InstructorManualtoMikePeng&KlausMeyer(2011):InternationalBusiness,CengageLearning.
Instructor Manual
Chapter 7: Exchange Rates
to accompany Mike Peng & Klaus Meyer: International Business, Cengage Learning
Prepared by Klaus Meyer
version February 2011
Introduction to the Topic
Learning Objectives
1. understand the determinants of exchange rates
2. track the evolution of the international monetary system
General Teaching Suggestions
Many students (at least in Europe) underestimate the volatility of exchange rates. They seem
to be very stable, and unless students have personal experiences of winning or losing money
through exchange rate moves, they may not appreciate the extent of exchange rate risk. My
suggestion thus is to start the class with the two Figures on page 202 – or a similar graph for
currencies relevant to your students (which can be generated on the FT website, for example).
From there, move the question of taking out a foreign currency mortgage (opening case) and
then into the substance of concepts and theories surrounding exchange rates.
Opening Case Discussion Guide
The opening case links issues of exchange rate dynamics to a sphere of life that students may
be familiar with. While they are unlikely to have mortgages themselves, their parents often
InstructorManualtoMikePeng&KlausMeyer(2011):InternationalBusiness,CengageLearning.
would. The case shows that different East European countries – despite many similarities –
experienced the 2008 crisis very differently. To motivate the case, the instructor may ask,
Chapter Outline, Section by Section
Section 1: Markets for Currencies
Key Ideas
This section introduces lot of concepts and theoretical explanations of exchange rates
movements that are very important to anyone engaging even in simple transactions abroad –
such as a tourist trip. Students who have taken an international economics or finance course
may be familiar with the concepts and theories. If this is not the case, instructors should go
through this material very carefully.
Key Concepts
exchange rate
The price of one currency in another currency.
appreciation (of a currency)
An increase in the value of a currency
InstructorManualtoMikePeng&KlausMeyer(2011):InternationalBusiness,CengageLearning.
Hypothesis suggesting that changes in exchange rates will be proportional to differences in inflation
rates
Spot market rate
The exchange rate for immediate payment
forward transaction
A currency exchange transaction in which participants buy and sell currencies now for future delivery,
typically in 30, 90, or 180 days, after the date of the transaction.
Forward exchange rate
The exchange rate for forward transactions
financial account (of the BoP)
sales and purchases of financial assets
bandwagon effect
The result of investors moving as a herd in the same direction at the same time.
Section 2: Institutions of the International Monetary System
Key Ideas
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Exchange rate regimes – or the institutions governing exchange rate markets – are essential to
understand the actual movements of exchange rates, and of the nature of exchange rate risks.
Key Concepts
gold standard
A system in which the value of most major currencies was maintained by fixing their prices in terms of
gold, which served as the common denominator.
World Bank
International organization that provides loans for specific projects in developing countries
post–Bretton Woods system
A system of flexible exchange rate regimes with no official common denominator.
floating (or flexible) exchange rate policy
The willingness of a government to let the demand and supply conditions determine exchange rates.
free float
A pure market solution to determine exchange rates.
fixed exchange rate
an exchange rate of a currency relative to other currencies.
InstructorManualtoMikePeng&KlausMeyer(2011):InternationalBusiness,CengageLearning.
Section 3: Managing Exchange Risks
Key Ideas
This section takes a managerial perspective on exchange rate management. What can
companies do to handle exchange rates? We distinguish financial and strategic approaches: It
may not be necessary to engage in complex financial transactions to reduce exchange risk
exposure!
Key Concepts
exchange rate risk (or currency risk)
The risk of financial losses because of unexpected changes in exchange rates
forward discount
A condition under which the forward rate of one currency relative to another currency is higher than
the spot rate.
forward premium
A condition under which the forward rate of one currency relative to another currency is lower than the
spot rate.
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offer rate
The price offered to sell a currency.
bid rate
The price offered to buy a currency.
Section 4: Debates and Extensions
Key Ideas
The first debate concerns the macro-economic discussion regarding the US$/Yuan exchange
rate that keeps re-emerging in various disguises. (Teaching Idea: I found a funny video on
counter party risk
the risk of a business partner not being able to fulfil a contract
Section 5: Implications for Practice
Key Ideas
The main message here is that exchange rate risks affect most businesses, and there for the
workings of exchange rates and the causes of risks thus emerging are important to understand
for any manager.
Review Questions
InstructorManualtoMikePeng&KlausMeyer(2011):InternationalBusiness,CengageLearning.
Review questions are provided to students on the website accompanying the book. They
directly ask to summarize the material provided in the text. Instructors may also use the
questions to structure their lectures or review sessions.
Review Questions
(as provided to students on the website)
Material in the Book
1. Why did Polish, Hungarian, Latvian and Slovakian
homeowners with mortgages have very different
experiences during the currency turmoil in the
currency markets in 2008?
6. How do different items in the balance of payment
affect the demand for a country’s currency?
7. How did the ‘Bretton Woods’ system of exchange
rates work after 1945?
8. Why did the ‘Bretton Woods’ system of exchange
rates brake down in the 1970s?
11. How does a currency board work?
12. How can companies organize their operations in
ways that minimize the exchange rate risk they face?
13. How can firms financial market instruments to
minimize the exchange rate risk they face?
Page 200-02
Page 206-07
Page 209-10
Page 210-11
In Focus 7.1
Page 213-14
Page 214-17
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used at a basis for in-class discussions, group work, or individual assignments. Below,
provide some indicative answers of issues that may be raised in response to these questions.
Discussion Questions
(as provided in the book)
Indicative Responses
1. Identify the currencies of the top-three
trading partners of your country in the
2. Should China revalue the yuan against
the dollar? If so, what impact may this
have on (1) US balance of payments, (2)
Chinese balance of payments, (3)
relative competitiveness of Mexico and
Thailand, (4) European firms importing
from China, and (5) European retail
consumers?
4. The English Premierleague earns £250
million annually arises from
broadcasting contracts abroad, of which
16% arise from Southeast Asia.
Contracts are usually signed for three
year periods after a competitive tender.
As manager of a television company in
South East Asia, you want a share of the
1. This is a question in which the answer
is not as important as the thought
with the windshield painted black and
trying to predict what lies ahead in the
road by looking only in the rear view
mirror.
2. A revaluation will shift the relative
prices of firms having their cost base in
different currencies – taking into
consideration which currencies are tied
take on such exchange rate risks
without approval from top
management. You may want to give
your students a more diplomatic
answer and suggest a two year hedge
(with the costs being deducted from the
sales managers’ salary).
4. This real life situation challenges
InstructorManualtoMikePeng&KlausMeyer(2011):InternationalBusiness,CengageLearning.
Closing Case
The closing case provides further opportunities to apply ideas and concepts learned in this
chapter in a real world setting. The Closing Case for this Chapter is “Markel corporations
fights currency fluctuations” and focuses on exchange risks faced by an exporting company.
Below are some indicative responses to the case discussion questions.
Case Discussion Questions
(as provided in the book)
Indicative Responses
1. Some argue that given the
complexity and
unpredictability, currency
hedging is not worth it. Is
1. It is important that students correctly explain
what financial hedging can and cannot
achieve. It seems from the case that the
CFOs personal view on the expected
Further Learning Activities
In addition to the cases and discussion questions provided in the book, instructors may want
to use any of the following activities to further engage students with the material.
1. Based in the United States, your firm trades extensively in European countries that
have adopted the euro. You have been asked to evaluate the impact of currency
fluctuations on sales in this region over the past month. The first step in this process is
to develop an exchange rate table for daily exchange rates over the past month
between the U.S. dollar and the euro. Once this has been accomplished, what general
trends do you notice? How could these trends impact your firm’s sales in countries
that use the euro?
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the Euro, analysis can take place. Generally, as the USD reduces in value versus the
Euro, goods and services from the United States are less expensive. As a result, this
2. Your company is examining possible market opportunities in the Asia Pacific region.
As a part of this possible strategic shift, the benchmark currencies of the region must be
identified to diversify currency risk for future operations. Using a resource that examines
foreign exchange, determine which predominant currencies are likely candidates for your
analysis.
One resource which can be used is “Bloomberg Online: Foreign Exchange”. This
website can be found by entering the search term “foreign exchange” at the
Further Readings
At the end the chapter, suggested further readings are provided. The primary aim is to
provide students a starting point for further work, for example when preparing a class
assignment or dissertation. These references also are recommended for instructors not
familiar with the topic and wishing to ‘get ahead of the students’ before lecturing on a topic.
S. Y. Cross, 1998, The Foreign Exchange Market in the United States, New York: Federal Reserve Bank of
New York – a clear exposition of the institutions and practice in currency markets.
InstructorManualtoMikePeng&KlausMeyer(2011):InternationalBusiness,CengageLearning.