International Business Chapter 10 International Monetary System
Bretton Woods Agreement
Agreement (1944) among nations to create a new international monetary system based on the value of the US dollar. The new system was designed to balance the strict discipline of the gold standard with the flexibility that countries needed in order to deal with the temporary domestic monetary difficulties.
Smithsonian Agreement
Agreement (1971) among IMF members to restructure and strengthen the international monetary systecreated at Bretton Woods.
Jamaica Agreement
Agreement (1976) among IMF members to formalize the existing system of floating exchange rates as the new international monetary system
A market is efficient if prices of financial instruments quickly reflect new public information made available to traders.
Efficient Versus Inefficient Market View
They affect the cost of borrowing
How do interest rates affect inflation?
Special Drawing Right
IMF asset whose value is based on a weighted basket of five currencies
Exchange rates influence business activities for domestic and international companies
What are the main implications for business strategy?
Fundamental Disequilibrium
economic condition in which a trade deficit causes a permanent negative shift in a country's balance of payments
Managed Float System
exchange-rate system in which currencies float against one another, with governments intervening to stabilize their currencies at particular target exchange rates
Free Float System
exchange-rate system in which currencies float freely against one another, without governments intervening in currency markets
Devaluation
intentionally lowering the value of a nation's currency
Revaluation
intentionally raising the value of a nation's currency
Currency Board
monetary regime based on an explicit commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate
1. The weight of gold made transporting expensive 2. When a transport ship sank at sea, the gold also sank and was lost
What are some disadvantages using gold as a medium of exchange in international trade?
A country's unemployment and interest rates
What are some key factors in the inflation equation?
Pegged exchange-rate arrangements
A country's currency to a more stable and widely used currency in international trade
International Monetary Fund
An agency that regulates the fixed exchange rates and to enforce the rules of the international monetary system
Role of Inflation
Inflation is the result of the supply and demand for a currency. Inflation erodes people's purchasing power.
Gold Standard
International monetary system in which nations link the value of their paper currencies to specific values.
Fiscal Policy
Involves using taxes and government spending to influence the money supply indirectly.
Relation between inflation rate and interest rate
Nominal Interest Rate = Real Interest Rate + Inflation Rate
1. Human element 2. Unexpected events 3. Changes in government regulation of business
What are some difficulties of forecasting?
Evaluating PPP
PPP is better at predicting long-term exchange rates but accurate forecasts of short-term rates are more beneficial to international managers.
International Fisher Effect
Principle that a difference in nominal interest rates supported by two countries' currencies will cause an equal but opposite change in their spot exchange rates.
Fisher effect
Principle that the nominal interest rate is the sum of the real interest rate and the expected rate of inflation over a specific period.
Monetary Policy
Refers to activities that directly affect a nation's interest rates or money supply.
Fixed Exchange Rate System
System in which the exchange rate for converting one currency into another is fixed by international agreement
Fundamental Analysis
Technique that uses statistical models based on fundamental economic indicators to forecast exchange rates.
European Monetary System
The EMS was established in 1979 to stabilize exchange rates, promote trade among nations, and keep inflation low through monetary discipline
Par Value
The gold standard required a nation to fix the value (price) of its currency to an ounce of gold. The value of a currency expressed in terms of gold is called its
Fixed exchange rate system
The gold standard was what type of exchange rage system?
An example of how currency boards work
The government with a currency board is legally bound to hold an amount of foreign currency that is at least equal to the amount of domestic currency.
Exchange Rate Mechanism
The mechanism limited the fluctuations of EU members currencies within a specified trading range (or target zone)
Big Mac Index
This index uses the law of one price to determine the exchange rate that should exist between the US dollar and other major currencies.
1. Prune Operations 2. Adapt Products 3. Source Abroad 4. Freeze Prices
What are a ways how companies can export successfully despite a strong currency?
1. The gold standard drastically reduced the risk in exchange rates because it maintains highly fixed exchange rates between currencies. 2. The gold standard imposed strict monetary policies on all countries that participated in the system. 3 The gold standard could help correct a nation's trade imbalance.
What are advantage of the gold standard?
1. Developing nation's debt crisis 2. Mexico's peso crisis 3. Southeast Asia's currency crisis 4. Russia's ruble crisis 4. Argentina's Peso Crisis
What are financial crises examples the world has experienced in recent years?
Impact of Added costs, Impact of Trade Barriers, Impact of Business Confidence and Psychology
What are impacts short-term plans must realize?
1. Fixed Exchange Rates 2. Built-in Flexibility 3. World Bank 3. International Monetary Fund
What are important features of the Bretton Woods system?
Exchange rates also affect the amount of profit a company earns from its international subsidiaries
What are main implications for forecasting earnings and cash flows?
1. The limited supply of gold made it a commodity in high demand 2. Gold is highly resistant to corrosion 3. Can be melted into either small coins or large bars
What are some advantages using gold as a medium of exchange in international trade?
1. Promoting international monetary cooperation 2. Facilitating expansion and balanced growth of international trade 3. Promoting exchange stability, maintaining orderly exchange arrangements, and avoiding competitive exchange devaluation 4. Making the resources of the fund temporarily available to members 5. Shortening the duration and lessening the degree of disequilibrium in the international balance of payments of members nations
What are the main purposes of the International Monetary Fund?
Fundamental analysis and Technical analysis
What are the two main forecasting techniques based on this belief in the value of added information?
Real interest rates and nominal interest rates
What are the two types of interest rates?
1. Pegged Exchange Rate Arrangement 2. Currency Board
What are two ways nations attempt to maintain more-stable exchange rates by tying their currencies to other currencies?
1. Source Domestically 2. Grow at Home 3. Push Exports 4. Reduce Expenses
What are ways how companies can adjust to a weak currency?
The first World War when everyone printed paper currency
What caused the collapse of the gold standard?
Reduces
What does devaluation do to the buying power of consumers in a nation?
A market's expectation about the future values of two currencies
What does forward exchange rate reflect?
Increases; Decreases
What does revaluation do to the price of exports and the price of imports?
When applying the law of one price to a single product it can bee too simplistic a method for estimating exchange rates.
What is a drawback of the Big Mac Index?
Purchasing Power Parity
What is the calculation of currency's par value based on what concept?
Increases the amount of its exports
What is the implication of a weak currency to a company involved international business?
Recurring crises
What is the main reason a new system needs to be created to meet the challenges of a global economy?
It helps us determine whether a currency is overvalue or undervalued
What is the usefulness of the law of one price?
2.25 percent
What percent were members required to keep their highest and lowest valued currencies?
Law of one price and Purchasing power parity
What two factors help determine exchange rates?
Predictable
What type of movements do managers want for exchange rates?
To finance European reconstruction following the Second World War
What was the immediate purpose of the World Bank?
PPP theory is only meaningful only when applied to a basket of goods
When is purchasing power parity meaningful?
Britain in the early 1700s
Who was the first nation to implement the gold standard?
Appreciation in the value of the yen
Why did Sony lose over 90 billion yen when the company converted revenues from US dollar to yen?
The main problem was that the United States was experiencing a trade deficit and a budget deficit.
Why did the Bretton Woods system falter in the 1960s and inevitably collapse?
Example of two types of interest rates
Your bank quotes you an interest rate on a new car loan. That rate is the nominal interest rate, which consists of the real interest rate plus an additional charge for inflation.
International monetary system
collection of agreements and institutions that govern exchange rates
World Bank
officially called the International Bank for Reconstruction and Development
Law of one price
principle that an identical item must have an identical price in all countries when the price is expressed in a common currency
Technical Analysis
technique that uses charts of past trends in currency prices and other factors to forecast exchange rates
Inefficient market view
view that prices of financial instruments do not reflect all publicly available information
Efficient Market View
view that prices of financial instruments reflect all publicly available information at any given time