Essay on Chapter 11 Finance

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International Business: The New Realities by Cavusgil, Knight and Riesenberger

Learning Objectives
1. Exchange rates and currencies in international business
2. How exchange rates are determined
3. Emergence of the modern exchange rate system 4. The monetary and financial systems
5. Key players in the monetary and financial systems International Business: The New Realities

11-2

Currencies and Exchange Rates
• Some 175 currencies are in use worldwide.
• Currency regimes are simplifying. E.g., the euro in
Europe; the dollar in Panama and Belize.
• Most currencies are not very convertible. The dollar, yen, pound, euro are hard currencies – universally accepted and preferred in international transactions.
• Exchange rate: Price of one currency in terms of another • Exchange rates affect the fortunes of the firm in various ways – costs of inputs, sales performance, which market entry strategies International
Business: The to
New use,
Realities etc.

11-3

Recent Exchange Rates against the Dollar

International Business: The New Realities

11-4

Japanese Yen/Dollar

Indian Rupee/Dollar

Russian Ruble/Dollar

Brazilian Real/Dollar

Mexican Peso/Dollar

Venezuelan Bolivar/Dollar

Average (372 days): High: Low:

2.63426
4.30000
2.14230

South African Rand/Dollar

South Korean Won/Dollar

Turkish Lira/Dollar

Chinese Yuan/Dollar

The Four Risks of International Business

Foreign Exchange Markets
• Foreign exchange: All forms of internationally-traded monies including foreign currencies, bank deposits, checks, and electronic transfers.
• Foreign exchange market: The global marketplace for buying and selling national currencies

$

• Exchange rates are in constant flux. For example,
• In 2007, the Japanese yen was trading at 116 yen to the U.S. dollar. By 2009, the yen was trading at 85 yen to the dollar, an appreciation of over 25 percent.

¥

Exchange Rates Over Time

11-17

International Business: The New Realities

18

Example: Euro vs. the Dollar
• Suppose, last year, the exchange rate was 1 = $1.
• Now, suppose the rate has gone to: 1.50 = $1.
• What is the effect of this change on Europeans?
Effect on European Firms:
$
€
European firms pay more for inputs from the U.S.
Higher costs reduce profitability; require higher prices
European firms can increase their exports to the U.S.
European firms can raise their prices to the U.S.
Increased exports to the U.S. lead to higher revenues
What is the effect on European consumers?

11-19

How are Exchange Rates Determined?
In a free market, the “price” of any currency (the exchange rate) is determined by supply and demand: The greater the supply of a currency, the lower its price
The lower the supply of a currency, the higher its price
The greater the demand for a currency, the higher its price
The lower the demand for a currency, the lower its price
International Business: The New Realities

11-20

Factors that Influence the Supply and Demand for a Currency
Economic growth is the increase in value of the goods and services produced by an economy.
• Measured as the annual increase in real GDP (in which the inflation rate is subtracted from growth).
• Driven by entrepreneurship and innovation
• The nation’s central bank regulates the money supply, issues currency and manages the exchange rate, to accommodate economic growth

Market psychology refers to investor behavior, such as herding behavior or momentum trading.
International Business: The New Realities

11-21

Factors that Influence the
Supply and Demand for a Currency (cont’d)
Inflation refers to increases in the prices of goods and services; thus, money buys less than before.
• Some countries (e.g., Argentina, Israel, Russia) have experienced hyperinflation.
• High inflation erodes a currency’s purchasing power.
• Interest rates and inflation are positively related; high inflation forces banks to pay high interest.
• That is, investors expect to be compensated for inflation-induced decline in the
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