International Business, 2e
Geringer, McNett, Ball
Instructor Guide to Module 8
08-1
Module 8: The International Monetary System and
Financial Forces
YOUR CONTENT
Summary
Learning Objectives
Key Terms and Definitions
Content Outline
ENGAGEMENT & APPLICATION
Boxed Text Discussion Questions with Suggested Answers
End of Module Exercises
Critical Thinking Questions
globalEDGE Research Task
MiniCase
Bonus Activities
CONNECT TOOLS FOR ASSESSEMENT OF LEARNING
Connect Content Matrix
Connect Activities
International Business, 2e
Geringer, McNett, Ball
Instructor Guide to Module 8
08-2
YOUR CONTENT
SUMMARY
This chapter reviews the international monetary system, how it developed, today’s system,
exchange rate movements, the financial forces that governments can exert and with which
managers must contend, and the significance of balance of payments.
LEARNING OBJECTIVES
LO 8-1 Describe the international monetary system’s history.
LO 8-3 Describe the factors that influence exchange rate movement.
LO 8-5 Explain the significance of the balance of payments to international business
decisions.
KEY TERMS AND DEFINITIONS
arbitrage (p. 226)
The process of buying and selling instantaneously to
make profit with no risk
ask price (p. 225)
Lowest-priced sell order currently in the market
balance of payments (BOP) (p.
233)
Record of a country’s transactions with the rest of the
world
Bank for International
Settlements (BIS) (p. 222)
Institution for central bankers; operates to build
cooperation in order to foster monetary and financial
stability
bid price (p. 225)
Highest-priced buy order currently in the market
Bretton Woods system (p.
217)
The international monetary system in place from 1945
to 1971, with par value based on gold and the U.S.
dollar
efficient market approach (p.
228)
Assumption that current market prices fully reflect all
available relevant information
International Business, 2e
Geringer, McNett, Ball
Instructor Guide to Module 8
08-3
fiscal policies (p. 225)
Policies that address the collecting and spending of
money by the government
Fischer effect (p. 226)
The relationship between real and nominal interest
rates: The real interest rate will be the nominal interest
rate minus the expected rate of inflation
fixed exchange rate (p. 217)
Exchange rate regime in which the currency’s value is
tied to the value of another currency or gold
floating exchange rates (p.
219)
Exchange rates determined by supply and demand that
allow currency values to float against one another
forward currency market (p.
225)
Trading market for currency contracts deliverable 30,
60, 90, or 180 days in the future
forward rate (p. 225)
The exchange rate between two currencies for delivery
in the future, usually 30, 60, 90, or 180 days
fundamental approach (p.
228)
Exchange rate prediction based on econometric models
that attempt to capture the variables and their correct
relationships
gold standard (p. 216)
A monetary system that defines the value of its
currency in terms of a fixed amount of gold
international Fischer effect (p.
226)
Concept that the interest rate differentials for any two
currencies will reflect the expected change in their
exchange rates
intervention currency (p. 224)
A currency used by a country to intervene in the foreign
currency exchange markets
Jamaica Agreement (p. 219)
The 1976 IMF agreement establishing flexible exchange
rates among IMF members
law of one price (p. 226)
Concept that in an efficient market, like products will
have like prices
monetary policies (p. 225)
Government policies that control the amount of money
in circulation and its growth rate
par value (p. 217)
Stated value
International Business, 2e
Geringer, McNett, Ball
Instructor Guide to Module 8
08-4
purchasing power parity (PPP)
(p. 226)
The amount of adjustment that must be made in the
exchange rates for two currencies in order for them to
have equivalent purchasing power
random walk hypothesis (p.
228)
Assumption that the unpredictability of factors suggests
that the best predictor of tomorrow’s prices is today’s
prices
reciprocal currency (p. 224)
In FX, using the dollar as the base currency, a currency
that is quoted as dollars per unit of currency instead of
in units of currency per dollar
reserves (p. 217)
Assets held by nation’s central bank, used to back up
government liabilities
special drawing rights (SDR)
(p. 218)
An international reserve asset established by the IMF;
the unit of account for the IMF and other international
organizations
spot rate (p. 225)
The exchange rate between two currencies for delivery
within two business days
technical analysis (p. 228)
An approach that analyzes data for trends and then
projects these trends forward
Triffin paradox (p. 217)
A problem in which a national currency that is also a
reserve currency will eventually run a deficit, leading to
lack of confidence in the reserve currency and a
financial crisis
vehicle currency (p. 224)
A currency used as a vehicle for international trade or
investments
International Business, 2e
Geringer, McNett, Ball
Instructor Guide to Module 8
CONTENT OUTLINE
The following section provides the flow of information using the LEARNING OBJECTIVES as a
guide, KEY TERMS learners will need to take away from the course, and LECTURE NOTES to
drive home teaching points.
LO 8-1
Describe the international monetary system’s history.
• The International Monetary System: A Brief History
o The Gold Standard
o The Bretton Woods System
o The Central Reserve/National Currency
Conflict
Key Terms:
• gold standard
• Bretton Woods system
• fixed exchange rate
• par value
• reserves
• Triffin paradox
• special drawing rights
(SDRs)
The International Monetary System: A Brief History
A. The Gold Standard
Established in Britain 1717, Newton, from silver standard.
Simplicity is at core of its appeal.
Government does not have monetary flexibility.
B. The Bretton Woods System
Allies set up monetary systems at end of WWII, including IMF and World Bank.
Fixed rate exchange system, with gold-backed U.S. dollar as standard.
Supported trade growth into 1960s, but growing international trade required a more
flexible system.
Triffin paradox—U.S. deficit due to dollar’s use as reserve currency.
C. Central Reserve/National Currency Conflict
Reserve currency effects national currency, leading to deficit.
SDR a way to avoid this result.
International Business, 2e
Geringer, McNett, Ball
Instructor Guide to Module 8
o Current Currency Arrangements
o The Bank for International Settlements
• Bank for International
Settlements (BIS)
The Floating Currency Exchange Rate System
U.S. left the gold system in response to growing deficit.
Free floating system emerged (Jamaica Agreement).
A. Current Currency Arrangements
IMF recognizes 8 arrangements, vary in degree of flexibility.
Have no currency and use the currency of another nation.
Peg currency to value of another currency.
Manage a floating currency.
Maintain a freely floating currency.
B. The Bank for International Settlements
The BIS operates as intermediary.
Central bankers’ central bank.
LO 8-3
Describe the factors that influence exchange rate movement.
• Financial Forces: Fluctuating Currency Values
o Fluctuating Currency Values
o Why Foreign Currency Exchange Occurs
o Exchange Rate Quotations and the FX Market
o Causes of Exchange Rate Movement
o Exchange Rate Forecasting
Key Terms:
• vehicle currency
• intervention currency
• reciprocal currency
• spot rate
• forward currency
market
• forward rate
International Business, 2e
Geringer, McNett, Ball
Instructor Guide to Module 8
• international Fischer
effect
• purchasing power
parity (PPP)
• efficient market
approach
• random walk
hypothesis
• fundamental
approach
• technical analysis
Financial Forces: Fluctuating Currency Values
A. Fluctuating Currency Values
B. Why Foreign Currency Exchange Occurs
Buyers want to purchase in own currency, so sellers assume risk as part of their offering.
Risk of movement may be substantial, as freely floating currencies can shift considerably.
C. Exchange Rate Quotations and the FX Market
Reciprocal is a currency that is quoted as dollars per unit (using dollar as base currency) of
currency instead of in units of currency per dollar.
Forward rate is for a contract deliverable in a specified time in the future (30, 60, 90 days).
Bid is highest-priced buy order, while ask is lowest-priced sell order.
D. Causes of Exchange Rate Movement
understand exchange rate movement.
1. Interest rate parity: interest rates vary to take into account varying rates of
inflation, the Fischer effect.
2. International application: the interest rate differentials for any two currencies will
International Business, 2e
Geringer, McNett, Ball
Instructor Guide to Module 8
3. Purchasing Power Parity (PPP), an application of the law of one price: currency
exchange rates between two currencies should equal the ratio of the price levels of
their commodity baskets (The Economist’s Big Mac Index).
E. Exchange Rate Forecasting
Efficient market approach: assumption that current market prices reflect all available
information.
Random Walk Approach: assumption that the unpredictability of the factors that influence
exchange rates suggests that the best predictor of tomorrow’s prices are today’s prices.
Fundamental approach: prediction based on economic models that attempt to capture
the variables and their correct relationships.
a. Technical analysis: approach analyzes data and projects these trends forward.
LO 8-4
Discuss financial forces governments can exert.
• Financial Forces Governments Can Exert
o Currency Exchange Controls
o Taxation
o Inflation and Interest Rates
Key Terms:
Financial Forces Governments Can Exert
A. Currency Exchange Controls
Governments can control currency exchange of their currency and other currencies within
their borders.
Convertible and nonconvertible currencies.
Motivation is to manage foreign reserves.
With currency controls, exchange rates usually above open market rates.
B. Taxation—financial as well as legal force.
1. Income—direct tax on corporations and individual income.
2. Value-added—really a sales tax, and collected at each step of value added, then
credited back on earlier payments.
International Business, 2e
Geringer, McNett, Ball
Instructor Guide to Module 8
08-9
C. Inflation and Interest Rates
Inflation-sustained increase in prices.
Determines real cost of borrowing in capital markets.
Rising rates encourage borrowing.
Inflated currencies tend to weaken—interest rates rise with inflation.
LO 8-5
Explain the significance of the balance of payments to
international business decisions.
• Balance of Payments
o BOP Accounts
o Deficits and Surpluses in BOP Accounts
Key Terms:
• balance of payments
(BOP)
Balance of Payments
A record of a country’s transactions with the rest of the world.
What balance of payments shows:
Flows of capital in and out of country.
Demand for the currency, hence a comparison of imports (flows out) and exports
(flows in).
A. BOP Accounts
Three major accounts:
1. Current account tracks goods—tangibles, known as trade balance, services-
intangibles, unilateral transfers (gifts, aid, migrant worker earnings).
2. Capital account tracks financial assets and liabilities, direct investment, portfolio
investment, short-term capital flows (credit when resident sells stock to
nonresident).
exceeds outward flows (as in U.S.).
2. To give meaning to a deficit, you need to look at total picture.
International Business, 2e
Geringer, McNett, Ball
Instructor Guide to Module 8
08–10
ENGAGEMENT & APPLICATION
BOXED TEXT DISCUSSION QUESTIONS WITH SUGGESTED ANSWERS
IB IN PRACTICE: G7 Foreign Exchange Intervention
After the 2011 earthquake and tsunami that hit Japan, the yen strengthened considerably. That
seemed illogical, because you would expect a country facing a disaster of such huge proportions
1. With a natural disaster, why would we expect a country’s currency to weaken?
2. Why were the G7 so quick to intervene?
GLOBAL DEBATE: Fixed FX Rates, Perhaps Hooked to Gold, or Floating Rates, Hooked to Faith?
1. If the SDR were used, would a viable fixed-rate regime be possible or not?
2. Given the inclusion of the SDR, outline the pro and con arguments for a fixed-rate regime.
Pro
A fixed rate system in theory could use the SDR as its basis. This would impose monetary
International Business, 2e
Geringer, McNett, Ball
Instructor Guide to Module 8
Con
It is questionable whether any government in a fixed rate system could handle the massive
GET THAT JOB! FROM BACKPACK TO BRIEFCASE: Angela Schmitz: Develop Experience by
Traveling and Working Abroad
The box explores Angela Schmitz’s summer job in which she spent eight weeks working for
1. Angela Schmitz experienced meetings that were scheduled at noon, but did not start until
4:00 PM. If you were assigned to work for a company that sourced coffee beans from
Guatemala, how would you deal with these late starts for meetings with company employees
and suppliers in Guatemala?
2. Schmitz said that her experience in Guatemala helped her to get other internships and jobs.
What might an employer look for in a person that has had such an experience abroad?