Transcript MS34B-Week 5

International Business
Management (MS34B)
Foreign Exchange Systems and Management
Facilitator: Densil A. Williams
MS34B, UWI Mona, Department
of Management Studies
Contents
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Introduction
Exchange Rate Concepts
Determinants of Exchange Rate
Theories of Exchange Rate
Exchange Rate and Economic Growth
MS34B, UWI Mona, Department
of Management Studies
Introduction
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In international transactions, companies need a
mechanism to exchange one currency for another.
This mechanism is called the foreign exchange
market.
Currencies are bought and sold in this market.
Institutions exchange one currency for another at
a specific exchange rate.
This rate depends on a number of factors : size of
the transaction, the trader conducting the
transaction, general economic conditions and
sometimes government mandate.
MS34B, UWI Mona, Department
of Management Studies
Introduction
Functions of the Foreign Exchange Market
 Currency Conversion
 In international trade, the seller normally wants
to have payments in his/her local currency while
the buyer wants to pay in his/her local currency
which are both different
 To solve this problem, the buyer goes to the
foreign exchange market and exchange his
currency for that of the seller so that s/he can pay
in the sellers local currency
 Companies that invest in FDI and want to
repatriate profits must convert local currency to
the currency of the host country. This is done on
the foreign exchange market.
MS34B, UWI Mona, Department
of Management Studies
Introduction
Functions of the Foreign Exchange Market
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Currency Hedging
International business traders normally try to insure
against potential losses that result from adverse changes
in the exchange rate. This is called Hedging.
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Hedging serves two purposes:
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A) to reduce the risks associated with international transfer
of funds.
B) to protect the trades interest in transactions where
there is a time lag between billing and receipt of payment.
MS34B, UWI Mona, Department
of Management Studies
Exchange Rate Determination
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Like other commodities, the exchange rate is determined by
interaction of supply and demand for currency.
Demand and Supply are influenced by:
- Trade (imports/exports of goods and services),
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Investment (portfolio and foreign direct initial investment repatriation of capital and remittance of dividends)
- Monetary factors – changes in supply of domestic currency.
MS34B, UWI Mona, Department
of Management Studies
Theories
of
Determination
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Exchange
Rate
Purchasing Power Parity: Spot Exchange Rates
Change in Proportion to the Differential Inflation
between Two Economies.
It tells us how much of one currency a consumer in
one country needs in order to buy the same
amount of products as a consumer in another
country.
In other words, it is the relative ability of two
countries currencies to buy the same basket of
goods in those two countries.
MS34B, UWI Mona, Department
of Management Studies
Theories of Exchange Rate Determination
Inflation and Exchange Rate
 Inflation erodes purchasing power. As a result,
governments try to control by managing the supply
and demand of their currency.
 Factors affecting money supply change include:
Public Sector Credit, Private Sector Credit, Changes
in Monetary Base (currency issue, cash reserves,
current accounts), changes in net international
reserves, open market operations of central bank.
MS34B, UWI Mona, Department
of Management Studies
Exchange Rate and Economic Growth
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Countries in the Caribbean that adopt a
fixed regime have seen higher growth
rates while those with a flexible regime
except for a few (Trinidad & Tobago)
have seen lower growth rates.
The verdict is still out as to which
regime is most suitable in small, open
developing economies.
MS34B, UWI Mona, Department
of Management Studies
Concluding Remarks
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In this discourse, we have shown how the foreign
exchange market works and the impact of the
exchange rate on the economic growth in
developing economies.
The exchange rate is a critical price in the economy
and improper management can have serious
negative implications for the competitiveness of the
economy.
It is therefore critical that managers and policy
makers fully understand the factors that drive
exchange rate determination and manage these
effectively.
MS34B, UWI Mona, Department
of Management Studies