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The Bretton Woods Agreement


International Business Section IV: World Financial Environment
Chapter Ten The Determination of Exchange Rates The Bretton Woods Agreement established a par value, or benchmark value, for each currency initially quoted in terms of gold and the U.S. dollar.

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Chapter Objectives
To describe the International Monetary Fund and its role in the determination of exchange rates To discuss the major exchange-rate arrangements that countries use To explain how the European Monetary System works and how the euro came into being as the currency of the euro zone To identify the major determinants of exchange rates To show how managers try to forecast exchange-rate movements To explain how exchange-rate movements influence business decisions
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The IMF Today


The Quota System Assistance Programs Special Drawing Rights (SDRs) The Global Financial Crisis and the SDR

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The International Monetary Fund


Originally organized in 1945 Objectives: To ensure stability in the international monetary system To promote international monetary cooperation and exchange-rate stability To facilitate the balanced growth of international trade To provide resources to help members in balance-of-payments difficulties or to assist with poverty reduction
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Evolution to Floating Exchange Rates


The Smithsonian Agreement 8% devaluation of the dollar Revaluation of other currencies Widening of exchange rate flexibility The Jamaica Agreement

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Exchange Rate Arrangements

The Euro
European Monetary System (EMS): established by the EU (then the EC) in 1979 as a means of creating exchange rate stability within the bloc European Central Bank: established by the EU on July 1, 1998, to set monetary policy and to administer the euro Euro: the common European currency established on Jan. 1, 1999 as part of the EUs move toward monetary union as called for by the Treaty of Maastricht of 1992 European Monetary Union (EMU): a formal arrangement linking many but not all of the currencies of the EU Pluses and Minuses of the Conversion to the Euro The Euro and Global Financial Crisis
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Dhiraj Karki, Course Instructor, Global Business Management

Dhiraj Karki, Course Instructor, Global Business Management

Exchange Arrangements with No Separate Legal Tender


Dollarization Currency Board Arrangements Pegged Arrangements More Flexible Arrangements Crawling Pegs Managed Float Independently Floating

The Determination Of Exchange Rates


Currencies that float freely respond to supply and demand conditions free from government intervention The demand for a countrys currency is a function of the demand for its goods and services and the demand for financial assets denominated in its currency Fixed exchange rates do not automatically change in value due to supply and demand conditions but are regulated by their Central Banks
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Dhiraj Karki, Course Instructor, Global Business Management

Dhiraj Karki, Course Instructor, Global Business Management

Exchange Rates: The Bottom Line


Countries may change the exchange-rate regime they use, so managers need to monitor country policies carefully.

Central Banks
Central banks are the key institutions in countries that intervene in foreign-exchange markets to influence currency values The Bank for International Settlements (BIS) in Switzerland acts as a central bankers bank. It facilitates communication and transactions among the worlds central banks A central bank intervenes in money markets by increasing a supply of its countrys currency when it wants to push the value of the currency down and by stimulating demand for the currency when it wants the currencys value to rise

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Black Markets The Result of Fixed Exchange Rates


Many countries that strictly control and regulate the convertibility of their currency have a black market that maintains an exchange rate that is more indicative of supply and demand than is the official rate

Exchange Rates and Purchasing Power Parity


The Big Mac Index Short Run problems that affect PPP

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Foreign-Exchange Convertibility
Fully convertible currencies, often called hard currencies, are those that the government allows both residents and nonresidents to purchase in unlimited amounts Currencies that are not fully convertible are often called soft currencies, or weak currencies They tend to be the currencies of developing countries

Exchange Rates and Interest Rates


The Fisher Effect The International Fisher Effect Other Factors in Exchange Rate Determination
Confidence Information

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Exchange Controls
To conserve scarce foreign exchange, some governments impose exchange restrictions on companies or individuals who want to exchange money, such as
import licensing multiple exchange rates import deposit requirements quantity controls
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Forecasting Exchange-Rate Movements


Fundamental forecasting uses trends in economic variables to predict future rates. The data can be plugged into an econometric model or evaluated on a more subjective basis. Technical forecasting uses past trends in exchange rates themselves to spot future trends in rates.
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Factors to Monitor
Major factors that managers should monitor when trying to predict the timing, magnitude, and direction of an exchangerate change include
the institutional setting fundamental analysis confidence factors events technical analysis
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Business Implications of Exchange-Rate Changes


Exchange rates can affect business decisions in three major areas:
Marketing Production Finance

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Future:
Latin America
Emerging market currencies should strengthen as commodity prices recover

Europe
The euro is gaining popularity and will take market share away from the dollar as the prime reserve asset

Asia
China is moving forward to establish the yuan as a major world currency
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Dhiraj Karki, Course Instructor, Global Business Management