Currency and Exchange Rate

• more than 170 currencies are in use around the world
• when buying a product or service from a Mexican supplier you must convert your own currency to pesos to pay the supplier
• dollarization: countries that have adopted the US dollar as their currency. examples include Ecuador, Panama, and East Timor
• exchange rate: price of one currency exxpressed in terms of another; varies over time
• most common exchange rates are EUR/USD, USD/JPY, and GBP/USD
• the forex market is the over the counter global marketplace that determines exchange rate of currencies around the world
• currencies appreciate (go up in value) and depreciate (go down in value) relative to other currencies
• currency risk: potential harm that can arise from changes in price of one currency relative to another
• currency risk is also known as financial risk
• if you buy from a supplier whose currency is appreciating against yours, you may need to pay more of your currency to complete the purchase
• if you receive from a buyer whose currency is depreciating against yours, you may receive a smaller amount of your currency
• managers must keep in mind 3 facts related to fluctuating exchange rates:

  1. prices firm charges can be quoted in either currency
  2. fluctuations during time between placement and delivery can cost or earn firm money
  3. firm and customers can use exchange rate as it stands on date of transaction or agree to a specific exchange rate
• convertible currency: easily exchanged for other currencies
• most easily convertible currencies are called hard currencies and include the British pound, European euro, Japanese yen, and US dollar
• nations prefer to hold hard currencies as reserves because of their relative strength and stability
• nonconvertible currency: not acceptable for international transactions; some countries do this to preserve supply of hard currencies to avoid problem of capital flight
• capital flight: rapid sell off by residents or foreigners of holdings in a nation's currency or other assets
• capital flight usually occurs in response to a domestic crisis that causes them to lose confidence in the country's economy
• capital flight from a country diminishes its ability to service debt and pay for imports
• cryptocurrency: electronic units of exchange that use secure digital code to facilitate buying, selling, and other transactions
• the most well known cryptocurrency is bitcoin
• cryptocurrencies are supported through blockchain technology
• blockchain: unlimited list of digital, highly secure records called blocks that comprise an electronic ledger of account activity
• it is unclear whether cryptocurrencies will emerge as an alternative to money or become widely used in international business
• foreign exchange market: global marketplace for buying and selling national currencies
• foreign exchange market has no fixed location
• foreign exchange market trading occurs through continuous buying and selling among banks, currency traders, governments, and others
• international business would be impossible without foreign exchange and the foreign exchange market
• foreign exchange market is the largest financial market in the world, even larger than the stock market
• foreign exchange: all forms of money that are traded internationally, including foreign currencies, bank deposits, checks, and electronic transfers
• today, 19 member states of the European Union have adopted the euro as their common currency
• when a firm protects itself against foreign exchange risk, it is called hedging
• governments attempt to manage exchange rates by buying and selling hard currencies and by keeping inflation under control
• when a government wants to strengthen its currency, it may buy its own currency using hard currencies, increasing demand leading to appreciation. conversely, if a government wants to weaken its currency, it may sell its own currency in exchange for hard currencies
• in 2014, the European euro was trading at 0.784 euros to the US dollar. by 2016, the US dollar was buying 0.940 euros - the euro's value went down relative to the dollar by 20%
• in 2014, an American could obtain one euro for 1.27 dollars - by 2016 the same euro could be bought for 1.06 dollars
• European firms had increase in exports because European products became less expensive, meanwhile the euro buying power for dollars decreased, leading to a decline in US exports to Europe
• the French franc is one of the European currencies taken out of circulation and replaced by the euro
• the exchange rate is determined by supply and demand
• exchange rates fluctuate constantly because the global market for most major currencies is free and active