Business and Economics

INTERNATIONAL BUSINESS MGF2351

Objectives

Group Presentation (20 Minutes, QnA 10 minutes)

Tutorial Program Week 8

Overall Essay performance has been good!

Foreign Exchange and the International Monetary System

Key Terms Foreign Exchange Rate: The rate at which one currency is converted

into another or the price of a unit of foreign currency

FOREX Market: Currency Conversion, Insurance

Spot exchange rate, Forward exchange rate, Currency Swap

www.xe.com

A firm that insures itself against foreign exchange risk is hedging

The law of one price, PPP, Money Supply and Price Inflation.

Transaction vs Translation Exposure

Implications of Managers of IB

Currency management

The current system is a managed float, government intervention can influence exchange rates

Speculation can also create volatile movements in exchange rates

Business strategy

Exchange rate movements can have a major impact on the competitive position of businesses

Need strategic flexibility

Corporate-government relations : Businesses can influence government policy towards the international monetary system

Companies should promote a system that facilitates international growth and development

Videos

A view of the FOREX Market

Big MAC index

http://www.youtube.com/watch?v=6F9xIj1YDxo

Q1. Discuss the functions of the foreign exchange market.

The foreign exchange market is the market where currencies are bought and sold and currency prices are determined.

It is a network of banks, brokers and dealers that exchange currencies 24 hours a day.

Exchange rates determine the value of one currency in terms of another. While dealing in multiple currencies is a requirement of doing business

internationally, it also creates risks and significantly impacts the attractiveness of different investments over time.

The foreign exchange market is used for

Currency conversion, Currency hedging, Currency arbitrage Currency speculation.

Firms can use the foreign exchange market to minimize the risk of adverse exchange rate movement

Q2. Why did the gold standard collapse? Is there a case for returning to some type of gold standard? What is it?

The Gold Standard was first abandoned in 1914. During the war several governments financed their massive military expenditures

by printing money. This resulted in inflation, and by the war's end in 1918, price levels were higher everywhere.

Several countries returned to the gold standard after World War I. However, the period that ensued saw so many countries devalue their currencies that it became impossible to be certain how much gold a currency could buy. Instead of holding on to another country's currency, people often tried to exchange it into gold immediately, lest the country devalue its currency in the intervening period. This put pressure on the gold reserves of various countries, forcing them to suspend gold convertibility. As a result, by the start of World War II, the gold standard was dead. https://www.youtube.com/watch?v=iRzr1QU6K1o

• The great strength of the gold standard was that it contained a powerful mechanism for simultaneously achieving balance-of-trade equilibrium by all countries. This strength is the basis for reconsidering the gold standard as a basis for international monetary policy.

Q3.What opportunities might current IMF lending policies to Third World nations create for international businesses? What threats might they create?

The IMF lending policies require the recipient countries to implement governmental reforms to stabilize monetary policy and encourage economic growth.

One of the principal ways for a developing nation to spur economic growth is to solicit foreign direct investment and to provide a hospitable environment for the foreign investors. These characteristics of IMF lending policies work to the advantage of international businesses that are looking for investment opportunities in developing countries.

https://www.youtube.com/watch?v=NQ952ba75Yk

Q 4. Debate the relative merits of fixed and floating exchange rate regimes. From the perspective of an international business, what are the most important criteria for choosing between the systems? Which system is the more desirable for an international business?

Fixed Exchange Rate: The case for fixed exchange rates rests on arguments about monetary discipline, speculation, uncertainty, and the lack of connection between the trade balance and exchange rates.

Floating Exchange Rate: The case for floating exchange rates has two main elements: monetary policy autonomy and automatic trade balance adjustments.

Case: Caterpillar In the 1980sastronger dollar hurt Caterpillar’s competitive position,

but in 2008 a stronger dollar did not seem to have the same effect. What had changed?

How did Caterpillar use strategy as a “real hedge” to reduce its exposure to foreign exchange risk? What is the downside of its approach?

Explain the difference between transaction exposure and translation exposure using the material in the Caterpillar Tractor case to illustrate your answer.

In the 1980sastronger dollar hurt Caterpillar’s competitive position, but in 2008 a stronger dollar did not seem to have the same effect. What had changed?

Between the 1980s and 2000s Caterpillar was able to reduce its economic exposure by completely changing its global strategy. In the 1980s, much of Caterpillar’s operations were in the United States where it also had significant labour costs. Therefore, the company was unprepared to deal with a strong dollar and lost as much as $1 million per day as well as market share to Komatsu. By the 2000s though, Caterpillar had reduced its dependency on the United States and established foreign manufacturing in China, India, and Brazil. This more diversified strategy meant that while revenues translated into dollars may have fallen with a strong dollar, so too did costs.

How did Caterpillar use strategy as a “real hedge” to reduce its exposure to foreign exchange risk? What is the downside of its approach?

Company’s Global Footprint: Our manufacturing, marketing, logistics, service, R&D and related facilities along with our dealer locations total more than 500 locations worldwide, ensuring that we remain geographically close to our global customer base. (www.caterpillar.com)

To reduce its economic exposure Caterpillar established a significant number of foreign manufacturing facilities. These were important to the company because they lessened the impact of changing rates. When the dollar rose, revenues from the foreign facilities fell when translated into dollars, but costs also fell.

While the more diversified strategy appears to have been beneficial for Caterpillar it is important to note that the company is now dealing with a significantly more complex organization.

Explain the difference between transaction exposure and translation exposure using the material in the Caterpillar tractor case to illustrate your answer.

• Transaction exposure refers to the extent to which the income from individual transactions is affected by fluctuations in foreign exchange rates while translation exposure refers to the extent to which a firm’s future earning power is affected by changes in exchange rates.

• An example of transaction exposure could be the prices that Caterpillar pays for inputs acquired from foreign producers, while translation exposure can be discussed in terms of Caterpillar’s overall strategic moves and their implications for the company.