Foreign Exchange

1. Foreign Exchange

2. http://online.wsj.com/video/why-letting-the-dollar-fall-could-be-a-good-thing/CEFF770C-429C-45F0-9602-582FC173FEAD.html?mod=WSJ_article_relatedhttp://online.wsj.com/video/why-letting-the-dollar-fall-could-be-a-good-thing/CEFF770C-429C-45F0-9602-582FC173FEAD.html?mod=WSJ_article_related

3. Your money or mine….What’s the difference?????http://finance.yahoo.com/currency?uhttp://www.usatoday.com/money/world/2010-10-22-g20-opens_N.htm

4. Samples

5. Money Money1– something generally accepted as a medium of exchange Currency 1 – something that is in circulation as a medium of exchange Domestic Currency - that established and used by a nation state Foreign Currency – belonging to another nation state 1Webster’s new Collegiate Dictionary

6. FOREIGN EXCHANGE • Foreign exchange includes: • - currencies • - and other instruments of payment denominated in currencies

7. Foreign Exchange Market • Purpose • Provides for the conversion of payments received in the exchange of goods and services • Market for investments of “available” funds in the money market • Provides a Market for the speculation on exchange rate movements • Reduce the risks of currency changes on business transactions

8. Currency Exchange Rates • Exchange Rate • The price of any one country’s currency in terms of another country’s currency

9. Monday, February 22, 2010 Currency Exchange • So what is a $ US worth?? Compared to what???

11. The current account is the broadest measure of a nation's trade and investment balances. Countries are wary of committing themselves to specific goals because of the implications for the value of their currency. For the U.S. to shrink its massive current-account deficit, it needs to export more and import less -- which means U.S. customers would have to spend more of their income on imports. A weaker dollar is an important way to accomplish that goal because it makes imported goods more expensive and makes U.S.-made goods more attractive to foreigners For countries with current-account surpluses, rebalancing the world economy means doing the opposite -- relying less on exports for growth, and more on home-grown demand. To that end, their currencies may rise further against the dollar. That has created anxiety in some surplus countries, including South Korea and Japan, who fear that their currencies are rising so much that their exports -- and thus their growth -- are endangered. A large current-account surplus, such as the one China is running, is seen by economists as a sign that a country is deliberately keeping its currency from rising. Doing so makes exports cheaper to its customers at the expense of producers in other countries. http://online.wsj.com/article/SB10001424052702303738504575567431511483738.html?mod=WSJ_article_related

12. Currency Exchange • Find someone who trades in currency or where rates are publicized • Where? Newspaper, computer, bank, etc. Look to see what the exchange is…. $1.000 = 0.73389 € (as of what time period) 1.000 € = $1.3626

13. Exchange Rate Determination LAW of ONE PRICE In competitive markets free of transportation costs and trade barriers, identical products sold in different countries must sell for the same price. If the US/Euro rate was $1US= €0.7800, a leather purse selling for $50US in New York should sell for €39.24 in Paris. Purchasing Parity (PPP) If a basket of “goods” in Saudi Arabia costs 1000 Riyals and the same basket costs $250 in the US, Then the dollar/riyal exchange rate should be …$0.25 per Riyal Changes in purchase price (due to inflation,etc) should thus reflect a change in the EXCHANGE RATE

14. Exchange Rate Determination • PPP defines the relationships between currencies • PPP claims that a change in relative inflation (comparison of countries’ rates of inflations) between two countries must cause a change in exchange rates to keep the prices of goods in 2 countries fairly similar • PPP falsely assumes no barriers to trade and that transportations costs are zero

15. The Hamburger Standard --Sample data Big Mac Prices Implied Actual $ Local Currency In Local In PPP* Exchange Under (-)/Over (+) Country Currency Dollars of the dollar Rate 7/4/97 Valuation,† % USA $2.42 2.42 — — — Brazil Real2.97 2.81 1.23 1.06 +16 Britain £1.81 2.95 1.34†† 1.63†† +22 Canada C$2.88 2.07 1.19 1.39 -14 China Yuan 9.70 1.16 4.01 8.33 -52 Israel Schekel11.5 3.40 4.75 3.38 +40 Japan ¥294 2.34 121.00 126.00 -3 Mexico Peso14.9 1.89 6.16 7.90 -22 South Africa Rand7.80 1.76 3.22 4.43 -27 Switzerland SFr5.90 4.02 2.44 1.47 +66 *Purchasing-power parity; local price divided in the United States. †Against the dollar. ††Dollars per pound. Source: McDonald’s

16. MARKET Determination of Exchange Rates • The VALUE that a currency has in the market place is determined by the demand and supply of the currency relative to the supply and demand of another. • The more $$$ needed to buy US goods the stronger the $$ is terms of the currency of the purchaser wanting those goods

17. Currency Exchange • So why the need? • Most countries have across time constructed their own currency system to support economic activities • Thus producers and consumers have a common currency to use • Most Countries generally require the use of their currency for transactions within their borders

18. 6-8 Currency Exchange Controls • Government controls that limit the legal uses of a currency in international transactions • Government sets value regardless of market • Government has to approve foreign currency purchases • Retains funds in the country

19. Exchange Restrictions by Governments • Licensing • Licensing occurs when a government requires that all foreign-exchange transactions be regulated and controlled by it • Multiple Exchange Rates • In a multiple exchange-rate system, a government sets different exchange rates for different types of transactions • Import Deposit Requirement • Some governments require an import deposit, that is, a deposit prior to the release of foreign exchange • Quantity Controls • With quantity controls, the government limits the amount of foreign currency that can be used in a specific transaction

20. Currency convertibility • Political decision. • Many countries have some kind of restrictions • Governments limit convertibility to preserve foreign exchange reserves • Service international debt • Purchase imports • Government afraid of capital flight

21. Exchange Rates FIXED CURRENCY EXCHANGE RATES when two or more countries agree on the exchange rate(s) of their currencies and undertake to maintain those rates FLOATING CURRENCY EXCHANGE RATES values are set not by governments but by markets, although governments intervene frequently

22. Free (clean) floatapproaches perfect competition no government intervention in currency tradingManaged (dirty) floatsmooth market irregularities assuring orderly markets Currency Floats

23. Managed Fixed Rate Regime • Government buys and sells its currency in the open market as a means of influencing the currency’s price • Central banks hold foreign-exchange reserves built up through years for contingencies • Central banks then sell these reserves in order to maintain an implied exchange-rate balance

24. Managed Fixed Rate Regime • Managed Fixed Exchange-Rate Systems • Devaluation occurs when a government reduces the value of its currency relative to that of a foreign currency • Revaluation occurs when a government increases the value of its currency relative to that of a foreign currency

25. Exchange rate systems • Pegged Exchange Rates. • Peg own currency to a major currency ($). • Popular among smaller nations • Evidence of moderation of inflation • Currency Boards. • Country commits to converting domestic currency on demand into another currency at a fixed exchange rate • Country holds foreign currency reserves equal to 100% of domestic currency issued

26. Foreign-Exchange Convertibility • Fully convertible currencies • those that the government allows both residents and nonresidents to purchase in unlimited amounts • “Hard currencies” are fully convertible • “Soft currencies” (or weak currencies) are not fully convertible • Typically from developing countries • Known as exotic currencies

27. Business Implications of Exchange-Rate Changes • Marketing Decisions • A devaluation of a currency could help the country’s imports become more expensive and its exports less expensive • When a currency changes in value, exporters and importers need to decide whether to change prices

28. Business Implications of Exchange-Rate Changes • Production Decisions • Companies might locate production in weak-currency countries because • Initial investment there is relatively cheap • Such a country is a good base for inexpensive exportation • Financial Decisions • Exchange rates can influence the sourcing of financial resources, the cross-border remittance of funds, and the reporting of financial results

29. 6-7 Exchange Rates • Spot rate • exchange rate between two currencies for delivery within two business days • Forward rate • exchange rate between two currencies for delivery in the future, commonly 30, 60, 90, or 180 days • RISKS • Transaction—risk of value change

31. DIRECT QUOTEis the number of units of the domestic currency needed to acquire one unit of the foreign currencyexample- US $s and Euros $1.3626 / Euro means it takes $1.3626 to buy 1 € Currency Exchange Rates INDIRECT QUOTE is the number of units of the foreign currency needed to acquire one unit of the domestic currency0.73389 € = $1.000 (USD)