🖇️Principles of International Business Unit 5 – Global Monetary Systems & Forex Markets

Key Concepts & Terminology

• Foreign exchange market (forex) enables currency conversion, cross-border trade, and investment
• Exchange rate represents the value of one currency in terms of another (USD/EUR)
• Spot rate is the current exchange rate for immediate delivery
• Forward rate is the agreed-upon exchange rate for a future date
• Currency appreciation occurs when a currency gains value relative to another
• Currency depreciation happens when a currency loses value relative to another
• Hedging strategies help mitigate foreign exchange risk exposure
• Currency arbitrage exploits price differences across markets for profit

Evolution of Global Monetary Systems

• Gold standard (1870-1914) linked currency values to gold, providing stability but limiting flexibility
• Bretton Woods system (1944-1971) established fixed exchange rates pegged to the US dollar
  • Created the International Monetary Fund (IMF) and World Bank
  • Collapsed due to US economic pressures and currency speculation
• Smithsonian Agreement (1971) allowed greater exchange rate flexibility, but ultimately failed
• Jamaica Agreement (1976) officially ended the Bretton Woods system, leading to floating exchange rates
• European Monetary System (1979) aimed to stabilize European currencies and paved the way for the euro
• Introduction of the euro (1999) created a common currency for participating European Union countries

Major Currency Markets & Exchange Rates

• Forex market is decentralized, operating 24 hours a day, five days a week
• Major trading centers include London, New York, Tokyo, and Singapore
• Most traded currencies are US dollar (USD), euro (EUR), Japanese yen (JPY), and British pound (GBP)
• Currency pairs are quoted as base currency/counter currency (EUR/USD)
  • Base currency is the first currency in the pair, counter currency is the second
• Bid price is the price at which a dealer is willing to buy a currency
• Ask price is the price at which a dealer is willing to sell a currency
• Spread is the difference between the bid and ask price, representing the dealer's profit

Factors Influencing Forex Markets

• Interest rates affect currency demand and value, with higher rates attracting investment
• Inflation erodes currency value, leading to depreciation
• Economic growth and stability boost currency demand and value
• Political stability and government policies impact investor confidence and currency value
  • Trade policies, regulations, and geopolitical events can influence exchange rates
• Balance of payments reflects a country's international transactions, affecting currency supply and demand
• Market speculation and investor sentiment can lead to short-term currency fluctuations
• Central bank interventions aim to stabilize or manipulate exchange rates

International Financial Institutions

• International Monetary Fund (IMF) promotes global monetary cooperation and financial stability
  • Provides loans to countries facing balance of payments difficulties
  • Conducts surveillance of member countries' economic policies
• World Bank focuses on poverty reduction and economic development in developing countries
  • Offers loans, grants, and technical assistance for infrastructure and social projects
• Bank for International Settlements (BIS) serves as a bank for central banks and fosters international monetary cooperation
• Regional development banks (Asian Development Bank, African Development Bank) support economic growth and development in specific regions

Exchange Rate Regimes & Policies

• Fixed exchange rate regime maintains a constant rate against another currency or a basket of currencies
  • Requires central bank intervention to maintain the peg
• Floating exchange rate regime allows the market to determine currency values based on supply and demand
  • Clean float has no central bank intervention, while a dirty float involves occasional intervention
• Managed float regime combines elements of fixed and floating rates, with central banks influencing exchange rates
• Currency board is a strict form of fixed exchange rate, backing the domestic currency with foreign reserves
• Dollarization occurs when a country adopts a foreign currency (often the US dollar) as its official currency

Forex Trading Strategies & Tools

• Technical analysis uses historical price and volume data to identify trends and predict future price movements
  • Employs charts, indicators (moving averages, relative strength index), and pattern recognition
• Fundamental analysis examines economic, political, and social factors to determine a currency's intrinsic value
  • Considers interest rates, GDP growth, inflation, and geopolitical events
• Sentiment analysis gauges market participants' emotions and opinions to predict currency movements
• Leverage allows traders to control larger positions with a smaller capital outlay, amplifying potential gains and losses
• Risk management tools (stop-loss orders, position sizing) help limit potential losses and preserve capital

Impact on International Business Operations

• Exchange rate fluctuations affect the value of international investments, trade, and financial transactions
  • Appreciation of a company's home currency can make exports less competitive and imports cheaper
  • Depreciation of a company's home currency can boost export competitiveness but increase import costs
• Translation exposure arises when consolidating financial statements from foreign subsidiaries into the home currency
• Transaction exposure occurs when a company has future cash flows denominated in a foreign currency
• Economic exposure refers to the impact of exchange rate changes on a company's long-term competitiveness
• Hedging strategies (forward contracts, options, swaps) help manage foreign exchange risk
• Invoicing in the home currency or a stable third currency can reduce transaction exposure