International Monetary Market (Global Business)

8/3/2019 International Monetary Market (Global Business)

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InternationalMonetary System

Eva Lyn E. FuentesGlobal BusinessEnvironmentMBAPhilippine ChristianUniversity

Engr. Mario Mecate


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Chapter PreviewChapter Preview

List the benefits of stable and

predictable exchange rates

Discuss the law-of-one-price principle

Describe purchasing power parity and

the factors that affect exchange rates

Explain how the gold standardfunctioned

Discuss the experience with Bretton

Woods


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Stability and PredictabilityStability and Predictability

Stableexchange rates

Predictableexchange rates

Improve accuracyof financial planningImprove accuracyof financial planning Reduce surprisesof unexpectedrate changesReduce surprisesof unexpectedrate changes


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Law of One PriceLaw of One Price

Identical item must havean identical price in all countrieswhen expressed in a common currency

Identical item must havean identical price in all countrieswhen expressed in a common currency

McCurrencycCurrency

Undervaluedor overvalued

Undervaluedor overvalued

Limited use inbusiness decisions

Limited use inbusiness decisions

Fairly goodrate predictor

Fairly goodrate predictor


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Purchasing Power ParityPurchasing Power Parity

Relative ability of two nations currenciesRelative ability of two nations currencies

to buy the same basket of goods into buy the same basket of goods in

those two nationsthose two nations

Re

lative ability of two nations currenciesRelative ability of two nations currencies

to buy the same basket of goods into buy the same basket of goods in

those two nationsthose two nations

Considers priceConsiders price

levels in adjustinglevels in adjusting

relative currency valuesrelative currency values

Considers priceConsiders price

levels in adjustinglevels in adjusting

relative currency valuesrelative currency values

Purchasing powerPurchasing power

of a currency isof a currency is

eroded by inflationeroded by inflation

Purchasing powerPurchasing power

of a currency isof a currency is

eroded by inflationeroded by inflation


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Inflation: Key FactorsInflation: Key Factors

Monetary policy directly affects interestrates and money supply

Fiscal policy indirectly affects taxesand spending

High employment raises wages, whichare embodied in consumer prices

High rates lower borrowing and spending,

which lowers inflation

Exchange rates adjust to maintain PPP

Money supply

Employment

Interest rates

Adjustment


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Fisher Effectisher Effectisher Effectisher Effect

InternationalnternationalFisher Effectisher EffectInternationalnternationalFisher Effectisher Effect

Nominal Interest rate =Nominal Interest rate =

real interest rate + inflation ratereal interest rate + inflation rate

Nominal Interest rate =Nominal Interest rate =

real interest rate + inflation ratereal interest rate + inflation rate

Difference in nominal interest ratesDifference in nominal interest rates

supported by two nations currenciessupported by two nations currencies

will cause an equal but oppositewill cause an equal but opposite

change in their spot exchange rateschange in their spot exchange rates

Difference in nominal interest ratesDifference in nominal interest rates

supported by two nations currenciessupported by two nations currencieswill cause an equal but oppositewill cause an equal but opposite

change in their spot exchange rateschange in their spot exchange rates

Interest RatesInterest Rates


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Adjusting to Currency SwingsAdjusting to Currency Swings

Strong currency: Prune operations

Adapt products

Source abroad

Freeze prices

Export strategies in the face of currency swings

Weak currency: Source domestically

Grow at home

Push exports

Reduce expenses


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Gold StandardGold Standard

International monetary system that linkedInternational monetary system that linked

nations currencies to specific values of goldnations currencies to specific values of goldInternational monetary system that linkedInternational monetary system that linked

nations currencies to specific values of goldnations currencies to specific values of gold

Restricted monetary policiesRestricted monetary policies

Reduced exchange-rate riskReduced exchange-rate risk

Corrected trade imbalancesCorrected trade imbalances

Ended by competitive devaluationEnded by competitive devaluation

In place from 1700s to 1939In place from 1700s to 1939In place from 1700s to 1939In place from 1700s to 1939


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Jamaica AgreementJamaica Agreement

Formalized the system of floating exchange ratesFormalized the system of floating exchange rates

as the new international monetary system (1976)as the new international monetary system (1976)Formalized the system of floating exchange ratesFormalized the system of floating exchange rates

as the new international monetary system (1976)as the new international monetary system (1976)

Managed

float system

Currencies float withgovernment intervention

Managed

float system

Currencies float withgovernment intervention

Free

float system

Currencies float withoutgovernment intervention

Free

float system

Currencies float withoutgovernment intervention


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The System Todayhe System TodayManaged float systemManaged float system

Pegged exchange ratesPegged exchange rates

Currency boardCurrency board

uropean monetary systemuropean monetary system


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The Foreign Exchange

Market

The Foreign Exchange

Market


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Key Issuesey IssuesWhat is the form and function of the foreignexchange market?

What is the difference between spot and forwardexchange rates?

How are currency exchange rates determined?What is the role of the foreign exchange market ininsuring against foreign exchange risk?

What are the merits of different approaches towardexchange rate forecasting?

Why are some currencies not always convertible intoother currencies?

How is countertrade used to mitigate problemsassociated with an inability to convert currencies?


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Foreign Exchangeoreign ExchangeThe foreign exchange market

- Is the market where one buys (or sells)the currency of country A with (or for)

the currency of country BA currency exchange rate

- Is simply the ratio of a unit of currency ofcountry A to a unit of the currency of

country B at the time of the buy or selltransaction


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The Foreign Exchange Markethe Foreign Exchange MarketCurrency conversion in the foreign exchange market

- Is necessary to complete private and commercialtransactions across borders

- A tourist needs to pay expenses on the road in

local currency- A firm

Buys/sells goods and services in the othercountrys local currency

Uses the foreign exchange market to invest

excess fundsIs used to speculate on currency movements


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The Foreign Exchange Markethe Foreign Exchange MarketMinimizes foreign exchange risk (unpredictable rateswings)

There are different ways to trade currencies

- Spot exchange rates: the days rate offered by adealer/bank

-Forward exchange rates:

Agreed in advance rates to buy/sell a currency on afuture date

Usually quoted 30, 90, 120 days in advance

The market is open 24 hoursArbitrage: buying low and selling high given slightlydifferent exchange rate quotes in one location vs another(e.g., London vs Tokyo)


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Prices and Exchange Ratesrices and Exchange RatesThe law of one price:

- In competitive markets free of transportationcosts and trade barriers, identical productssold in different countries must sell for the

same price when their price is expressed inthe same currency

Purchasing Power Parity (PPP):

- If the law of one price holds for all goods andservices, the PPP exchange rate can be found

by comparing the prices of identical productsin different countries

- Changes in relative prices will changeexchange rates...


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Money Supply and Currencyoney Supply and CurrencyValuealueChanges in relative prices in two countries willchange the exchange rate of their currencies;the country with the highest price inflation

should see its currency decline in value.Relative inflation rate levels and trends canpredict relative exchange rate movements

Inflation happens when the quantity of money

in circulation rises faster than the stock ofgoods and services; money supply growth isrelated to currency value


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Exchange Rate Forecastingxchange Rate ForecastingThe efficient market school

- Prices reflect all available public information

The inefficient market school

- Prices do not reflect all available publicinformation

Approaches to forecasting future movements

- Fundamental analysis: predictions witheconometric models based on economic theory

-Technical analysis: extrapolation/interpretation ofpast trends assuming they predict future


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Convertibil ityonvertibil ityConvertibility and government policy

- Currency freely convertible: residents/non-residentsallowed to purchase unlimited amounts of a foreigncurrency with the local currency

- Currency not freely convertible: residents/non-residents not allowed to purchase unlimited amountsof a foreign currency with the local currency

Countertrade

- Barter-like agreements by which goods and servicescan be traded for other goods and services

-

Used to get around the non-convertibility of currencies

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