International Business Chapter 10 International Monetary System

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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


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