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Multinational Financial Management Alan Shapiro 9 th Edition J.Wiley & Sons

Multinational Financial Management Alan Shapiro 9 th Edition J.Wiley & Sons. Power Points by Joseph F. Greco, Ph.D. California State University, Fullerton. The International Monetary System. CHAPTER 3. ALTERNATIVE EXCHANGE RATE SYSTEMS. I. FIVE MARKET MECHANISMS

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Multinational Financial Management Alan Shapiro 9 th Edition J.Wiley & Sons

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  1. Multinational Financial Management Alan Shapiro9th Edition J.Wiley & Sons Power Points by Joseph F. Greco, Ph.D. California State University, Fullerton

  2. The International Monetary System CHAPTER 3

  3. ALTERNATIVE EXCHANGE RATE SYSTEMS • I. FIVE MARKET MECHANISMS • A. Freely Floating (Clean Float) • 1. Market forces of supply and demand determine rates. • 2. Forces influenced by • a. price levels • b. interest rates • c. economic growth • 3. Rates fluctuate over time randomly.

  4. ALTERNATIVE EXCHANGE RATE SYSTEMS • B. Managed Float (Dirty Float) • 1. Market forces set rates unless excess volatility occurs, • 2. Then, central bank determines rate.

  5. ALTERNATIVE EXCHANGE RATE SYSTEMS • C. Target-Zone Arrangement • 1. Rate Determination • a. Market forces constrained to upper and lower range of rates. • b. Members to the arrangement adjust their national economic policies to maintain target.

  6. ALTERNATIVE EXCHANGE RATE SYSTEMS • D. Fixed Rate System • 1. Rate determination • a. Government maintains target rates. • b. If rates threatened, central banks buy/sell currency. • c. Monetary policies coordinated.

  7. ALTERNATIVE EXCHANGE RATE SYSTEMS • D. Fixed Rate System (con’t) • 2. Some Government Controls: • a. On global portfolio investments. • b. Ceilings on direct foreign direct insurance. • c. Import restrictions.

  8. ALTERNATIVE EXCHANGE RATE SYSTEMS • E. Current System • 1. A hybrid system • a. Major currencies: • use freely-floating method • b. Others move in and out • of various fixed-rate systems

  9. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • I. THE USE OF GOLD • A. Desirable properties • B. In short run: High production costs limit short- run changes. • C. In long run: Commodity money insures stability.

  10. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • II. The Classical Gold Standard (1821-1914) • A. Major currencies on gold standard. • 1. Involved commitment by nations to fix the price of domestic currency in terms of a specific amount of gold.

  11. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • 2. Maintenance involved the buying and selling of gold at that price. • 3. Disturbances in Price Levels: • Would be offset by the price- specie*-flow mechanism. • * specie refers to gold coins

  12. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • a. Price-specie-flow mechanism • had automatic adjustments: • 1.) When a balance of payments surplus led to a gold inflow; • 2.) Gold inflow led to higher prices which reduced surplus; • 3.) Gold outflow led to lower prices and increased surplus.

  13. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • III. The Gold Exchange Standard (1925-1931) • A. Only U.S. and Britain allowed to hold gold reserves. • B. Others could hold both gold, dollarsor pound reserves.

  14. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • C. Currencies devalued in 1931 • - led to trade wars. • D. Bretton Woods Conference • - called in order to avoid future protectionist and destructive economic policies

  15. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • IV. The Bretton Woods System (1946-71) • A. The Bretton Woods Agreement • 1. U.S.$ was key currency; • valued at $1 = 1/35 oz. of gold. • 2. All currencies linked to that price in a fixed rate system. • 3. Exchange rates allowed to fluctuate by 1% above or below initially set rates.

  16. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • B. Collapse, 1971 • 1. Causes: • a. U.S. high inflation rate • b. U.S.$ depreciated sharply.

  17. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM V. Post-Bretton Woods System (1971-Present) • A. Smithsonian Agreement, 1971 • US$ devalued to 1/38 oz. of gold. • By 1973: World on a freely floating exchange rate system.

  18. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • B. OPEC and the Oil Crisis (1973-1974) • 1. OPEC raised oil prices four fold; • 2. Exchange rate turmoil resulted; • 3. Caused OPEC nations to earn • large surplus B-O-P. • 4. Surpluses recycled to debtor nations which set up debt crisis of 1980’s.

  19. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • C. Dollar Crisis (1977-78) • 1. U.S. B-O-P difficulties • 2. Result of inconsistent monetary policy in U.S. • 3. Dollar value falls as confidence shrinks.

  20. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • D. The Rising Dollar (1980-85) • 1. U.S. inflation subsides as the Fed raises interest rates • 2. Rising rates attracts global capital to U.S. • 3. Result: Dollar value rises.

  21. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • E. The Sinking Dollar (1985-87) • 1. Dollar revaluated slowly downward; • 2. Plaza Agreement (1985) • G-5 agree to depress US$ further. • 3. The Louvre Agreement (1987) • G-7agree to support the falling US$.

  22. A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM • F. Recent History (1988-Present) • 1. 1988 US$ stabilized • 2. Post-1991 Confidence resulted in stronger dollar • 3. 1993-1995 Dollar value falls

  23. THE EUROPEAN MONETARY SYSTEM • I. INTRODUCTION • A. The European Monetary System (EMS) • 1. A target-zone method (1979) • 2. Close macroeconomic policy • coordination required.

  24. THE EUROPEAN MONETARY SYSTEM • B. EMS Objective: • to provide exchange rate stability to all members by holding exchange rates within specified limits.

  25. THE EUROPEAN MONETARY SYSTEM • C. European Currency Unit (ECU) • a “cocktail” of European currencies with specified weights as the unit of account. • 1. Exchange rate mechanism (ERM) • each member determines mutually agreed upon central cross-rate for its currency.

  26. THE EUROPEAN MONETARY SYSTEM • 2. Member Pledge: • to keep within 15% margin above or below the central rate. • D. EMS ups and downs • 1. Foreign exchange interventions failed due to lack of support by coordinated monetary policies.

  27. THE EUROPEAN MONETARY SYSTEM • 2. Currency Crisis of Sept. 1992 • a. System breaks down • b. Britain and Italy forced to withdraw from EMS • E. Failure of the EMS • members allowed political priorities • to dominate exchange rate policies

  28. THE EUROPEAN MONETARY SYSTEM • F. Maastricht Treaty • 1. Called for Monetary Union by 1999 (moved to 2002) • 2. Established a single currency: the euro • 3. Calls for creation of a single central EU bank • 4. Adopts tough fiscal standards

  29. THE EUROPEAN MONETARY SYSTEM • I. Costs / Benefits of A Single Currency • A. Benefits • 1. Reduces cost of doing business • 2. Reduces exchange rate risk • B. Costs • 1. Lack of national monetary flexibility.

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