HillChap09.ppt

7/23/2019 HillChap09.ppt

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InternationalBusiness 7e

by Charles W.L. Hill

McGraw-Hill/Irwin Copyright 2009 by The McGraw-Hill Companies,Inc !ll ri hts reser"e#


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Chapter 9

The Foreign Exchange Market


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9-3

Introduction

A ir!"s sales# $roits# and strategy are aected by e%entsin the oreign exchange !arket

The oreign exchange !arketis a !arket or con%ertingthe currency o one country into that o another country

The exchange rateis the rate at &hich one currency iscon%erted into another


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9-4

The Functions ' TheForeign Exchange Market

The oreign exchange !arket(

is used to con%ert the currency o one country into thecurrency o another

$ro%ide so!e insurance against oreign exchange risk

)the ad%erse conse*uences o un$redictable changes inexchange rates+


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9-5

Currency Con%ersion

International co!$anies use the oreign exchange !arket &hen(

the $ay!ents they recei%e or ex$orts# the inco!e they recei%e ro!oreign in%est!ents# or the inco!e they recei%e ro! licensingagree!ents &ith oreign ir!s are in oreign currencies

they !ust $ay a oreign co!$any or its $roducts or ser%ices in itscountry"s currency

they ha%e s$are cash that they &ish to in%est or short ter!s in!oney !arkets

they are in%ol%ed incurrency s$eculation)the short,ter! !o%e!ent

o unds ro! one currency to another in the ho$es o $roiting ro!shits in exchange rates+


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9-6

Insuring Against Foreign Exchange -isk

The oreign exchange !arket can be used to $ro%ideinsurance to $rotect against oreign exchange risk

)the$ossibility that un$redicted changes in uture exchangerates &ill ha%e ad%erse conse*uences or the ir!+

A ir! that insures itsel against oreign exchange risk ishedging


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The s$ot exchange rateis the rate at &hich a oreignexchange dealer con%erts one currency into anothercurrency on a $articular day

$ot rates change continually de$ending on the su$$lyand de!and or that currency and other currencies


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Classroo! /eror!ance yste!

The 00000000 is the rate at &hich one currency iscon%erted into another.

a+ Exchange rateb+ Cross rate

c+ Con%ersion rate

d+ Foreign exchange !arket


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To insure or hedge against a $ossible ad%erse oreignexchange rate !o%e!ent# ir!s engage in or&ardexchanges

Aor&ard exchangeoccurs &hen t&o $arties agree toexchange currency and execute the deal at so!e s$eciicdate in the uture

A or&ard exchange rateis the rate go%erning suchuture transactions

-ates or currency exchange are ty$ically *uoted or 12#32# or 452 days into the uture


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A currency s&a$is the si!ultaneous $urchase and saleo a gi%en a!ount o oreign exchange or t&o dierent%alue dates

&a$s are transacted bet&een international businessesand their banks# bet&een banks# and bet&eengo%ern!ents &hen it is desirable to !o%e out o onecurrency into another or a li!ited $eriod &ithout incurringoreign exchange rate risk

Th 6 t ' Th


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9-11

The 6ature ' TheForeign Exchange Market

The oreign exchange !arket is a global net&ork obanks# brokers# and oreign exchange dealers connectedby electronic co!!unications syste!sit is not located in

any one $laceThe !ost i!$ortant trading centers are London# 6e&8ork# Tokyo# and inga$ore

The !arkets is al&ays o$en so!e&here in the &orldit

ne%er slee$s

Th 6 t ' Th


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9-12

The 6ature ' TheForeign Exchange Market

High,s$eed co!$uter linkages bet&een trading centersaround the globe ha%e eecti%ely created a single !arketthere is no signiicant dierence bet&een exchange rates

*uotes in the diering trading centersI exchange rates *uoted in dierent !arkets &ere notessentially the sa!e# there &ould be an o$$ortunity orarbitrage)the $rocess o buying a currency lo& and selling

it high+# and the ga$ &ould closeMost transactions in%ol%e dollars on one sideit is a%ehicle currency along &ith the euro# the 9a$anese yen#and the :ritish $ound


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9-13


The 0000000 is the rate at &hich a oreign exchange dealercon%erts one currency into another currency on a $articularday.

a+ Currency s&a$ rate

b+ For&ard rate

c+ $eciic rate

d+ $ot rate

E i Th i '


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9-14

Econo!ic Theories 'Exchange -ate ;eter!ination

Exchange rates are deter!ined by the de!and andsu$$ly or dierent currencies.

Three actors i!$act uture exchange rate !o%e!ents(a country"s $rice inlation

a country"s interest rate

!arket $sychology


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9-15

/rices And Exchange -ates

The la& o one $ricestates that in co!$etiti%e !arketsree o trans$ortation costs and barriers to trade# identical$roducts sold in dierent countries !ust sell or the sa!e$rice &hen their $rice is ex$ressed in ter!s o the sa!e

currency/urchasing $o&er $arity )///+ theory argues that gi%enrelati%ely eicient !arkets)!arkets in &hich e&i!$edi!ents to international trade and in%est!ent exist+the $rice o a


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9-16

/rices And Exchange -ates

A $ositi%e relationshi$ bet&een the inlation rate and thele%el o !oney su$$ly existsWhen the gro&th in the !oney su$$ly is greater than thegro&th in out$ut# inlation &ill occur

/// theory suggests that changes in relati%e $ricesbet&een countries &ill lead to exchange rate changes# atleast in the short runA country &ith high inlation should see its currency

de$reciate relati%e to othersE!$irical testing o /// theory suggests that it is !ostaccurate in the long run# and or countries &ith high inlationand underde%elo$ed ca$ital !arkets


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9-17

Interest -ates And Exchange -ates

There is a link bet&een interest rates and exchange rates

The International Fisher Eectstates that or any t&ocountries the s$ot exchange rate should change in ane*ual a!ount but in the o$$osite direction to the dierencein no!inal interest rates bet&een t&o countries

In other &ords(

)4 , >+ ? > x 422 @ i , i B

&here i and i B are the res$ecti%e no!inal interestrates in t&o countries )in this case the and 9a$an+# 4is the s$ot exchange rate at the beginning o the $eriod and> is the s$ot exchange rate at the end o the $eriod

I t / h l


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9-18

In%estor /sychologyAnd :and&agon Eects

In%estor $sychology also aects exchange rates

The band&agon eectoccurs &hen ex$ectations on the$art o traders can turn into sel,ulilling $ro$hecies# andtraders can Doin the band&agon and !o%e exchange ratesbased on grou$ ex$ectations

o%ern!ental inter%ention can $re%ent the band&agonro! starting# but is not al&ays eecti%e


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9-19

u!!ary

-elati%e !onetary gro&th# relati%e inlation rates# andno!inal interest rate dierentials are all !oderately good$redictors o long,run changes in exchange rates

o# international businesses should $ay attention tocountries" diering !onetary gro&th# inlation# and interestrates


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9-20


Which o the ollo&ing does not i!$act uture exchangerate !o%e!ents

a+ A country"s $rice inlationb+ A country"s interest rate

c+ A country"s arbitrage o$$ortunities

d+ Market $sychology


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9-21

Exchange -ate Forecasting

hould co!$anies use exchange rate orecasting ser%icesto aid decision,!aking

The eicient !arket school argues that or&ard exchangerates do the best $ossible Dob o orecasting uture s$otexchange rates# and# thereore# in%esting in orecastingser%ices &ould be a &aste o !oney

The ineicient !arket school argues that co!$anies cani!$ro%e the oreign exchange !arket"s esti!ate o utureexchange rates by in%esting in orecasting ser%ices


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9-22

The Eicient Market chool

An eicient !arketis one in &hich $rices relect alla%ailable inor!ation

I the oreign exchange !arket is eicient# then or&ardexchange rates should be unbiased $redictors o utures$ot rates

Most e!$irical tests conir! the eicient !arkethy$othesis suggesting that co!$anies should not &astetheir !oney on orecasting ser%ices


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9-23

The Ineicient Market chool

An ineicient !arketis one in &hich $rices do not relectall a%ailable inor!ation

o# in an ineicient !arket# or&ard exchange rates &illnot be the best $ossible $redictors o uture s$ot exchangerates and it !ay be &orth&hile or international businessesto in%est in orecasting ser%ices

Ho&e%er# the track record o orecasting ser%ices is notgood


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9-24

A$$roaches To Forecasting

There are t&o schools o thought on orecasting(

Funda!ental analysisdra& u$on econo!ic actors likeinterest rates# !onetary $olicy# inlation rates# or balance o$ay!ents inor!ation to $redict exchange rates

Technical analysischarts trends &ith the assu!$tion that$ast trends and &a%es are reasonable $redictors o uturetrends and &a%es


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9-25

Currency Con%ertibility

A currency is reely con%ertible&hen a go%ern!ent o acountry allo&s both residents and non,residents to$urchase unli!ited a!ounts o oreign currency &ith thedo!estic currency

A currency is externally con%ertible&hen non,residentscan con%ert their holdings o do!estic currency into aoreign currency# but &hen the ability o residents to con%ertcurrency is li!ited in so!e &ay

A currency is noncon%ertible&hen both residents andnon,residents are $rohibited ro! con%erting their holdingso do!estic currency into a oreign currency


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9-26

Currency Con%ertibility

Most countries today $ractice ree con%ertibility# although!any countries i!$ose so!e restrictions on the a!ount o!oney that can be con%erted

Countries li!it con%ertibility to $reser%e oreign exchangereser%es and $re%ent ca$ital light)&hen residents andnonresidents rush to con%ert their holdings o do!esticcurrency into a oreign currency+

When a country"s currency is noncon%ertible# ir!s !ay

turn to countertrade)barter like agree!ents by &hichgoods and ser%ices can be traded or other goods andser%ices+ to acilitate international trade


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9-27


When a go%ern!ent o a country allo&s both residents andnon,residents to $urchase unli!ited a!ounts o oreigncurrency &ith the do!estic currency# the currency is

a+ 6oncon%ertible

b+ Freely con%ertible

c+ Externally con%ertible

d+ Internally con%ertible


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9-28

I!$lications For Managers

Fir!s need to understand the inluence o exchangerates on the $roitability o trade and in%est!ent deals

There are three ty$es o oreign exchange risk(

4.Transaction ex$osure>.Translation ex$osure

1.Econo!ic ex$osure


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9-29

Transaction Ex$osure

Transaction ex$osureis the extent to &hich the inco!ero! indi%idual transactions is aected by luctuations inoreign exchange %alues

It includes obligations or the $urchase or sale o goodsand ser%ices at $re%iously agreed $rices and the borro&ingor lending o unds in oreign currencies


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9-30

Translation Ex$osure

Translation ex$osureis the i!$act o currency exchangerate changes on the re$orted inancial state!ents o aco!$any

It is concerned &ith the $resent !easure!ent o $aste%ents

ains or losses are


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9-31

Econo!ic Ex$osure

Econo!ic ex$osureis the extent to &hich a ir!"s utureinternational earning $o&er is aected by changes inexchange rates

Econo!ic ex$osure is concerned &ith the long,ter!eect o changes in exchange rates on uture $rices# sales#and costs


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9-32


The extent to &hich a ir!"s uture international earning$o&er is aected by changes in exchange rates is called

a+ Accounting ex$osureb+ Translation ex$osure

c+ Transaction ex$osure

d+ Econo!ic ex$osure

-educing Translation


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9-33

-educing TranslationAnd Transaction Ex$osure

To !ini!ie transaction and translation ex$osure# ir!scan(

buy or&ard

use s&a$s

leading and lagging $ayables and recei%ables )$ayingsu$$liers and collecting $ay!ent ro! custo!ers early orlate de$ending on ex$ected exchange rate !o%e!ents+

-educing Translation


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9-34

-educing TranslationAnd Transaction Ex$osure

A lead strategyin%ol%es atte!$ting to collect oreigncurrency recei%ables early &hen a oreign currency isex$ected to de$reciate and $aying oreign currency$ayables beore they are due &hen a currency is ex$ected

to a$$reciateA lag strategyin%ol%es delaying collection o oreigncurrency recei%ables i that currency is ex$ected toa$$reciate and delaying $ayables i the currency is

ex$ected to de$reciateLead and lag strategies can be diicult to i!$le!ent


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9-35

-educing Econo!ic Ex$osure

To reduce econo!ic ex$osure# ir!s need to(

distribute $roducti%e assets to %arious locations so their!"s long,ter! inancial &ell,being is not se%erely aectedby changes in exchange rates

ensure assets are not too concentrated in countries&here likely rises in currency %alues &ill lead to da!agingincreases in the oreign $rices o the goods and ser%icesthe ir! $roduces

'ther te$s For Managing


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9-36

'ther te$s For ManagingForeign Exchange -isk

In general# ir!s should(

ha%e central control o ex$osure to $rotect resourceseiciently and ensure that each subunit ado$ts the correct!ix o tactics and strategies

distinguish bet&een transaction and translation ex$osureon the one hand# and econo!ic ex$osure on the otherhand

atte!$t to orecast uture exchange rates

establish good re$orting syste!s so the central inanceunction can regularly !onitor the ir!"s ex$osure $osition

$roduce !onthly oreign exchange ex$osure re$orts


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Fir!s that &ant to !ini!ie transaction and translationex$osure can do all o the ollo&ing exce$t

a+ buy or&ard

b+ ha%e central control o ex$osure

c+ use s&a$s

d+ lead and lag $ayables and recei%ables

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