world financial environment and exchange rate

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The Bretton Woods Agreement International Business Section IV: World W orld Financial Environment

The Bretton Woods Agreement established a par value, or benchmark value, for each currency initially quoted in terms of gold and the U.S. dollar.

Chapter Ten The Determination of Exchange Rates

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Dhiraj Karki, Course Instructor, Global Business Management


Chapter Objectives

The IMF Today

• To describe describe the International International Monetary Monetary Fund Fund an and d its role in the determination of exchange rates • To discuss discuss the major exchange-rate exchange-rate arrangements arrangements that that countries use • To explain explain how how the European Monetary System works and how the euro came into being as the currency of the euro zone • To identify identify the major determinants determinants of of ex exchange change rates rates • To show show ho how w managers managers try to forecast forecast exchange-rate exchange-rate movements • To explain how exchange-rate exchange-rate movements movements influence business decisions

• The Quota Quota Syste System m • Assist Assistanc ance e Program Programs s • Special Special Drawi Drawing ng Rights Rights (SDRs (SDRs)) The Global Financial Crisis and the SDR 

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The International Monetary Fund • Original Originally ly organi organized zed in in 1945 1945 • Obje Object ctiv ives es:: To ensure stability in the international monetary system 

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To promote international monetary cooperation and exchange-rate stability

Evolution to Floating Exchange Rates • The Smithson Smithsonian ian Agreem Agreement ent 8% devaluation of the dollar Revaluation of other currencies Widening of exchange rate flexibility • The Jamaica Jamaica Agreeme Agreement nt 

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To facilitate the balanced growth of international trade To provide resources to help members in balance-of-payments difficulties or to assist with poverty reduction 10-3 Dhiraj Karki, Course Instructor, Global Business Management

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The Euro

Exchange Rate Arrangements

• European Monetary System (EMS): established by the EU (then the EC) in 1979 as a means of creating exchange rate stability within the bloc • European Central Bank: established by the EU on July 1, 1998, to set monetary policy and to administer the euro • Euro: the common European currency established on Jan. 1, 1999 as part of the EU’s move toward monetary union as called for by the Treaty of Maastricht of 1992 • European Monetary Union (EMU): a formal arrangement linking many but not all of the currencies of the EU • Pluses and Minuses of the Conversion to the Euro • The Euro and Global Financial Crisis 10-7

Exchange Arrangements with No Separate Legal Tender • • • •



The Determination Of Exchange Rates • Currencies that float freely respond to supply and demand conditions free f rom government intervention • The demand for a country’s currency is a function of the demand for its goods and services and the demand for f inancial assets denominated in its currency • Fixed exchange rates do not automatically change in value due to supply and demand conditions but are regulated by their Central Banks

Dollarization Currency Board Arrangements Pegged Arrangements More Flexible Arrangements Crawling Pegs Managed Float Independently Floating 

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Exchange Rates: The Bottom Line

Central Banks • Central banks are the key institutions in countries that intervene in foreign-exchange markets to i nfluence currency values • The Bank for International Settlements (BIS) in Switzerland acts as a central banker’s bank. • It facilitates communication and transactions among the world’s central banks • A central bank intervenes in money markets by increasing a supply of its country’s currency when it wants to push the value of the currency down and by stimulating demand for the currency when it wants the currency’s value to rise

Countries may change the exchange-rate regime they use, so managers need to monitor country policies carefully.



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Black Markets – The Result of Fixed Exchange Rates • Many countries that strictly control and regulate the convertibility of their currency have a black market that maintains an exchange rate that is more indicative of supply and demand than is the official rate

Exchange Rates and Purchasing Power Parity • The Big Mac Index • Short Run problems that affect PPP

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Foreign-Exchange Convertibility • Fully convertible currencies, often called hard currencies, are those that the government allows both residents and nonresidents to purchase in unlimited amounts • Currencies that are not fully convertible are often called soft currencies, or weak currencies • They tend to be the currencies of developing countries

Exchange Rates and Interest Rates • The Fisher Effect • The International Fisher Effect • Other Factors in Exchange Rate Determination 

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Confidence Information


Forecasting Exchange-Rate Movements

Exchange Controls • To conserve scarce foreign exchange, some governments impose exchange restrictions on companies or individuals who want to exchange money, such as 

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• Fundamental forecasting uses trends in economic variables to predict future rates. The data can be plugged into an econometric model or evaluated on a more subjective basis. • Technical forecasting uses past trends in exchange rates themselves to spot future trends in rates.

import licensing multiple exchange rates import deposit r equirements quantity controls 10-15 Dhiraj Karki, Course Instructor, Global Business Management


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Factors to Monitor • Major factors that managers should monitor when trying to predict the timing, magnitude, and direction of an exchangerate change include     

the institutional setting fundamental analysis confidence factors events technical analysis 10-19 Dhiraj Karki, Course Instructor, Global Business Management

Business Implications of Exchange-Rate Changes • Exchange rates can affect business decisions in three major areas: 

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Marketing Production Finance


Future: • Latin America 

Emerging market currencies should strengthen as commodity prices recover

• Europe 

The euro is gaining popularity and will take market share away from the dollar as the prime reserve asset

• Asia 

China is moving forward to establish the yuan as a major world currency 10-21 Dhiraj Karki, Course Instructor, Global Business Management

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world financial environment and exchange rate

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