rate the spot ratefor&ard rate the spot rate! the! the

for&ard is trading at afor&ard is trading at a discountdiscount..

premiumpremium for&ard D spot 1%for&ard D spot 1%or discountor discount spot n spot n+ G Gx 1

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For&ardD$pot 3ifferentialFor&ardD$pot 3ifferential

For our example!For our example!

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For&ardD$pot 3ifferentialFor&ardD$pot 3ifferential

+ G Gx 1

For our example!For our example!

premiumpremium for&ard D spot 1%for&ard D spot 1%

or discountor discount spot n spot n

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For&ardD$pot 3ifferentialFor&ardD$pot 3ifferential

+ G Gx 1

+ G Gx 1

For our example!For our example!

premiumpremium for&ard D spot 1%for&ard D spot 1%

or discountor discount spot n spot n

.1A0, D .1A/0 1%.1A0, D .1A/0 1%

.1A/0 ,.1A/0 ,

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For&ardD$pot 3ifferentialFor&ardD$pot 3ifferential

+ G Gx 1

+ G Gx 1

For our example!For our example!

premiumpremium for&ard D spot 1%for&ard D spot 1%

or discountor discount spot n spot n

.1A0, D .1A/0 1%.1A0, D .1A/0 1%

.1A/0 ,.1A/0 ,

+ %.,.+ %.,.

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Kurchasing Ko&er KarityKurchasing Ko&er Karity

in's changes in exchange rates &ithin's changes in exchange rates &ithdifferences in inflation rates and thedifferences in inflation rates and the

purchasing po&er of each nation;s currency.purchasing po&er of each nation;s currency.

In the long run! exchange rates adLust so thatIn the long run! exchange rates adLust so thatthe purchasing po&er of each currency tendsthe purchasing po&er of each currency tends

to be the same.to be the same.

Exchange rate changes tend to reflectExchange rate changes tend to reflectinternational differences in inflation rates.international differences in inflation rates.

5ountries &ith high inflation tend to5ountries &ith high inflation tend to

experience currency de"aluation.experience currency de"aluation.

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Exchange Rate Ris'Exchange Rate Ris'

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Exchange Rate Ris'Exchange Rate Ris'

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@ultinational Wor'ingD5apital@ultinational Wor'ingD5apital

@anagement@anagement

Leading and LaggingLeading and Lagging

ead:ead:dispose of a net asset position in adispose of a net asset position in a

&ea' currency.&ea' currency.

Kay a net liability position in a &ea'Kay a net liability position in a &ea'

currency.currency.

ag:ag:3elay collection of a net asset position3elay collection of a net asset position

in a strong currency.in a strong currency.

3elay payment of a net liability position in3elay payment of a net liability position in

a &ea' currency.a &ea' currency.

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3irect Foreign In"estment3irect Foreign In"estment

RisksRisks

Kolitical Ris' DKolitical Ris' D firms must be a&arefirms must be a&are

that many foreign go"ernments arethat many foreign go"ernments arenot as stable as the #.$.not as stable as the #.$.

Exchange Rate Ris' DExchange Rate Ris' D exchange rateexchange rate

changes can affect sales! costs ofchanges can affect sales! costs ofgoods sold! etc. as &ell as the firm;sgoods sold! etc. as &ell as the firm;s

profit in dollars.profit in dollars.

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