International Business Study Set 9

Business

Quiz 8 :

The International Monetary System and Financial Forces

Quiz 8 :

The International Monetary System and Financial Forces

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Was the Bretton Woods system bound to fail?
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The allied representatives met at Bretton Woods for the planning of the monetary arrangements after the World War II. They needed the stable exchange rate Bretton Wood System is the international monetary system in place from the year 1945 to 1971, in which per value is based on gold and the Country UU's dollars.
The system of Bretton Woods supported the international trade growth in which, other countries changed the currency value against the dollar and gold. The dollar of Country UU remained fixed. In order to satisfy the growing demand for the reserve there was need to run the balance of payment deficit. The flow of dollars out was more than the flow of dollars in Country UU.
Bretton woods system was bound to fail due to the following reasons:
• There was cumulative deficiency suffered by Country UU
• The demand of dollars for holding outside the country was more than dollars flowed in due to foreign investment and export sales
• The currency value of other countries were changed while the currency value of Country UU remained fixed causing balance of payment deficit
• The deficit was financed partly by incurring liability to foreign central bank and partly by the gold reserve of Country UU
• There was financial crisis as lack of confidence on reserve currency
Hence, due to the above reasons, Bretton Woods was bound to fail.

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Your Boston-based company earned 54 percent of its profits from Germany and France. Given your answer in question 7, are you happy today? Why?
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There are different financial forces which affects the exchange rate and international trade among countries. The financial forces like fluctuation in exchange rate currency valuation, tax rate of countries, import duties, balance of trade affects the financial transaction during international trade.
The financial forces like taxation and the rate of interest influences any firm's finance position greatly. Inflation is accompanied by higher interest rate, and the firm will limit exposure to inflation drive economies.
The Company MM of Country BB has earned fifty four percent of the profit from Country GG and Country FF. While the Federal Reserve is slashing the interest rates, the Central Bank of European is keeping the interest rate steady. This policy of fluctuation and difference in the exchange rate of the currency two countries influences the strength of dollar against the euro.
The Company MM's owner is happy with the different in the interest of the two currencies of dollar and euro. As, Company MM of Country BB has earned fifty four percent from Country GG and Country FF, the slashing of the interest rate by Federal Reserve will increase the value of profit of Company MM.

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Use the globalEDGE site (http://globalEDGE.msu.edu/) to complete the following exercises: As an entrepreneur, you are interested in expanding your business to either Germany or Australia. As part of your initial analysis, you would like to know how much minimum investment is needed to enter each of these markets. To have an appropriate estimate, you hire a consulting firm to perform an initial investment analysis. The consulting firm provides a short report concerning the level of minimum investment needed for each country. Taken from the report, the minimum investment amounts enclosed are: 24 million euros (EUR) or 30 million Australian dollars (AUD). To make a clear comparison by using current exchange rates, you must convert each currency to U.S. dollars and suggest which country provides the better investment.
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http://globaledge.msu.edu
Go to Resource Desk: http://globaledge.msu.edu/ResourceDesk/
Search Phrase: "Exchange Rates"
Resource Name: FX Street
globalEDGE™ Category: "Money: Finance"
Website: http://www.fxstreet.com/
To obtain the requested information, click on the "Rates Charts" tab.

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The Asian Development Bank (ADB), a multilateral development bank owned by its 67 members whose primary goal is poverty reduction, makes its loans in SDR. As of September 2010, these loans totaled $44.3 billion, with the largest borrowers being China, Indonesia, India, Pakistan, and the Philippines. The ADB covers the exposure of its capital resources, $114.8 billion, by selling into the forward market the currencies that make up the SDR basket. Why would the ADB hold SDR instead of dollars or euro? What are the currency amounts that make up the SDR? To learn more about the SDR basket, visit http://imf.org/external/np/fin/data/rms_sdrv.aspx.
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If your firm is generating considerable revenues in operations in a country that suddenly and without warning imposes exchange controls that prohibit the purchase of foreign currency within the country and the export of the currency, what are some of the issues you will want to discuss with your regional finance staff?
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Your Munich-based company earns 64 percent of its revenues from high precision auto component exports to the United States. You need to expand manufacturing capacity, and the U.S. market has great growth potential for your product. Given your answer in question 7, where would you add capacity, in Germany or the United States? Why?
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Debate: Fixed FX Rates, Perhaps Hooked to Gold, or Floating Rates, Hooked to Faith? Most economists support the idea that floating exchange rates are beneficial for the world economy. A small minority of experts advocates a return to the gold standard and fixed exchange rates. Let's further consider this choice. In the early 1970s, the U.S. government could not continue to guarantee that dollars floating around the world would be convertible to gold at the agreed rate. So, the U.S. decoupled the dollar from gold, with the immediate effect that the world's currency exchange rates were not fixed any more. a The economists, Obstfeld and Rogoff, argue that the main reason exchange rates could not stay fixed was the rapid evolution of world capital markets since the 1950s. Because the volume of global transactions started exceeding most countries' foreign exchange reserves, governments could no longer intervene effectively to sustain the value of their currency. Until the volume of trade grew, governments would buy or sell significant amounts of their currencies in the global markets in an effort to sustain their currency's supply and demand equilibrium. At the same time, a speculative attack on a specific currency by the "market" could cause a run on a currency that a government could not counter. As we have already seen, with the advent of the Internet, in less than 15 years the amount of daily foreign exchange transactions has increased from $1 trillion in 1994 to more than $4 trillion in 2010. Thus, it is difficult to imagine the day when the main currency regimes around the world would be dominated by fixed rate relationships. Even if a central bank could support its currency effectively, the impact on the rest of the economy could be considerable. In this chapter, we have discussed the relationship between exchange rates and interest rates. In an environment where currency A is becoming relatively stronger than currency B, the interest rates in country A are likely to be higher than those in country B. This increases the cost of doing business in country A versus country B. Moreover, interest rate movements, exchange rate values, and inflationary pressures tend to be interlinked. Finally, the role of speculators cannot be overlooked. The currency market impressions of a currency's reputation can be enough to scare buyers away from a perceived weak currency toward a strong one. As with any other buying-selling relationship, this will weaken further the currency that buyers are fleeing from and strengthen the one they are going to. Then, the strengthening currency has a negative impact on that country's ability to export. The discussion up to here shows that we may not like "floating exchange rates" for whatever reasons, but is there an alternative in today's globalized economy and global capital markets? What are the key arguments for trying to "fix" exchange rates? Two are as follows: b First, exchange rate changes increase the risk and cost of trade for industries that are based on producing goods. These industries have products that have to be shipped from one country to another. This process is associated with a time lag from when an order is placed, to when the producer ships, to when the buyer receives a product. These three points in time may be associated with very different exchange rates among the currencies of the two countries involved. Whether it is the manufacturer or the buyer or both who bear the risk, there are ways to minimize foreign exchange risk related to timing. All these ways introduce a new cost to the transaction. Had the exchange rate been fixed, this cost would not arise. Second, exchange rate fluctuations may lead to protec-tionist measures that can impede trade and deprive a country's people from trade benefits. Yet, fixing the exchange rate means that the government is also depriving itself of the ability to manage its monetary policy. Finally, fixed-rate proponents say that fixed exchange rates impose monetary discipline on a government. A long, logical explanation shows, however, that this implies isolation from actions of other governments, an impossible option today. Given the preceding discussion, what is your own broad conclusion about the viability of fixed or floating exchange rates?
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Use the globalEDGE site (http://globalEDGE.msu.edu/) to complete the following exercises: Your company imports video equipment from Japan to sell in the United States. The exchange rate fluctuations over the past year have had a significant impact on your bottom line. In preparing an annual report for your company, you would like to include a one-year currency chart showing the movement of the U.S. dollar versus the Japanese yen. Describe the pattern you see. Over the past year, has the dollar gained or lost ground versus the yen?
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Why should managers regularly monitor the BOP of the countries in which their business operates?
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While the Federal Reserve has been slashing interest rates, the European Central Bank is holding interest rates steady. Could this policy difference have influenced the relative strength of the dollar against the euro? Why?
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You are on a business trip from Portugal to the United States for 90 days, and you have a per diem expense account of euro 400 per day, no receipts required. This per diem is advanced to you before the trip (euro 36,000). You deposit it into your checking account and use your Portuguese (euro) credit card to cover your costs while in the United States. After the first two weeks of your trip, the dollar weakened against the euro by 15% percent. What ethical dilemma might this currency fluctuation present for you?
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Briefly outline the advantages and disadvantages of the gold system.
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Your U.S. firm is about to sign a contract to supply services to a bank in Beijing, with a up-front payment agreement of 50 percent. Would you want this payment in U.S. dollars? Why or why not?
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If all nations used the SDR, what might the impact be on business?
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