International Business

Chapter 7: Currency and Risk ManagementChapter 7.1: Currency

Currency Management – if you want to make more money, you might have to take more risks: the greater the financial risk, the higher the chance of losing money

I.Money and Currencies

Money– used as a form of payment; can be in currency, or other “objects”

A.The 5 characteristics of money:

1.Acceptability – groups of people must find it valuable

2.Scarcity – a low supply of it increases its value

3.Durability – it won’t spoil or become damaged; made of durable materials

4.Divisibility–can be divided into smaller units to make change

5.Portability – can be easily carried around

B.Main purposes (Uses) of Money

1.Measure of Value–assigning a values to G&S

2.Medium of Exchange – it works only if people want it for trading of G&S

3.Savings Mechanism – gives people financial security & confidence to hold its value

C.Barter – trading G&S without currency

1.Can’t save for future

2.Can’t be taxed

3.Can’t be used out of a certain geographical area (not internationally)

D.Currency

1.There are 167 (197 independent countries & 72 dependent territories don’t have their own money) official national currencies circulating around the world

2.Examples:

Most traded currency:

  • United States (USD) = U.S. dollar $(used in 11 countries)

2nd most traded currency:

  • European Union (EU) = (EUR) euro € (used in 34 independent states & overseas territories)
  • Not used by England, Denmark, & Sweden, even though they are in EU

3rd most traded currency: Japan = yen ¥

4th most traded currency: Great Britain = pound £

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Brazil = real

China = yuan

India = rupee

Israel = new Israeli shekel

Saudi Arabia = riyal

South Africa = rand

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E.Currency exchange

1.Currency exchange rate – the rate to purchase another currency; traded on an exchange, like the stock market! Based on supply & demand

  • For up-to-date rates:
  • If the currency exchange rate is US $1.00 to €.91, you will get .91 euro for each $1.00
  • The ratio: is 1 to .91
  • To exchange US $300 into euro: $300 x .91 = € 273
  • When in Europe looking at euro prices: € 100 ÷ .91 = $109.89

2.Hard Currency – AKA “convertible currency”; a currency that has a uniform rate in major financial centers around the world (New York, Paris, London, or Tokyo)

3.Soft Currency – AKA “nonconvertible currency”

  • Found in underdeveloped & developing nations
  • Has limited use internationally
  • An unstable currency

F.Exchange Rates & International Business– when the value of one currency changes, its price in international markets fluctuates, causing prices on G&S to change!

1.When Currency Changes Value – look atthe following situationon international trade . . .

  • Spain imports American-made sandals. The price in Spain is €15 or USD $16.48 (15 ÷ .91). If the exchange rate changes from .91 to .99, Spain must raise their prices to have a higher profit margin. If they leave theprice at €15, it’s worth USD $16.48. But now with a rate of .99 (15 ÷ .99), that converts to USD $15.15, not USD $16.48.
  • The U.S. company sells the sandals to Spain for a wholesale price of €10, Spain adds a markup of €5. The €10 = USD $10.99 (10 ÷ .91). With the .99 rate, €10 = USD $10.10 (10 ÷ .99). When Spain pays the U.S. for the wholesale sandals, the American company loses $.89 in profits (USD $10.99 less USD $10.10).

2.Compensate – what must happen if currency rates change: must change prices to accommodate the possible loss of profits, so as not to lose as much in profits

G.3 Factors Affecting Exchange Rates

  • Currency value fluctuation – the change in value of one country’s currency when it is traded for another country’s currency.

1.Balance of Payments – the difference between the amount of money COMING IN from

other countries vs. the amount of money it PAYS out to other countries

  • Favorable balance of payments – the country is selling more than it is buying, so, receiving more money than you are paying out (exporting more than importing)
  • Unfavorable balance of payments – the country is buying more than it is selling (importing more than exporting)
  • The country’s currency lowers in value
  • Less currency is available in the home country to pay local businesses for their G&S
  • Can occur when citizens spend their money OUTSIDE of the home country (even as tourists)
  • Nations can & DO limit how much money you spend when traveling to other countries
  • When the U.S. dollar is strong, we travel more as we can “buy” more of a foreign currency and will “shop” more while out of the country

2.Economic Conditions–these statistics can have an impact on international trading (what they trade and prices they pay)

  • If there is an unfavorable balance of payments, it will negatively affect the home country’semployment (or unemployment rate), interest rates, inflation rates, and GDP

a.Interest Rates

  • Lower rates encourage borrowing & spending
  • Higher rates discourage borrowing & spending

b.Inflation Rates

  • Prices are increasing on G&S [and paychecks aren’t]

c.GDP vs. GNP

  • GDP = The total VALUE of all G&S SOLD in ONE country
  • GNP = The total value of all G&S sold by all companies owned by ONE company across the world (includes all international operations!)

e.Unemployment Rates

  • In the U.S., it’s the % of workers currently looking for a job
  • High unemployment rates negatively impacts the nation’s currency; indicates a weak economy

3.Political Conditions --

  • Currency values decrease when there is a possibility of war or government changes
  • There is a risk that governments will take over businesses

H.Exchange Rate Problems

1.The fluctuation of the rate can discourage trade

2.If rates change, profits can decrease

3.Might cause a problem with selling the goods in a timely manner

4.Home countries won’t trade with host countries if they predict that the currency will fluctuate due to an unstable economy

II.Managing Exchange Rates -- governments want to make sure that exchange rates are a neutral factor in business transactions to maintain a level playing field for currency exchange

A.Market Measures -- Devaluing its currency

  • It will take more of another currency to purchase the local currency -- helps protect the sales & profits of local businesses/stores
  • Creates deflation instead of inflation so that G&S cost LESS due to a lower value of its money – decreases imports & other foreign currencies

B.Nonmarket Measures – Exchange controls

  • Tariffs & quotas can limit the amount of currency that can be taken out of a country; can be imposed on tourists too!
  • Currency exchange rates can be “set” rather than using the floating market rates; imposed on tourists, too!

III.International Financial Organizations – they try to help countries create & participate in trade

A.International Monetary Fund (IMF)

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  • Created in 1946
  • Has over 180 member countries
  • A “deposit” bank

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  • Facilitates trade at established exchange rates
  • If a country has an unfavorable balance of trade, IMF will:
  1. Monitor the country’s imports & exports
  2. Make suggestions to help improve trade
  3. Issue low-interest loans to help protect a country from high debt with high interest rates

B.World Bank (AKA: International Bank for Reconstruction and Development)

  • Created in 1944
  • Helps various countries develop international trade (via the International Development Association, IDA)
  • Helps disadvantaged countries:

a.Provides loans

b.Helps to build & improve communication, transportation systems, & energy plants

1.International Development Association (IDA)

Give Soft Loans

  • Loan money given to promising new businesses
  • They have long grace periods [to begin paying back the loan] – can wait up to 40 years to start paying it back!!
  • Have lower payment amounts (lower installment loan payments)
  • Loans are more manageable for the borrower/debtor

2.International Finance Corporation (IFC)

Give Hard Loans

  • Loan money given to new businesses (joint ventures) in developing countries
  • Loan must be paid back starting immediately (no grace period)
  • Has to be paid back in a shorter amount of time
  • Provides technical assistance, management methods, & ways to achieve success

C.European Economic Monetary Union (EMU)– the European Union’s (EU) official “guiding” financial agreement

  • Via the European Central Bank – provides most of the financial support [to EU]

D.Other Exchange Organizations

1.AsDB –Asian Development Bank develops trade between Asia withthe U.S., Japan, & Europe ( others)

2.EBRD – European Bank for Reconstruction and Development promotes economic investment in the former Soviet Union & Eastern Europe

3.IDB – Inter-American Development Bank finances projects in Latin America

IV.Financing an International Business– How do you get money for your business??

Capital– start-up money, operating money, & expansion money for businesses; used to buy “capital resources” like buildings, equipment, office supplies, etc.

A.Intercompany Financing – interest is tax-deductible as loans are a legitimate “business expense”

1.Borrowing from the parent company

2.Borrowing from other corporations

B.Equity Financing – selling shares of stock

1.Owning Stock – get paid dividends or company reinvests the profits to increase the overall value of the business, which increases the value of the stock

2.Selling Stock – if expanding internationally, more stock can be issued or sold to the public in the home country, the host country, or in both!

Major stock exchanges:

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  • NYSE
  • Euronext (European Union)
  • NASDAQ
  • Tokyo Stock Exchange (Japan)

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C.Debt Financing – long-term loans

  • 3 sources of debt financing:

1.International Bank Loans – can take the form of Eurocredits

BBVA Compass bank:

2.Euronote markets – short term (<6months) unsecured promissory notes

3.International bond markets

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  • U.S. bonds = “Yankee Bonds”
  • Japanese bonds = “Samurai Bonds”
  • English bonds = “Bulldogs”

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D.Local Currency Financing – getting loans from local banks

  • Allowed to get money “on credit” – can write checks even when don’t have money (as a loan)
  • Kiting is illegal in the U.S.!! Writing a check when there isn’t money in the account yet (taking advantage of the float period)
  • Can get a “non-bank loan” from private local companies
  • Loans between companies = commercial paper (a loan for less than 9 months)

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