IMPACT OF INTREST RATE, INFLATION

AND FOREIGN EXCHANGE ON

INTERNATIONAL BUSINESS

GROUP MEMBERS
ANSHARAH RASHEED (10)
ASHNAA FAUZAN (13)
MADEEHA MAQBOOL (24)
MAHA SHAFAT (27)
PROMELA JACOB (43)
RABIYA AZHAR (46)

WHERE FOREIGN EXCHANGE

IMPACT YOUR BUSINESS

Foreign exchange rates affect virtually every aspect of a

companys business:

Sales income
Labor costs
Material costs
Financing costs
Capital purchases
Pricing
Margins
Competition
Market share

EXCHANGE RATE AND INTERNATIONAL

BUSINESS

The results of companies that operate in more

than one nation often must be "translated" from
foreign currencies into U.S. dollars. Exchange
rate fluctuations make financial forecasting more
difficult for these companies, and also have a
marked effect on unit sales, prices, and costs for
these companies.

THE IMPACTOF EXCHANGE RATE CHANGES

ON INTERNATIONAL BUSINESS

When selling products internationally, the

exchange rate for the two trading countries'
currencies is an important factor. Foreign
exchange rates, in fact, are one of the most
important determinants of a countries relative
level of economic health, ranking just after interest
rates and inflation. Exchange rates play a vital
role in a country's level of trade, which is critical to
most every free market economy in the world.

The differences in currency values can affect our ability to

buy imports or sell exports, affecting our standard of living.
Therefore, the effects of currency crises in other nations
are not limited to those nations -- they can affect our
economy and our lives in important ways.

EXAMPLE:
McDonald's saw sales in Europe increase in 2011, but the yearly
profits were actually down as a result of a weakening euro. Indeed,
some experts think investors should be cautious given that the US
dollar has strengthened so much recently and is expected to
continue doing so. As McDonald's generate nearly three quarters of
its profits overseas, this could be an issue if they have not hedged.

Coca cola is exposed to a significant amount of foreign

currency risk. its foreign currency exposures arise from
adverse changes in exchange rates between the euro,
the US dollar and the currencies in our non-euro
countries. Transaction exposures arise mainly from raw
materials purchased in currencies such as the US dollar
or euro which can lead to higher cost of sales in the
functional currency of the country.

THE IMPACT OF EXCHANGE RATE CHANGES

ON INTERNATIONAL BUSINESS

In the same way that supply and demand for

products shift to change the prices of those
products, the constant shifts in the supply and
demand for foreign currency result in changing
prices of currency. As a result, the price of
money changes as demand for foreign
currencies changes. This price of foreign
currency, in terms of U.S. currency, is known as
the foreign exchange rate.

 For example, if a US-based firm makes

EUR 10 million, they can end up with much
more or less than they thought depending on
the movement of the EUR/USD exchange
rate. For example, in June 2011 it would have
been worth $14.4 million, but in June 2012 it
would have been worth $2 million less.

price competition in the international market often

leads to fluctuating prices. For e.g. a foreign
company in the US market may increase or
decrease its prices depending on the changes in
the exchange rate.
Suppose some time ago, 1 pound was 1.5 US$.
However, today, it may decrease to 1.3 US$ if the
value of dollar appreciates. This will cause the
imported goods from UK to become cheaper for the
consumers in the US. However, this will not be a
good news for US exporters as UK consumers will
find that they are getting lesser returns for a pound's
worth.

FACTORS THAT CAN INCREASE THE DEMAND FOR A

FOREIGN CURRENCY
If another nations products sell at a lower price than
domestic products, consumers will increase their demand for
imports and for the foreign currency.
If domestic incomes rise or domestic inflation rates are
higher than those in other nations, demand for imports will
rise.
In capital markets, if another nations interest rate (return
on investment) is higher than the domestic interest rate,
some people will choose to invest in the other nations
securities.
When consumers import more products from a country or
invest in that countrys securities, their demand for that
currency increases.

As supply and demand for currencies

change, the values of those currencies
change. When the U.S. dollar is strong,
imports seem less expensive, leading to
increased demand for imported products and
the currency needed to purchase them.
In addition, when interest rates in another
nation are higher than those in the U.S.,
demand for the foreign currency rises, as
people buy the currency in order to invest in
the other nations securities.

 Simply put, increase in demand pushes the price

of the currency higher, so the currency appreciates
(rises in value).

When the demand for a foreign currency

increases, its international supply increases
proportionately. As the supply increases, the price
of the currency falls, causing it to depreciate (fall in
value).

When a countrys currency

appreciates it decreases
exports, because they
appear more expensive to
foreign consumers.
Therefore, a trade deficit
develops as the result of a
strong currency. The
opposite effects result
from a weak currency.
While importers prefer a
strong currency, exporters
prefer a weak currency.

In the cycle of international trade,

changes in relative incomes, inflation
rates, product prices, and interest rates
can affect the international value of
currencies. And at the same time, changes
in the international value of currencies can
affect the demand for products and
securities in the international marketplace.

INTEREST RATE
"The interest rate is the yearly price charged by a lender to a borrower
in order for the borrower to obtain a loan. This is usually expressed as
a percentage of the total amount loaned."

Interest rates are an everyday part of business. Companies pay

interest on money they borrow, and when they have extra cash,
they receive interest when they place that cash in a safe
investment. Companies also charge interest when their customers
buy goods and services on credit. A rise or fall in interest rates
affects these business activities as well as the buying habits of the
company's customers.

IMPACT OF HIGH INTEREST RATES

Interest rates are related to the amount of money
floating through the economic system, such as cash
in banks, cash loaned to consumers via credit cards,
car and home loans, cash paid by businesses to their
employees and cash that moves throughout the
business and investment sector.
When there is more buying demand relative to the
amount of cash in circulation, that cash is worth more.
Thus, banks charge a high rate of interest that
reflects its scarcity value.

Investors receive a high rate of interest, because the

financial system needs money to lend out, so financial
institutions are willing to pay high interest rates to
attract investor money.
High interest rates make it more expensive for
companies to borrow money to finance their
operations, payroll and purchases. High rates also
eventually discourage consumers from buying
because of the expense involved, which chokes off
economic activity.

LOW INTEREST RATES

Low interest rates represent the presence of plenty of money in the
system.
When banks have a lot of cash on hand, they are anxious to lend it
out, so they lower the interest rate they charge on loans.
Low interest rates are also reflected in the price of goods and
services, because low rates make the financing of operations,
manufacture and distribution less expensive for companies.
Low interest rates also drive investment into the stock market by
investors seeking higher returns on their money than is available in
bank certificates of deposit and bonds.

Companies watch the cycles in interest rates just like

consumers watch for sales in stores. Companies plan for
expansion during periods of low interest rates, because
the expense of that expansion is lower than during highinterest rate periods.

When companies expand, they put money into the consumer

sector and results in an increase in consumer purchases. As a
result, companies raise prices, make more profits and produce
more goods and services to meet growing consumer demand.
The increase in business activity and prices gradually increases
interest rates as the demand for money increases its value.
Eventually, this trend in rising prices and rising interest rates
prompts the Central Bank to remove money from the system and
raise interest rates so borrowing becomes too expensive, which
eventually drives the economy into recession again.

Low interest rates boost sales for

U.S. auto industry

Ford Motor Co. probably boosted sales of its cars

and light trucks more than any major automaker in
February, with an increase of 9.8 percent, the
average of 11 estimates. GM probably sold 4.9
percent more vehicles than a year earlier, the
average of 11 estimates.

Whenever the interest rate rises, return on

investment increases to investors both for private
and public investors. When interest rate raises the
country currency appreciates. The main reason
behind this appreciation is that more and more
people come inside the county and invest more and
more.
This inflow of investors increases the demand for
the recipient country and the supply of the foreign
currencies increase as compared to that of the home
currency. The demand pressure will appreciate the
home currency.

When there is a surplus balance in the

current account the home currency
appreciates while in case of the deficit in the
current
account the home currency
depreciates.

INFLATION
Inflation is a sustained increase in the general price level
of goods and services in an economy over a period of
time. When the general price level rises, each unit of
currency buys fewer goods and services.

CAUSES OF INFLATION

Increases in Money supply

Expansion of Bank Credit
Deficit Financing
Black Money
Scarcity
Taxes
Population Growth

High rates of inflation often discourage investment and lead to lower

long term growth for the following reasons:
High and volatile inflation creates uncertainty and confusion about
future prices and costs, this tends to reduce investment and lead to
lower rates of growth in the economy, and therefore less demand for
goods.
. When inflation is high, prices need to be changed more frequently,
which incurs a cost. Also high rates of inflation may incur frequent
wage negotiations with trades unions who will be trying to maintain
their real wages; this can be costly for a manufacturing firm.
High inflationary growth is often unsustainable. To reduce inflation
often requires painful readjustment such as higher interest rates and
deflationary fiscal policy; these lead to lower growth. Therefore
countries with high inflation may be susceptible to a recession in the
near future.

Less competitive. High inflation means rising costs and

this will make the countrys exports less competitive
compared to the rest of the world.
Less confidence. People are suspicious of countrys
with high rates of inflation, it discourages inward
investment and creates lower growth.
Inflation is considered to be a serious problem at over
10%. Anything over 100% could lead to hyper inflation
and serious destabilization.
Inflation between 2-4% would be considered a good
target.

EXAMPLE

Rising food commodity prices are passed on from

the wholesale food industry to retailers, which
must then bear the burden. Kelloggs has faced
higher grain prices. In response, the company
announced that it will raise its cereal prices 3% to
4%.

When the inflation rate of a country

increases the currency depreciates. Because
inflation is inversely related to that of the
value of currency.

Inflation does not only erode the value of

money, it also affects the value of a currency
relative to other currencies. Therefore
inflation is particularly important for
companies who pursue an export-led growth
model. This is where a company gains the
majority of its revenue from selling abroad.

EFFECTS OF INFLATION

Increase in production and investment: Inflation motivates

producers increase production as their goods or services will earn
more profits (law of supply).
Greater inequality of income: Poor people more adversely
affected by inflation. Inflation widens the gap between rich and poor.
Balance of trade: Inflation will cause the prices of the goods and
services to go up. It will make the countrys exports less competitive
in the international market and have a negative effect on the balance
of trade.
Exchange rate: High rate of inflation will affect the external value of
money or the exchange rate of the country. Other countries will find
the currency more expensive and hence there will be less demand
for it and the value of currency will fall.

Delta Airlines recently warned that increased

fuel costs due to the rise in oil prices could hurt
its earnings for the balance of the year.
Companies such as American Airlines , United,
Continental, U.S. Airways , and Delta have
increased the prices of most round-trip tickets
to domestic destinations by $4 to $10

Due to the soaring price of steel, producers of

appliances are having to find new ways to make up
costs. Whirlpool, which markets products under the
brands Maytag and KitchenAid, has cut jobs, shut
down plants, and moved manufacturing out of the
United States.

IMPACT OF INFLATION

When inflation in a country is more than that

in a competitive country, the exports from
former country will be less attractive
compared to the other country. This means
there will be less sales for that countrys
goods both at home and abroad and that will
create a larger trade deficit. At the same time,
high inflation in a country weakens its
competitive position in the international
market.

The interest rates, inflation rate, current account,

real interest rate and gross domestic products
have important role in the exchange rate
fluctuations. However, Inflation rate is that factor
which influences the exchange rate fluctuation
the most. When companies conduct business
internationally,
they
must
keep
into
consideration the importance as well as the
impact of the discussed variables i.e. the foreign
exchange, interest rate and inflation