More Winter ahead…. Trade, FDI, and the Economy offset by capital surplus F U.S. trade deficit –...
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Transcript of More Winter ahead…. Trade, FDI, and the Economy offset by capital surplus F U.S. trade deficit –...
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More Winter ahead…
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Foreign Currency
What is it? Why does it change? Risk for international managers How to manage risk
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Linkage Between Currencies
World Market for Euros
World Market for DollarsPrice = $ /
€Price = € /
$S
D
S
D
$1.30 / € € .77 / $
Same “market”…different perspective.Same “market”…different perspective.
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Trade, FDI, and the Economy
Increase demand for Japanese computers – trade deficittrade deficit Increase demand for computer inputs (components, labor, etc.) –
inflationaryinflationary Increase demand for Yen – appreciatesappreciates Stronger Yen increases U.S. prices – decreases demand for Japanese decreases demand for Japanese
computerscomputers
Computers
Cash $$
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German Market for BMWs
Price in Euros
€ 100,000
S
D
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Global Market for BMWs:Americans want to import BMWs
Price in Euros
€ 100,000
S
DD’
€ 110,000
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World Market for Euros
Price in Dollars
$0.77 / €
S
D
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World Market for D-Marks:Americans need to convert Dollars to Euros
Price = $ / €
$0.77 / €
S
DD’
$0.74 / €
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Linkage Between Currencies
World Market for Euros
World Market for Dollars
Price =$ / €
Price =
€ / $S
D
S
D
$0.77/ € € 1.30/$
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Linkage Between Currencies
World Market for Euros
World Market for Dollars
Price =$ / €
Price =
€ / $S
D
S
D
€ 1.30/$
D’
S’
$0.77/ €$0.74/ €
€ 1.35/$
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Other Forces Causing Change Foreign Direct Investment Foreign Portfolio Investment
– MNCs– Government Debt Instruments
Currency Arbitrage and Speculation Governmental Intervention
– Official and Unofficial “pegs”– International Agreements (e.g., G-7, the Euro)– Posturing (e.g., “talking” the dollar down)
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Index of Swiss Franc vs. Dollar1990 = 100
60
70
80
90
100
110
120
19901980 2000
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Depreciating Peso
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
Pesos per $
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The Big Mac Index
Big Mac: Local F/X
Actual
F/X Rate
Big Mac: in
US$
Implied
PPP Rate
% Under/ Over Value
U.S. $2.55 – $2.55 – –
EU ℮ 2.44 ℮ 1.08/$ $ 2.26 ℮ .96/$ - 11%
Japan Y 253 Y 118.2/$ $ 2.14 Y 99.2/$ - 16%
England ₤ 2.99 ₤ .69/$ $ 4.33 ₤ 1.17/$ + 70%
Poland Z 1.34 Z 4.12/$ $ .32 Z .52/$ - 87%
www.economist.com
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Short-term F/X Management Currency Hedges
– Forward Contracts– Options– Negotiation of Ratcheted Pricing Schedule
Adjustment of Prices and Target Profits– Lower foreign prices to keep market share when
home currency appreciates … lowers profit margin– Raise foreign prices to keep profit margins when
home currency depreciates … less price competitive
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Today: US Dealer to Import BMWs
Sales Contract:– Quantity: 100 BMW 750s– Price: € 100,000 each– Payment: Due in 3 months
Value of Sales Contract = – € 10.0 million– Spot Rate = $1.30 / €– $13.0 million$13.0 million
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In Three Months: Payment is DueUncovered Transaction
Euro appreciates– New spot rate = $1.35 / €– € 10.0 million
Adjusted Value of Sales Contract– “Risk penalty” = $0.05 per € traded– $13.5 million$13.5 million
US Dealer’s Loss = $500,000
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Today: US Dealer to Import BMWsHedged Transaction
Sales Contract:– Quantity: 100 BMW 535s– Price: € 100,000 each– Payment: Due in 3 months
Value of Sales Contract = – € 10 million– at 90-day Forward Rate = $1.305 / €– “Insurance premium” = $0.005 per € traded – $13.05 million$13.05 million
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In Three Months: Payment is Due Hedged Transaction
Euro appreciates– New spot rate = $ 1.35 / € (Doesn’t matter!!!) – € 10 million
Adjusted Value of Sales Contract– Locked-in Forward Rate = $ 1.305 / €– $13.05 million$13.05 million
Cost of Hedge (insurance premium) = $50,000
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In Three Months: Payment is Due Hedged Transaction
Euro Depreciates– New spot rate = $ 1.25 / € – € 10 million
Adjusted Value of Sales Contract– Locked-in Forward Rate = $ 1.305 / € (Spot better!!) – $12.5 million$12.5 million
Currency Windfall Currency Windfall -- Cost of Hedge = $450,000 Cost of Hedge = $450,000
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Medium-Term F/X Management Balance sheet hedge
– Match foreign assets with same level of foreign liabilities in same currency
Cash flow hedge– Match foreign A/P with A/R in same currency
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Long-Term F/X Management
Shift sourcing and procurementShift production Cut costs / improve productivity