1-IB

Value of the Currency : Trade Surplus vs. Trade Deficit -An undervalued national currency can result in a ?? -Trade Deficit results when a nation's imports exceed its ??

-An undervalued national currency can result in a trade surplus, which arises when a nation's exports exceed its imports for a specific period of time, causing a net inflow of foreign exchange -exports for a specific period of time, causing a net outflow of foreign exchange; the government may devalue the nation's currency to correct a trade deficit.

Black Market Exchange Rates -Governments sometimes tolerate some?? -ex. Venezuela's Bolivar devalued from 2.15 to 4.3 to the dollar, Black market rate remained ?? -Black markets allow governments to gauge ?

"unofficial currency dealings" of controlled currencies; Gray market of Iran -steady at 6.40 to the dollar -real market value of their currencies

-Inflation occurs when (2 reasons) -Inflation is a common challenge for developing economies and emerging markets. Inflation directly affects the value of the nation's _____. If it results from an excessive increase in the ??, all else being equal, the price of that money (expressed in terms of foreign currencies) will fall.

(1) demand for money grows more rapidly than supply, or (2) the central bank increases the nation's money supply faster than output. - Inflation directly affects the value of the nation's currency. If it results from an excessive increase in the money supply, all else being equal, the price of that money (expressed in terms of foreign currencies) will fall.

Factors that Influence the Supply and Demand for a Currency -Government Action** -Indirectly? -Directly?

- governments can intervene to influence the value of their own curriencies -Indirectly, by buying or selling their currency Directly, by setting a price for their currency and controlling currency convertibility if necessary

Greek Crisis Bailout

-$146 billion bailout from EU and International Monetary Fund (IMF) -Public sector pensions cut 15-20% -Taxes increased

Key factor in the 2008 Global Financial Crisis: -A key factor was the availability of ?? from the ? Bank -Also, China had been investing huge sums in U.S. ?? -These trends fostered a vast global ____ ____ which facilitated high demand for housing and commodities like oil and food, leading to inflation. -Much of the money was used to finance huge ??

-A key factor was the availability of 'easy money' from the U.S. Federal Reserve Bank. -Also, China had been investing huge sums in U.S. government securities. -These trends fostered a vast global money supply, which facilitated high demand for housing and commodities like oil and food, leading to inflation. -Much of the money was used to finance huge U.S. trade deficits.

Translation Exposure -Americans think in dollars= -The US stock market thinks in US dollars too!= Turkey 2001 Gillette Venezuela 2010 Avon

-After a major devaluation of the Turkish Lira, a major US pharmaceutical company reassessed its Turkish sales force, noting that their sales in dollars now looked bad not good. -Stock prices for some US firms have dropped significantly due to a devaluation abroad. (Turkey 2001 --> Gillette, Venezuela 2010 --> Avon)

The Unpredictable Devaluation?

In 2001, the Turkish lira dropped 50 percent against the dollar when news broke of a government corruption scandal.

Ex. The Shanghai Stock Exchange (SSE) is based in Shanghai, China and is one of the three stock exchanges operating independently in the People's Republic of China. The other two are the Hong Kong Stock Exchange and the Shenzhen Stock Exchange. The SSE is the world's ??

The SSE is the world's sixth largest stock market by market capitalization at US$2.4 trillion as of 2010. Unlike the Hong Kong Stock Exchange, the SSE is not entirely open to foreign investors due to tight capital account controls of the Chinese government.

Greek Life

Unemployment hit 27.6% Unemployment among job seekers age 15-24 was 64.9% Condos shut off heat in winter

Direct Government Action: -Controlling Currency Convertibility: When everyone wants to sell Argentine pesos for US dollars, you need to ? access to dollars in order to keep the ?? steady. -This used to be common in many?

When everyone wants to sell Argentine pesos for US dollars, you need to restrict access to dollars in order to keep the exchange rate steady. - developing countries. Today it is again true in Venezuela and recently in Argentina.

Key Participants in the Monetary and Financial Systems: -Commercial Banks. -Central Banks. -Ex. Switzerland, the Bank for International Settlements (www.bis.org) is an international organization that ??

-Commercial Banks. Lend money to finance business activity, play a key role in nations' money supplies, and exchange foreign currencies. -Central Banks. Regulate money supply, issue currency, manage exchange rates, and control national reserves. - that fosters cooperation among central banks and other governmental agencies. It provides banking services to central banks and assists them in devising sound monetary policy.

Example: Australian Wine Exports to Europe** -If the Australian dollar appreciates against the euro: -What happens to the price charged for the wine sold in Europe?

-Costs to produce Australian wine in Australian dollars stays the same. -Costs to produce Australian wine when translated into euros go up. =It's a Management Decision!

Hedging Instruments: -Currency option: Gives the purchaser the _____, but not the obligation, to buy a certain amount of foreign currency at a set ?? within a _____ amount of time. -Currency Swap: two parties agree to _____ a given amount of one currency for another and, after a specified period of time, ???. Thus, a swap is a simultaneous spot and forward transaction. When the agreement is activated, the parties exchange principals at the current spot rate. Usually each party must pay interest on the principal as well.

-Currency option: Gives the purchaser the right, but not the obligation, to buy a certain amount of foreign currency at a set exchange rate within a specified amount of time. -currency swap, two parties agree to exchange a given amount of one currency for another and, after a specified period of time, give back the original amounts. Thus, a swap is a simultaneous spot and forward transaction. When the agreement is activated, the parties exchange principals at the current spot rate. Usually each party must pay interest on the principal as well. If Party A loaned dollars and borrowed euros, it pays interest in euros and receives interest in dollars.

Greek Crisis and the Euro --Did adopting the euro give Greeks false security? -

-Did adopting the euro give Greeks false security? -Wage inflation not justified by productivity growth led to a loss of international competitiveness in Greece. -Over time: Why buy Greek goods when German goods were better and cheaper? -Greece's balance of payments deteriorate. -But Greece can't devalue its currency. It's in the euro zone.

Hedging Instruments: -Forward contract: A financial instrument to buy or sell a currency at ?? rate at the initiation of the contract for _____ delivery. -Futures contract: An agreement to buy or sell a currency in exchange for ?? at a pre-specified price and on a pre-specified date. A more ______ instrument than a forward contract.

-Forward contract: A financial instrument to buy or sell a currency at an agreed-upon exchange rate at the initiation of the contract for future delivery. -Futures contract: An agreement to buy or sell a currency in exchange for another at a pre-specified price and on a pre-specified date. A more standardized instrument than a forward contract.

Limitations of Hedging -Hedging options can disappear when the ??. No one wants to bet on it. -Hedging is a _______ option to address transaction risk or cover _______ obligations. -It doesn't help with ____ risk or long-term ____ ____

-Hedging options can disappear when the future of a currency is too uncertain or looks too bad. No one wants to bet on it. -Hedging is a management option to address transaction risk or cover shorter-term obligations. -It doesn't help with translation risk or long-term economic exposure.

-Many economists believe a persistent trade ____ is harmful to the national economy. When a trade deficit becomes severe or persists for a long time, the nation's central bank may ______ its currency. -A devaluation is a government action to reduce the official value of its currency relative to ?. It is usually accomplished by the ???. -Devaluation aims to deter the nation's residents from ???, potentially reducing the trade deficit.

-Many economists believe a persistent trade deficit is harmful to the national economy. When a trade deficit becomes severe or persists for a long time, the nation's central bank may devalue its currency. -action to reduce the official value of its currency relative to other currencies; accomplished by the buying and selling of currencies in the foreign exchange market. Devaluation aims to deter the nation's residents from importing from other countries, potentially reducing the trade deficit.

Key Participants in the Monetary and Financial Systems -The Firm -National Stock Exchanges and Bond Markets

-The Firm; international transactions require firms to deal with huge sums of foreign exchange; acquire large quantities of foreign exchange and must convert them into the currency of the home country. Firms also engage in investment, franchising, and licensing activities abroad that generate revenues they must exchange into their home currency. -National Stock Exchanges and Bond Markets; facilities for trading securities and bonds.Many exchanges are electronic networks not necessarily tied to a fixed location. Each country sets its own rules for issuing and redeeming stock. Trade on a stock exchange is by members only; Bonds form of debt that corporations and governments incur by issuing interest-bearing certificates to raise capital. Bonds enable the issuer to finance long-term investments

-The link between interest rates and inflation, and between inflation and the value of currency, implies there is a relationship between real ____ ____ and the value of _____. -For example, when interest rates in Japan are high, foreigners seek profits by buying Japan's interest-bearing investment opportunities, such as bonds and deposit certificates. Investment from abroad will have the effect of ??

-The link between interest rates and inflation, and between inflation and the value of currency, implies there is a relationship between real interest rates and the value of currency. -For example, when interest rates in Japan are high, foreigners seek profits by buying Japan's interest-bearing investment opportunities, such as bonds and deposit certificates. Investment from abroad will have the effect of increasing demand for the Japanese yen.

Currency Risk: -Transaction exposure: If during the three-month period the exchange rate shifts to US$1 = T$27, Gateway will have to pay an extra US$11,111 as a result of the rate change ([3,000,000/27] - [3,000,000/30]). From Gateway's standpoint, the Taiwan dollar has become more expensive. -Translation exposure: as exchange rates fluctuate, so do the functional-currency values of exposed assets, liabilities, expenses, and revenues. Translating quarterly or annual foreign financial statements into the ?? results in gains or losses on the date financial statements are consolidated; gains or losses are ?? -Economic exposure: Exchange rate fluctuations help or hurt sales by making the firm's products ?? for foreign buyers. Similarly, the firm may be harmed by currency shifts that raise the price of ??. The value of foreign investments can also fall, in home currency terms, with _____ _____ changes.

-Transaction exposure: Such gains or losses affect the firm's value directly by affecting its cash flows and profit. -Translation exposure: Translating quarterly or annual foreign financial statements into the parent's functional currency results in gains or losses on the date financial statements are consolidated. Note that gains or losses in translation exposure are "paper" or "virtual" changes and do not affect cash flows directly. -Economic exposure: Exchange rate fluctuations help or hurt sales by making the firm's products relatively more or less expensive for foreign buyers. Similarly, the firm may be harmed by currency shifts that raise the price of inputs sourced from abroad. The value of foreign investments can also fall, in home currency terms, with exchange rate changes.

Growing integration of financial and monetary global activity is due to:

-Worldwide evolution of monetary and financial regulations. -Emergence of new technologies and payment systems in global finance, e.g. the Internet. -Increased global and regional interdependence of financial markets.

Global Financial Crisis -Many bad mortgages were 'securitized' = -Over time, investors realized that many loans were high-risk, which led to ____ _____ -Like a ____, the crisis spread quickly to Europe and beyond. -As the global economy slowed, demand for _____ shrank, and ____-dependent countries floundered

-bundled into investment assets and sold in global financial markets. -capital flight. -contagion -As the global economy slowed, demand for exports shrank, and export-dependent countries floundered (e.g., Japan, Mexico, countries in Eastern Europe).

Economic Exposure= is currency risk that results from exchange rate fluctuations affecting the ??, the cost of ___, and the value of foreign ______ -Economic Exposure and Location of Value (what increases economic exposure? what eliminates it?) -The trade-offs?

-currency risk that results from exchange rate fluctuations affecting the pricing of products, the cost of inputs, and the value of foreign investments. -A global value chain increases economic exposure -Putting all activities in each country where the firm sells eliminates economic exposure -Trade-offs= Loss of economies of scale & Inability to perform activities in the best and/or cheapest countries

Globalization of Financial and Monetary Activities -Capital flows are much more volatile than FDI-type investments because it is much easier for investors to withdraw and reallocate???? -The globalization of financial flows is also associated with increased risk; contagion?; Financial instability is worsened when governments fail to ??

-much easier for investors to withdraw and reallocate liquid capital funds than FDI funds, which are directly tied to factories and other permanent operations that firms establish abroad. -Economic difficulties in one country can quickly spread to other countries, like a contagion. Financial instability is worsened when governments fail to adequately regulate and monitor their banking and financial sectors.

-Passive Hedging: each exposure is hedged as ?? and the hedge stays in place until maturity. -Active Hedging= the firm frequently reviews total exposure and hedges only a ??, usually those that pose the greatest risk. Hedges may be withdrawn before they ??. Some active hedgers seek to ____ from hedging, even maintaining active in-house trading desks.

-passive hedging, each exposure is hedged as it occurs and the hedge stays in place until maturity. -In active hedging, the firm frequently reviews total exposure and hedges only a subset of its total exposures, usually those that pose the greatest risk. Hedges may be withdrawn before they reach maturity. Some active hedgers seek to profit from hedging, even maintaining active in-house trading desks. However, most firms are conservative and simply try to cover all exposures—or their most important ones—and leave hedges in place until maturity.

Management of Currency Risk by= Hedging -refers to efforts to compensate for a possible loss from a bet or investment by making ???. In international business, it refers to using ? and other measures to reduce or eliminate exposure to currency risk. If the hedge is perfect, the firm is protected against the risk of ??

-refers to efforts to compensate for a possible loss from a bet or investment by making offsetting bets or investments. In international business, it refers to using financial instruments and other measures to reduce or eliminate exposure to currency risk. If the hedge is perfect, the firm is protected against the risk of adverse changes in the price of a currency.

Factors that Influence the Supply and Demand for a Currency -Inflation: -Hyperinflation:

-refers to increases in the prices of goods and services; thus, money buys less than before. -hyperinflation—persistent annual double-digit and sometimes triple-digit rates of price increases; The costs of producing goods and services in the local currency go up and decreases the country's ability to export.

-governments must manage their balance of payments= -what increasesthe demand for a local currency?

-the nation's balance sheet of trade, investment, and transfer payments with the rest of the world. It represents the difference between the total amount of money coming into and going out of a country. It represents the difference between the total amount of money coming into and going out of a country. -Incoming FDI, portfolio investment, remittances and aid increase the demand for a local currency.

Factors that Influence the Supply and Demand for a Currency -Psychological Factors (Capital Flight:)

Capital flight: -When holders of a currency fear that it will devalue significantly they hurry to sell it -This is no longer a phenomenon of elites alone -And remember the contagion effect and portfolio investments

Costs in euros go up _______. Prices in euros do not rise unless ???.

Costs in euros go up automatically. Prices in euros do not rise unless managers decide to raise them.

Currency Risk Management -Currency risk concerns _____ _____ fluctuations that harm _____ profits.

Currency risk concerns exchange rate fluctuations that harm business profits.

Post-devaluation Inflation -Devaluations make prices on _____ products decrease/increase? immediately fueling ____ -Venezuela's inflation increased from 27% to ___% in 2010 after a devaluation

Devaluations make prices on imported products increase immediately fueling inflation Venezuela's inflation increased from 27% to 60% in 2010 after a devaluation

Economists v. Managers ; Costs v. Prices** -Economists tend to speak about prices changing as an ??. -Managers differentiate between costs changing as the result of ?? and price changes that result from a ?? as to how to respond to the cost changes.

Economists tend to speak about prices changing as an automatic outcome of currency changes. Managers differentiate between costs changing as the result of currency changes and price changes that result from a managerial decision as to how to respond to the cost changes.

Greek Crisis - Why?** -Excessive _____ & budget _____ supported by low ____ ____ -Consumer and government ?? -Government and international banks ?? -Crushing national debt of $_____ per Greek citizen

Excessive borrowing & budget deficits supported by low interest rates Consumer and government spending sprees Government and international banks hide extent of problem Crushing national debt of $27,000 per Greek citizen

In a high-inflation environment, the purchasing power of the currency is constantly ??. Interest rates and inflation are closely related. In countries with high inflation, interest rates tend to be ____ because investors expect to be compensated for the ??

In a high-inflation environment, the purchasing power of the currency is constantly falling. Interest rates and inflation are closely related. In countries with high inflation, interest rates tend to be high because investors expect to be compensated for the inflation-induced decline in the value of their money.

The Cost of Austerity**

Money pulled out of economy (austerity measures) depresses economy further Riots ensue

Just Say No to Euro? -Poland:

Poland is not in eurozone; Is required to join sometime; Maybe after 2016 -The 2010 eurozone debt crisis increased Polish opposition to adopting the Euro

ex. Zimbabwe dollar was made worthless by hyperinflation. -Dollarization

Replace it with the US dollar! -Dollarization has been adopted in some countries; Panama, Ecuador, El Salvador

The pricing of currencies affects company performance: -When a nation's currency is expensive to foreigners, its exports are likely to ____. When a nation's currency is cheap to foreigners, exports _____. When the value of a nation's currency depreciates over a prolonged period, consumer and investor confidence ???. A steep currency depreciation weakens the nation's ability to ??.

The pricing of currencies affects company performance. When a nation's currency is expensive to foreigners, its exports are likely to fall. When a nation's currency is cheap to foreigners, exports increase. When the value of a nation's currency depreciates over a prolonged period, consumer and investor confidence can be undermined. A steep currency depreciation weakens the nation's ability to pay foreign lenders, possibly leading to economic and political crisis.

The three types of Currency Exposure can produce positive results when _____ _____ fluctuate favorably for the ____. Managers are more concerned with ??. Such problems help explain why many countries in Europe use ?

The three types of currency exposure can produce positive results when exchange rates fluctuate favorably for the firm. Managers are more concerned with fluctuations that harm the firm. Such problems help explain why many countries in Europe use a single currency, the euro.

Transaction Exposure= is currency risk that firms face when outstanding ??? are denominated in foreign _____. This is a major concern of exporters and importers

Transaction exposure is currency risk that firms face when outstanding accounts receivable or payables are denominated in foreign currencies. This is a major concern of exporters and importers

Translation Exposure= currency risk that results when a firm translates ?? denominated in a foreign currency into the functional currency of the ??.

Translation exposure is currency risk that results when a firm translates financial statements denominated in a foreign currency into the functional currency of the parent firm. Assets Sales Profits

In 2008 the Global Financial Crisis emerged in the global financial and monetary systems. It was triggered in the United States where investors lost confidence in the value of ??

home mortgages. As commercial banks, mortgage lenders, and insurance companies entered a period of high volatility, stock markets crashed around the world, and many national economies sank into a deep recession. In the ensuing months, much of the world experienced sharp declines in consumer wealth, economic activity, and international trade.

Greek Crisis - -When international bond holders realized Greece was near bankruptcy, Greece's cost to borrow ??

jumped from 7%-18% in one month!