FINA 351 – Managerial Finance, Chapter 18 (Ref. 18a)
1. In broad terms, exchange rate systems are either free-floating or pegged. Free-floating exchange rates respond
to economic events and the pressures of supply and demand (e.g. Australia, Canada, Chile, Japan, Mexico,
Sweden, Switzerland, etc.). In contrast, pegged systems have government-controlled currency values fixed in
terms of another major trading currency, such as the USD (e.g. Bahrain, Bhutan, Bolivia, Hong Kong, Kuwait,
Qatar, and Venezuela).
Question: What is one advantage for each of these two systems? (See instructor notes).
Use the spot rates in Figure 18-1 in your text (dated April 13, 2012) to answer questions below. Figure 18-1 has
been reproduced at the end of the document for your convenience.
2. If you converted $100 USD into U.K pounds, how many pounds would you get?
3. If you converted 100 U.K. pounds USD, how many USDs would you get?
4. T or F: There are many millionaires in Lebanon (measured in Lebanese currency).
5. Determine how many South Korean won would be needed to buy a loaf of bread worth $2.50 in the U.S. Do
you think you could buy one crumb with one won?
6. T or F: If you were offered enough Indonesian Rupiah to fill a wheel-barrow, or alternatively just an empty
wheel-barrow, you should choose the wheel-barrow.
7. Which would you rather have (because of its worth): A dollar from Australia, Canada, Hong Kong, New
Zealand, Singapore, or the U.S.?
8. Which would you rather have (because of its worth): a peso from Argentina, Chile, Columbia, Mexico,
Philippines, or Uruguay?
9. From your keen mathematical observations, what do you observe to be the mathematical relationship between
the two columns of exchange rates in Figure 18.1 in your textbook?
10. When quoting foreign currency exchange rates, which of the two columns in Figure 18.1 should usually be
assumed (unless it is the Euro, UK Pound or currencies of other former Commonwealth countries)?
11. List the foreign currencies you have personally exchanged before. (If you haven’t exchanged any, write
“none.” However, you should plan foreign travel into your life soon. Even Canada qualifies :)
12. Below are two short opinion articles about the value of the U.S. dollar compared to the Euro. The Dollar vs.
Euro controversy is part of the struggle for global economic domination. Some believe that the United States
of Europe (European Union) will ultimately win. Others believe that the United States of America will remain
the sole super power. Note: for sake of argument, we are ignoring the BRIC countries (Brazil, Russia, India,
and China).
(A) According to the discussion below, what are two reasons the USD will eventually collapse?
(B) What are four reasons the USD will remain strong against the Euro over the long-term? (Provide at least
one statistic supporting reasons 3 & 4.)
(C) Go to http://www.ecb.int/stats/exchange/eurofxref/html/eurofxref-graph-usd.en.html (which shows the
value of the Euro) and expand the graph for the maximum period allowed (“all” years). Record the lowest,
highest, and average values of the Euro (Hint: see min, max, and average under the top title).
(D) Who do you think will win the USD vs. Euro argument 20 years down the road? Why?
TWO OPINIONS ABOUT THE CURRENCY WAR BETWEEN THE EURO AND U.S. DOLLAR
Arguments Favoring the Euro
The U.S. dollar will ultimately lose against the Euro. Here’s why:
---- (1) The U.S. faces significant internal economic problems, including its huge budget deficit, massive public
debt, and continual trade deficits. There is nothing the U.S. can do to prevent the eventual collapse of its currency
and economy. The political system is in a stalemate and the gov’t seems paralyzed. The U.S. has no reserves to
support the USD and is dependent on credit from other countries (primarily China and Japan) to feed its massive
borrowing. Asian countries, including China and Japan, have threatened to switch their considerable dollar
reserves into other currencies. This would only hasten the lack of confidence in the USD and send it into free-fall,
and the American economy along with it.
---- (2) The U.S. has lost the confidence of the world and thus the confidence in its currency. While the world
once looked up to and admired America, today it is held in contempt for its failed economic policies and its
international arrogance. America has entangled itself in a long war with Islamic fundamentalists, which will drain
its resources, keep its citizens in fear, and put a damper on the American spirit. America claims to be the moral
leader of the world, while flooding the media with degenerate filth and garbage. This is the epitome of hypocrisy.
As the reputation of America continues to decline, its currency will also decline.
Arguments Favoring the US Dollar (USD)
Every time the USD takes a beating, pundits who can get air time are shouting about the death of the USD and the
rise of the Euro. Gloom and doom sells. But there are several reasons to expect continued long-term strength in
the USD versus the Euro . . . and it comes from (surprise!) fundamental analysis. Here are the facts:
---- (1) The European Union (or EU) is in a political mess. In order for a common currency to work, both
monetary and fiscal policies must be coordinated but this will never happen in Europe because it is impossible to
merge the disparate interests, given different languages, cultures, priorities and economies. The only reason the
powerhouse of Europe, Germany, has so far been willing to bail out its less industrious neighbors is the German
guilt over World Wars. The Euro can only be as stable as the union that backs it up . . . and that union is
splintering.
---- (2) European countries (especially in the south) tend to have sluggish growth, high debt, low
productivity, and high unemployment. Many European countries have anti-business policies, such as France’s
mandatory 35-hour work-week, which discourages productivity and efficiency. With an anti-business atmosphere,
Europe cannot possibly keep up to the U.S. in economic growth. Unemployment in Europe is perpetually very
high (e.g. double digit unemployment in Spain and 50% unemployment for its young people). Under these
conditions, the Euro cannot maintain strength. Although the U.S. has plenty of its own problems, the American
economy tends to be very resilient over time and can adjust quickly to new conditions. The U.S. national debt in
relation to GDP is still lower than in many European countries. U.S. productivity is higher than in its European
counterparts, and American businesses are more flexible and able to cope with changing business environments.
---- (3) Europe’s generous social welfare and retirement programs are in big trouble as its population ages.
Many Eurozone governments already face huge debt loads. These debts will only get worse as the population
ages. The working-age population in most European countries is expected to decline alarmingly in the next few
decades. In Italy, for example, the working-age population will decline by 40% in the next four decades. Over
that same time, the working-age population in the U.S. is expected to increase by 33%. In Europe, the ratio of
taxpayers to retirees is expected to drop to 2:1 by 2050. Who will pay for Europe’s generous social benefits?
Until now, Europe has borrowed to fill the gap, but this trend cannot continue.
---- (4) Not only is Europe aging but its overall population is declining rapidly. The generous social welfare
programs, lack of optimism about the future, and strong environmentalism are disincentives for having children.
In Europe, the fertility rate is between 1.2 and 1.4 children per child-bearing couple. Obviously, the rate needs to
be above two just to replace mom and dad. In the next half-century, Germany’s population will decrease by 11%,
Italy’s by 13%, and Spain’s by 12%. The population decline would be even greater if not for immigration, which
brings a whole new set of social/economic problems (e.g. Moslem riots in France). Although Russia is not part of
the EU, it also will undergo a huge population decline of about 30% in the next half-century, due to high death
rates, low birth rates (1.3 children per women), a high rate of abortion, and a low level of immigration. Russia has
even created a “fertility day” which offers financial incentives for patriotic women who give birth. Japan, the
world’s most elderly nation, is also experiencing a huge population crisis, as is its neighbor Korea. Even China is
faced with a population crisis resulting from its one-child policy. Compare these statistics with the expected
population growth in the U.S. Up until the financial crisis, the U.S. fertility rate was exactly the rate needed for a
stable population -- 2.1 children per woman (2.5 for Hispanics, 2 for African-Americans, 4.1 for Mormons, and 1.9
for others!). Immigration also helps a lot. People still flock in droves to the land of freedom and opportunity. The
fact should be obvious -- only a growing nation can maintain its economic power and thus a strong currency. So
God bless immigrants and those with large families!
All of these factors favor the Dollar over the Euro.