International Monetary
System


Each country has developed its own money
system with its own currency
Ours is the dollar
World Currency
Israel
a.
b.
c.
d.
Ruges
Pesos
Shekels
Pounds
Egypt
a.
b.
c.
d.
Punt
Pounds
Dollars
Drachmas
South Korea
a.
b.
c.
d.
Yen
Won
Renminbi
Rupee
Poland
a.
b.
c.
d.
Zloty
Riyal
Dinar
Schilling
France
a.
b.
c.
d.
Pounds
Euro
Franc
Lira
Canada
a.
b.
c.
d.
Peso
Dollar
Riyal
Krone
History



By 1880’s, most countries had backed their
currencies with gold, which was recognized
throughout the world as having value
During the time of 1914 (WWI) to WWII
(1944), countries printed money to help
finance war efforts
Having depleted gold reserves, 44 countries
met at Bretton Woods, New Hampshire in
1944
Bretton Woods Agreement


Countries agreed to peg their currencies to the
U.S. dollar, which would still be backed by gold
at $35 per ounce
Created the International Monetary Fund (IMF)
to maintain order in the monetary system and
the World Bank to promote economic
development


By the late 1960’s there were problems and in
the early 1970’s the U.S. refused to continue to
keep its exchange rate fixed
It had depleted its gold reserves and President
Nixon said that we would not continue


1976 Jamaica Agreement that lead to a floating
exchange rate system where currencies are
traded for each other
Gold is no longer backing currencies

Free floating currency


Dirty float
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
Currency value determined by market forces
Gov’t influences value of currency by buying or
selling but hasn’t declared it fixed
Pegged or fixed currency
Currency value tied to another currency
 Gov’t buys or sells currency to maintain rate

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
Korean won tied to U.S. dollar
Chinese yuan tied to basket of currencies
How exchanging works
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

Foreign exchange market
Over $1 trillion exchanged each day
Traders and government central banks buy and
sell just like stock
Exchange rates

http://www.x-rates.com/d/USD/table.html
Fluctuations in Currency Value

U.S. dollar compared to the Japanese yen
1/1/2008
1/1/2009
$1 = 75 yen
$1 = 85 yen
U.S. dollar is increasing in value against the yen
because it can buy more
The yen is decreasing against the dollar because
it’s worth less.
12/1/2008 12/1/2009
$1 = 75 yen
$1 = 85



If you wanted to see a movie that cost 1,250 yen,
what would it cost you in 2009 compared to
2008?
What would happen to the cost of importing
goods from Japan to the U.S.?
What would happen to the cost of exporting
from the U.S. to Japan?

U.S. dollar compared to the Japanese yen
1/1/2009
1/1/2010
$1 = 85 yen
$1 = 80 yen
U.S. dollar is decreasing in value against the yen because it
buys less
The yen is increasing against the dollar because it’s worth
more.
12/1/2009 12/1/2010
$1 = 85 yen $1 = 80 yen



If you wanted to see a movie that cost 1,250 yen,
what would it cost you in 20010 compared to
2009?
What would happen to the cost of importing
goods from Japan to the U.S.?
What would happen to the cost of exporting
from the U.S. to Japan?
Currency 12/2/1997
Units/US$
South
Korean
Won
Japanese
Yen
Great
Britain
Pound
12/1/2010
Units/US$
Percent Change in
Value of Currency
931
1150.6
23.59%
112.3
84.03
(25.17%)
0.49
0.64
30.61%
Source: Pacific FX Database, 12/2/2010
http://fx.sauder.ubc.ca/data.html
Trade with Japan Impact
(Figures in millions)
 Exports = $ 51,134.20
 Imports = $95,803.70
 Total Value of Goods Traded= $ 146,937.90
 25% change in value of currency = $36,734.48
million ($36,734,480,000) worth of impact on
goods


Impact of currency value changes can be visually
seen
http://fx.sauder.ubc.ca/
What causes exchange rates to
change?
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Supply and Demand for a currency
Inflation rates
Interest rates
Strength of economy
Political system
Political events
Companies use Foreign Exchange
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Payments for exports or foreign investments
Purchase supplies
Invest in another country
Speculate on exchange rates
JAL airlines
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Purchase airlines from Boeing
Prices range from $35 – 160 million
Order aircraft 2-6 years in advance
10% down and rest when aircraft delivered
1985, Boeing placed order for $100 million 747
aircraft
$1= ¥240 in 1985
90,000,000 US$ = ¥ 21,600,000,000




What if exchange rate changed?
Total cost of ¥2.4 billion
If rate changes to $1= ¥300, price raises to ¥3.0
billion - a 25% increase!
If rate changes to $1 = ¥200, price decreases to
¥2.0 billion.
Exchange Rate Risk


The chance of loss due to changing exchange
rates
Ideas on managing the risk
Assume risk and deal in foreign currency
 Only deal in your currency
 Transfer risk to someone else through hedging
 Countertrade

Hedging


Buy a currency in the future at a price set today
so the risk is minimized
Example: Buy euros 120 days into the future –
forward contract
JAL
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

Purchased right to buy dollars for next ten years
for a set rate of $1 = ¥185
forward exchange contract
Allows company to know what they will pay and
plan ahead
Looked like a great deal when $1 = ¥240
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1994 contracts executed
Yen had risen against dollar
$1 = ¥99
JAL admitted that they were paying 86% more
than necessary
Mistake of $450 million or ¥45 million
http://fx.sauder.ubc.ca/plot.html
Countertrade

Form of payment in which a seller accepts
something other than money in compensation
Types



Barter – products exchanged
1990, State Trading Corp. of India exchanged
wheat to Turkmenistan for cotton
Pepsi sold soft drinks in China in exchange for
mushrooms for Pizza Hut pizzas
Counterpurchase
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

Buyer and seller purchase goods from each
other
Business A sells to Business Z for cash. At the
same time, Business A agrees to buy stuff from
Business Z for an equal amount.
Most common form of countertrade

McDonnell Douglas has bought hams, irons,
and rubber bumper guards
Offset


Part of exported good is produced in the
importing country
General Dynamics sold military jets to Belgium,
Norway and Denmark and allowed them to
offset the cost by producing 40% of the value of
the aircraft in their countries
Different risk is that of not
getting paid

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
Letter of credit is used to remove this risk
Letter issued by a bank at the request of an
importer
Promise by the bank to pay a specified sum of
money to a beneficiary (exporter) on
presentation of certain documents
Types of Letters of Credit
Irrevocable – terms can only be modified if both
exporter and importer agree
 Revocable – Issuing bank can modify terms without
approval from the exporter or importer

--Buy/sell goods-Exporter
Exporter ships
Importer
Exporter
Importer
Bank
checks
delivers
applies for LC
documents
and
documents
from its bank
pays
exporter
I. Bank delivers Importer
to E. bank
pays for
documents
Bank
E. Bank delivers
to importer goods
notifies
documents to I.
exporter that
Bank
Importer’s
it has LC Exporter’s
I. bank issues
Bank
Bank
LC to E.
Bank sends
bankpayment to
exporter’s bank
Purchasing Power Parity
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
Theory that a dollar should buy the same
amount in all countries
Economist measures with “Big Mac Index”
NationMaster has index