International International Monetary SystemMonetary System

Each country has developed its own Each country has developed its own money system with its own currencymoney system with its own currency

Ours is the dollarOurs is the dollar

World CurrencyWorld Currency

IsraelIsrael

a.a. RugesRuges

b.b. PesosPesos

c.c. ShekelsShekels

d.d. PoundsPounds

EgyptEgypt

a.a. PuntPunt

b.b. PoundsPounds

c.c. DollarsDollars

d.d. DrachmasDrachmas

South KoreaSouth Korea

a.a. YenYen

b.b. WonWon

c.c. RenminbiRenminbi

d.d. RupeeRupee

PolandPoland

a.a. ZlotyZloty

b.b. RiyalRiyal

c.c. DinarDinar

d.d. SchillingSchilling

FranceFrance

a.a. PoundsPounds

b.b. EuroEuro

c.c. FrancFranc

d.d. LiraLira

CanadaCanada

a.a. PesoPeso

b.b. DollarDollar

c.c. RiyalRiyal

d.d. KroneKrone

HistoryHistory

By 1880’s, most countries had By 1880’s, most countries had backed their currencies with gold, backed their currencies with gold, which was recognized throughout which was recognized throughout the world as having value the world as having value

During the time of 1914 (WWI) to During the time of 1914 (WWI) to WWII (1944), countries printed WWII (1944), countries printed money to help finance war effortsmoney to help finance war efforts

Having depleted gold reserves, 44 Having depleted gold reserves, 44 countries met at Bretton Woods, countries met at Bretton Woods, New Hampshire in 1944New Hampshire in 1944

Bretton Woods Bretton Woods AgreementAgreement

Countries agreed to peg their Countries agreed to peg their currencies to the U.S. dollar, which currencies to the U.S. dollar, which would still be backed by gold at $35 would still be backed by gold at $35 per ounceper ounce

Created the International Monetary Created the International Monetary Fund (IMF) to maintain order in the Fund (IMF) to maintain order in the monetary system and the World monetary system and the World Bank to promote economic Bank to promote economic developmentdevelopment

By the late 1960’s there were By the late 1960’s there were problems and in the early 1970’s the problems and in the early 1970’s the U.S. refused to continue to keep its U.S. refused to continue to keep its exchange rate fixedexchange rate fixed

It had depleted its gold reserves and It had depleted its gold reserves and President Nixon said that we would President Nixon said that we would not continuenot continue

1976 Jamaica Agreement that lead 1976 Jamaica Agreement that lead to a floating exchange rate system to a floating exchange rate system where currencies are traded for where currencies are traded for each othereach other

Gold is no longer backing currenciesGold is no longer backing currencies

Free floating currencyFree floating currency Currency value determined by market Currency value determined by market

forcesforces Dirty floatDirty float

Gov’t influences value of currency by Gov’t influences value of currency by buying or selling but hasn’t declared it fixedbuying or selling but hasn’t declared it fixed

Pegged or fixed currencyPegged or fixed currency Currency value tied to another currency Currency value tied to another currency Gov’t buys or sells currency to maintain Gov’t buys or sells currency to maintain

raterate

Korean won tied to U.S. dollarKorean won tied to U.S. dollar Chinese yuan tied to basket of Chinese yuan tied to basket of

currencies currencies

How exchanging worksHow exchanging works

Foreign exchange marketForeign exchange market Over $1 trillion exchanged each dayOver $1 trillion exchanged each day Traders and government central Traders and government central

banks buy and sell just like stockbanks buy and sell just like stock

Exchange ratesExchange rates

http://www.x-rates.com/d/USD/http://www.x-rates.com/d/USD/table.html table.html

Fluctuations in Currency Fluctuations in Currency ValueValue

U.S. dollar compared to the U.S. dollar compared to the Japanese yenJapanese yen

1/1/20081/1/2008 1/1/20091/1/2009

$1 = 75 $1 = 75 yenyen

$1 = 85 $1 = 85 yenyen

U.S. dollar is increasing in value against the yen because it can buy more

The yen is decreasing against the dollar because it’s worth less.

12/1/200812/1/2008 12/1/200912/1/2009$1 = 75 yen $1 = 75 yen $1 = 85$1 = 85

If you wanted to see a movie that If you wanted to see a movie that cost 1,250 yen, what would it cost cost 1,250 yen, what would it cost you in 2009 compared to 2008?you in 2009 compared to 2008?

What would happen to the cost of What would happen to the cost of importing goods from Japan to the importing goods from Japan to the U.S.?U.S.?

What would happen to the cost of What would happen to the cost of exporting from the U.S. to Japan?exporting from the U.S. to Japan?

U.S. dollar compared to the U.S. dollar compared to the Japanese yenJapanese yen

1/1/20091/1/2009 1/1/20101/1/2010$1 = 85 yen$1 = 85 yen $1 = 80 yen$1 = 80 yen

U.S. dollar is decreasing in value against the U.S. dollar is decreasing in value against the yen because it buys lessyen because it buys less

The yen is increasing against the dollar The yen is increasing against the dollar because it’s worth more.because it’s worth more.

12/1/200912/1/2009 12/1/201012/1/2010$1 = 85 yen$1 = 85 yen $1 = 80 $1 = 80

yenyen If you wanted to see a movie that If you wanted to see a movie that

cost 1,250 yen, what would it cost cost 1,250 yen, what would it cost you in 20010 compared to 2009?you in 20010 compared to 2009?

What would happen to the cost of What would happen to the cost of importing goods from Japan to the importing goods from Japan to the U.S.?U.S.?

What would happen to the cost of What would happen to the cost of exporting from the U.S. to Japan?exporting from the U.S. to Japan?

CurrenCurrencycy

12/2/19912/2/19977Units/US$ Units/US$

12/1/20112/1/20100Units/US$Units/US$

Percent Percent Change in Change in Value of Value of CurrencyCurrency

South South Korean Korean

WonWon

931931 1150.61150.6 23.59%23.59%

JapanesJapanese Yene Yen

112.3112.3 84.0384.03 (25.17%)(25.17%)

Great Great Britain Britain PoundPound

0.490.49 0.640.64 30.61%30.61%

Source: Pacific FX Database, 12/2/2010 http://fx.sauder.ubc.ca/data.html

Trade with Japan ImpactTrade with Japan Impact

(Figures in millions)(Figures in millions) Exports = $ 51,134.20Exports = $ 51,134.20 Imports = $95,803.70Imports = $95,803.70 Total Value of Goods Traded= $ Total Value of Goods Traded= $

146,937.90146,937.90 25% change in value of currency = 25% change in value of currency =

$36,734.48 million ($36,734,480,000) $36,734.48 million ($36,734,480,000) worth of impact on goodsworth of impact on goods

Impact of currency value changes Impact of currency value changes can be visually seencan be visually seen

http://fx.sauder.ubc.ca/ http://fx.sauder.ubc.ca/

What causes exchange What causes exchange rates to change?rates to change?

Supply and Demand for a currencySupply and Demand for a currency Inflation ratesInflation rates Interest ratesInterest rates Strength of economyStrength of economy Political system Political system Political eventsPolitical events

Companies use Foreign Companies use Foreign ExchangeExchange

Payments for exports or foreign Payments for exports or foreign investmentsinvestments

Purchase suppliesPurchase supplies Invest in another countryInvest in another country Speculate on exchange ratesSpeculate on exchange rates

JAL airlinesJAL airlines

Purchase airlines from BoeingPurchase airlines from Boeing Prices range from $35 – 160 millionPrices range from $35 – 160 million Order aircraft 2-6 years in advance Order aircraft 2-6 years in advance 10% down and rest when aircraft 10% down and rest when aircraft

delivereddelivered 1985, Boeing placed order for $100 1985, Boeing placed order for $100

million 747 aircraftmillion 747 aircraft $1= $1= ¥¥240 in 1985240 in 1985 90,000,000 US$ = 90,000,000 US$ = ¥ ¥ 21,600,000,00021,600,000,000

What if exchange rate changed?What if exchange rate changed? Total cost of Total cost of ¥¥2.4 billion2.4 billion If rate changes to $1= If rate changes to $1= ¥300, price ¥300, price

raises to ¥3.0 billion - a 25% raises to ¥3.0 billion - a 25% increase!increase!

If rate changes to $1 = ¥200, price If rate changes to $1 = ¥200, price decreases to ¥2.0 billion.decreases to ¥2.0 billion.

Exchange Rate RiskExchange Rate Risk

The chance of loss due to changing The chance of loss due to changing exchange ratesexchange rates

Ideas on managing the riskIdeas on managing the risk Assume risk and deal in foreign Assume risk and deal in foreign

currencycurrency Only deal in your currencyOnly deal in your currency Transfer risk to someone else through Transfer risk to someone else through

hedginghedging CountertradeCountertrade

HedgingHedging

Buy a currency in the future at a Buy a currency in the future at a price set today so the risk is price set today so the risk is minimizedminimized

Example: Buy euros 120 days into Example: Buy euros 120 days into the future – forward contractthe future – forward contract

JALJAL

Purchased right to buy dollars for Purchased right to buy dollars for next ten years for a set rate of $1 = next ten years for a set rate of $1 = ¥¥185185

forward exchange contractforward exchange contract Allows company to know what they Allows company to know what they

will pay and plan aheadwill pay and plan ahead Looked like a great deal when $1 = Looked like a great deal when $1 =

¥¥240240

1994 contracts executed 1994 contracts executed Yen had risen against dollarYen had risen against dollar $1 = $1 = ¥99¥99 JAL admitted that they were paying JAL admitted that they were paying

86% more than necessary86% more than necessary Mistake of $450 million or ¥45 Mistake of $450 million or ¥45

millionmillion http://fx.sauder.ubc.ca/plot.html http://fx.sauder.ubc.ca/plot.html

CountertradeCountertrade

Form of payment in which a seller Form of payment in which a seller accepts something other than money accepts something other than money in compensationin compensation

TypesTypes

Barter – products exchanged Barter – products exchanged 1990, State Trading Corp. of India 1990, State Trading Corp. of India

exchanged wheat to Turkmenistan exchanged wheat to Turkmenistan for cottonfor cotton

Pepsi sold soft drinks in China in Pepsi sold soft drinks in China in exchange for mushrooms for Pizza exchange for mushrooms for Pizza Hut pizzasHut pizzas

CounterpurchaseCounterpurchase

Buyer and seller purchase goods Buyer and seller purchase goods from each otherfrom each other

Business A sells to Business Z for Business A sells to Business Z for cash. At the same time, Business A cash. At the same time, Business A agrees to buy stuff from Business Z agrees to buy stuff from Business Z for an equal amount.for an equal amount.

Most common form of countertrade Most common form of countertrade

McDonnell Douglas has bought McDonnell Douglas has bought hams, irons, and rubber bumper hams, irons, and rubber bumper guardsguards

OffsetOffset

Part of exported good is produced in Part of exported good is produced in the importing countrythe importing country

General Dynamics sold military jets General Dynamics sold military jets to Belgium, Norway and Denmark to Belgium, Norway and Denmark and allowed them to offset the cost and allowed them to offset the cost by producing 40% of the value of the by producing 40% of the value of the aircraft in their countries aircraft in their countries

Different risk is that of Different risk is that of not getting paidnot getting paid

Letter of credit is used to remove Letter of credit is used to remove this riskthis risk

Letter issued by a bank at the Letter issued by a bank at the request of an importerrequest of an importer

Promise by the bank to pay a Promise by the bank to pay a specified sum of money to a specified sum of money to a beneficiary (exporter) on beneficiary (exporter) on presentation of certain documentspresentation of certain documents

Types of Letters of CreditTypes of Letters of Credit

Irrevocable – terms can only be Irrevocable – terms can only be modified if both exporter and importer modified if both exporter and importer agreeagree

Revocable – Issuing bank can modify Revocable – Issuing bank can modify terms without approval from the terms without approval from the exporter or importerexporter or importer

Importer

Importer’s Bank

Exporter’sBank

Importer applies for LC from its bank

I. bank issues LC to E. bank

Bank notifies exporter that it has LC

Exporter ships

Exporter delivers documents to E. bank

ExportExporterer

--Buy/sell goods----Buy/sell goods--

Bank checks documents and pays exporter

E. Bank delivers documents to I. Bank

Importer pays for goods

Bank sends payment to exporter’s bank

I. Bank delivers documents to importer

Purchasing Power ParityPurchasing Power Parity

Theory that a dollar should buy the Theory that a dollar should buy the same amount in all countriessame amount in all countries

Economist measures with “Big Mac Economist measures with “Big Mac Index”Index”

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