This chapter covers:
11
•The foreign
exchange markets
•Foreign exchange
quotations
Financial Forces
•Currency exchange
risks
•Currency exchange
controls
•How financial forces
affect business
•Sovereign debt
•Small business in a
developing country
International Business
by Ball, McCulloch, Frantz,
Geringer, and Minor
McGraw-Hill/Irwin
Copyright © 2006 The McGraw-Hill Companies, Inc. All rights reserved.
Chapter Objectives
 Realize that money is made, and lost, in the foreign
exchange markets
 Understand foreign exchange quotations, including
cross rates
 Recognize currency exchange risks
 Understand currency exchange controls
 Understand financial forces that affect business
 Explain sovereign debt, its causes, and its solutions
 Recognize the role of small business in a
developing country
11-2
Uncontrollable Financial Forces







Foreign Currency Exchange
Risks
National Balances of
Payment
Taxation
Tariffs
National monetary and fiscal
policies
Inflation
National business
accounting rules
11-4
Fluctuating Currency Values
Most currencies in the world are free to fluctuate
against each other
 Fluctuations may be quite large
 Financial managers must understand how to protect
against losses or optimize gains
 Another risk is encountered when a national
suspends or limits convertibility of its currency
 International currency exchange quotes can be
found in business publications

11-5
Foreign Exchange Quotations
 In the world’s currency exchange markets
 the U.S. dollar is the common unit being
exchanged for other currencies
 Reasons for the continued central position of the
U.S. dollar include that the U.S. dollar
is the main central reserve asset of many countries
 is the most used vehicle currency and intervention
currency
 is in great demand worldwide as a result of its safe
haven aspect and its universal acceptance

11-6
Foreign Exchange Quotations
 Exchange Rates

By using the reciprocal of the US$ equivalent rate, the
currency per US$ rate can be reached and vice versa.
1
US$ equivalent rate = currency per US$ rate
1
currency per US$ rate = US$ equivalent rate
11-7
Exchange Rates
 Spot rates
 The exchange rate
between two currencies
for delivery within two
business days
 Forward rate
 The exchange rate
between two currencies
for delivery in the future.
 Commonly 30, 60, 90,
or 180 days
11-8
Exchange Rates
 Trading at a premium
 When a currency’s forward rate quotes are
stronger than spot
 Trading at a discount
 When a currency’s forward rate quotes are
weaker than spot
 Premium or a discount depends on the expectations
of the world financial community, businesses,
individuals, and governments about what the future
will bring
11-9
Exchange Rates
 Cross Rates
 Currency exchange
rates directly
between non-U.S.
dollar currencies
 Use of the Japanese yen
and European euro is
increasing
11-10
Currency Exchange Controls
 Government controls that
limit the legal uses of a
currency in international
transactions
 Value of currency is
arbitrarily fixed at a rate
higher than its market value
 If you see “official rate” next
to a currency rate quotation,
that country has currency
exchange controls in place
11-11
 A black market typically
surfaces as a result of
currency exchange controls
 However, this type of
currency exchange
transaction is illegal
 The black market is
rarely able to
accommodate
transactions of the size
involved in a
multinational business
Balance of Payments (BOP)
 The state of a nation’s BOP can tell about the state of that
country’s economy.
 If the BOP is slipping into deficit
 the government is probably considering one or more
market or nonmarket measures to correct or suppress that
deficit
 Currency devaluation or restrictive monetary or fiscal
policies to induce deflation are likely
 Currency or trade controls may be near
11-12
BOP
 If BOP slipping into deficit
 Companies may want to
start shopping for export
incentives
 Export incentives include
 tax breaks, lower-cost
financing, foreign aid,
and other government
related incentives to
make exporting easier
and more profitable
11-13
Taxation

Tariffs and duties used
interchangeably
 Taxes on imported goods
 Important for business to
minimize them
 Many tariffs have been
lowered or abolished
world wide
 If a business can lower
taxes, it can lower prices
to customers
11-14

Taxation in different
countries
 Income tax is generally
the biggest revenue
earner for governments
 Other types of taxes
include
 sales or value-added
taxes on goods or
services
 capital gains taxes,
property taxes, and
social security
Inflation

Inflation’s Effects on Interest Rates


The inflation rate determines the real cost of
borrowing
Real interest rates are found by subtracting
inflation from the nominal interest rates

11-15
When borrowed money is repaid in the
future after inflation, it is worth that much
less to the lender
Inflation
 Monetary and Fiscal Policies
Affect Inflation
 Monetary policies
 control the amount of
money in circulation,
whether it is growing,
and, if so, at what pace
 Fiscal policies
 address the collecting and
spending on money by
governments
11-16
Inflation and the International Company
High inflation rates
 Encourage borrowing because the loan will be repaid with
cheaper money
 Bring high interest rates
 Discourage lending
 Make capital expenditure planning more difficult
 Cause the cost of goods and services to rise
 Tend to cause BOP deficits
 Could lead to more restrictive fiscal or monetary policies,
currency controls, export incentives, and import obstacles
11-17
Accounting Practices




11-18
Vary widely from country to
country
Must use host country’s
practices then translate into
home country practices
U.S. uses Financial Accounting
Standards Board
 Establishes GAAP
 Rule based
Rest of the world follows
International Accounting
Standards Board
 Principle based
Countries Went Bust
 The sovereign debt crisis surfaced during the 1980s
 Poland’s sovereign debt crisis occurred in 1981
 The sovereign debt crisis for Mexico, Brazil,
Argentina, and others occurred in 1982 and later
 IMF took lead in resolving these crises, BIS made
bridge loans in the interim

The immediate causes of the growing country debts
were the jumps in oil prices
11-19
Debt Problem Solutions
 Short-Term Solutions
 Rescheduling of debts
that countries were
unable to pay as they
came due
 Renegotiations are
becoming more difficult
 BIS, commercial banks,

11-20
and central banks are
reluctant to come up with
more money
IMF’s resources are
limited
 Long-Term Solutions
 The Baker Plan
 Market-oriented
strategies to encourage
growth and bring
inflation under control
 The Brady Plan
 Private banks with
money backed by
funds from IMF,
World Bank, and
developed country
governments
Debt Problem Solutions


The three mechanisms of the Brady debt relief
1) The exchange of old debt for new at a discount
2) The exchange of old debt for new at a lower
interest rate
3) The buying back of debt from creditor banks at
a discount
This mechanism has resulted in debtor countries
buying their own debt and retiring it
11-21
Debt Problem Solutions


The Paris Club, which is a
group of Western creditor
governments
 forgave half of Poland’s
debt ($17.5 billion)
The U.S. forgave the
Egyptian debt
 as an expression of
thanks for Egypt’s
support in the war
against Iraq
11-22

The World Bank, the IMF,
and the Paris Club
 approved a plan to relieve
the massive debt load of
some of the world’s most
heavily indebted poor
countries (HIPC)
 Assistance can be
defended on a
humanitarian basis
 Most of these countries
are in sub-Saharan Africa
United States in Debt

Net negative international investment position


is the difference between the value of overseas assets owned by
Americans and the value of U.S. assets owned by foreigners
Differences in U.S. debt




11-23
First, over $300 billion of the U.S. foreign-owned assets are
obligations of the U.S. Treasury or U.S. corporations traded daily
in world financial markets
Second, U.S. foreign assets are often measured at book value
which results in an estimated undervaluation of up to $200 billion
Third U.S. assets abroad reportedly earn more in interest and
dividend per dollar of investment than foreign holdings earn in
America
Fourth, It is denominated in U.S. dollars
Sample Rates Bid vs. Offer
AUD/USD
BID
0.6979
OFFER
0.6989
EUR/CHF
1.5447
1.5457
EUR/CZK
31.3150
31.4150
EUR/DKK
7.4375
7.4395
EUR/GBP
0.67940
0.68040
EUR/JPY
133.68
133.78
EUR/USD
1.21830
1.21930
GBP/CHF
2.27150
2.27350
GBP/JPY
196.57
11-24
196.77
Australian Currency
11-25
U.S. BOP 2002
Category
Receipts
Payments
Net
I. Current Account
A. Merchandise Account
(Exports/Imports)
848,678
-1,224,417
-375,739
B. Income Account
(Rents, Interest, Profits)
352,866
-367,658
-14,792
C. Transfers
-54,136
Current Account Balance
-444,667
II. Capital Account
A. Foreign Investment in the U.S.
1,024,218
B. U.S. Investment Abroad
C. Statistical Discrepancy
Capital Account Balance
III. Balancing Account
(Official Reserve Transfers)
Source: Economic Report of the President 2002
-580,952
1,401
444,667
0
U.S. Inflation Rates per CPI & RPI
11-27
Retail Price Index
Consumer Price Index
List of 41 highly indebted
poor countries

Angola
Benin
Bolivia
Burkina Faso
Burundi
Cameroon
Central African Republic
Chad
Congo
Congo, Dem Rep.
Côte d'Ivoire
Ethiopia
The Gambia
Ghana
Guinea
Guinea-Bissau
Guyana
Honduras
Kenya
Lao PDR
Liberia

Madagascar
Malawi
Mali
Mauritania
Mozambique
Myanmar
Nicaragua
Niger
Rwanda
Sierra Leone
São Tomé Principe
Senegal
Somalia
Sudan
Tanzania
Togo
Uganda
Vietnam
Yemen, Rep. of
Zambia