Financial EnvironmentReview Question and Answer

1. How did the U.S. dollar become the international transaction currency in the post World War II era?

Chapter 3Kotabe & Helsen's Global Marketing Management, Third

Edition, 20042

Because of the strength of the military, economic, political, and fiscal power of the United States following World War II, the United States agreed to exchange the dollar at a rate of $35 per ounce of gold. With the value of the dollar stabilized, countries could deal in dollars without being constrained by currency fluctuations. Thus, the dollar became the common denominator in world trade.

2. Which international currency or currencies are likely to increasingly assume a role of the international transaction currency in international trade? Why?

3

Today, the global economy is increasingly dominated by three major currency blocs. The U.S. dollar, the Japanese yen, and the German mark each represent their “spheres of influence” on the currencies of other currencies in their respective regions. Each of these currencies has become the standard within its regions of the world (and thereby have also become international trading currencies).

3. Why is a fixed exchange rate regime that promotes the stability of the currency value inherently unstable?

The real rate of stability of currency value depends on the stability of economic and financial conditions. History has shown that these variables fluctuate. Government intervention is always a reality, therefore, instability must be managed if exchange rates are to be stable.

4

4. Discuss the primary roles of the International Monetary Fund and World Bank.• The International Monetary Fund (IMF) was created at Bretton Woods to

oversee the newly created monetary system. The IMF was a specialized agency within the United Nations established to promote international monetary cooperation and to facilitate the expansion of trade, and in turn to contribute to increased employment and improved conditions in all member countries.

• Another creation of the Bretton Woods conference was the International Bank for Reconstruction and Development, known as the World Bank. The World Bank (as different from the IMF) was initially intended for the financing of postwar reconstruction and development and later for infrastructure building projects in the developing world. More recently, the Bank has begun to participate actively with the IMF to resolve debt problems of the developing world and may also play a major role in bringing a market economy to the former members of the Eastern bloc.

5

5. What is the managed float?

A managed float allows for a limited amount of government intervention to soften sudden swings in value of a currency. If a nation’s currency enters into a rapid ascent or decline, that nation’s central bank may wish to sell or buy that currency on the open market in a countervailing movement to offset the prevailing market tendency. This is for the purpose of maintaining an orderly, less volatile foreign exchange market.

Chapter 3Kotabe & Helsen's Global Marketing Management, Third

Edition, 20046

6. How does a currency bloc help a multinational company’s global operations?The currency bloc helps a multinational within a regional area because a particular currency will be pegged as the currency to trade in and some degree of stability will occur. The currency bloc medium (a particular currency) will probably be more stable than the currency of any particular country (especially if it is a developing country). The currency bloc phenomenon encourages trade within a particular region.

7

7. Describe in your own words how the knowledge of spot and forward exchange rate market helps international marketers.

• In order to answer this question, students should refer to the definitional material in the chapter. A summary of this material is presented below.

• If payment on a transaction is to be made immediately, the purchaser has no choice other than to buy foreign exchange on the spot (or current) market, for immediate delivery. However, if payment is to be made at some future date, the purchaser has the option of buying foreign exchange on the spot market or on the forward market, for delivery at some future date. The advantage of the forward market is that the buyer can lock in an exchange rate and avoid the risk of currency fluctuations; this is called hedging, or protecting oneself against potential loss.

8

8. Why is the exchange rate pass-through usually less than perfect (i.e., less than 100 percent)?

The extent to which a foreign company changes dollar prices of its products in the U.S. market as a result of exchange rate fluctuations is called exchange rate pass-through. It is usually less than perfect because it requires an estimate of the average increase with respect to dollar prices (with respect to the currency of the trading country or company).

9

9. Define the four types of balance of payments measures.a. The balance of payments in goods account (trade balance, for short) shows trade

in currently produced goods as well as unilateral transfers (private gifts) of merchandise.

b. The balance of payments in current account (current account balance) shows trade in currently produced goods and services as well as unilateral transfers (private gifts and foreign aid) of merchandise.

c. The balance of payments in capital account (capital account) summarizes financial transactions and is divided into two sections, short and long capital accounts.

d. Subaccounts include direct investments and portfolio investment. Direct investments are those investments in enterprises or properties that are effectively controlled by residents of another country. Portfolio investment includes all long term investments that do not give the investors effective control over the investments.

10

10. Describe the sequence of events that took place to cause the Asian financial crisis in the late 1990s.The Asian Financial Crisis started in May 1997. China’s devaluation of its currency triggered the crisis which later spread to Thailand, Malaysia, Indonesia, and South Korea. This was one of the worst crisis in East Asia. For example, the Thai bath lost 60 percent of its value against the U.S. dollar. Currencies from South Korea, Malaysia and Indonesia were also depreciated. Countries which had borrowed heavily from abroad were the first to be hit by the crisis. Other reasons include: internal debt, careless foreign expansions, and government interventions in their local economies. In short, the Asian Financial crisis resulted in a disastrous competitive depreciation of the currencies as well as local economies. International marketers were equally hit by this crisis.

11

11. What are advantages and disadvantages of having the euro as a common currency in the European Union?

The European Union (EU) consists of fifteen countries. To bring the cost down and harmonize their economies, the member nations signed the Maastricht Treaty which aimed at replacing local currencies with a single currency. Except for the United Kingdom, all the members nations of the EU joined the Exchange Rate Mechanism (ERM) which determined bilateral currency exchange rates. For international marketers, the euro carries far reaching implications such as: harmonizing the economies, reducing prices and transaction costs, and more cross-border competition. In addition, other benefits include: streamlining supply-chains and new opportunities for small and medium-sized companies. One of the major disadvantages of the euro is its cost factor. Massive investment in computer infrastructure and logistical expenses are needed to put in place the change-over. The euro-conversion will cost companies abut $65 billion.

12