Multinational financial management 7th CH03

Multinational Financial Management Alan Shapiro Edition th J.Wiley & Sons Power Points by Joseph F Greco, Ph.D California State University, Fullerton CHAPTER THE INTERNATIONAL MONETARY SYSTEM CHAPTER OVERVIEW I ALTERNATIVE EXCHANGE RATE SYSTEMS II A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYTEM III THE EUROPEAN MONETARY SYSTEM AND MONETARY UNION IV EMERGING MARKET CURRENCY CRISES PART I ALTERNATIVE EXCHANGE RATE SYSTEMS I FIVE MARKET MECHANISMS A Freely Floating (“Clean Float”) Market forces of supply and demand determine rates ALTERNATIVE EXCHANGE RATE SYSTEMS Forces influenced by a price levels b c interest rates economic growth Rates fluctuate randomly over time ALTERNATIVE EXCHANGE RATE SYSTEMS B Managed Float (“Dirty Float”) Market forces set rates unless excess volatility occurs Then, central bank determines rate ALTERNATIVE EXCHANGE RATE SYSTEMS C Target-Zone Arrangement 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 ALTERNATIVE EXCHANGE RATE SYSTEMS D Fixed Rate System Rate determination a Government maintains target rates b If rates threatened, central banks buy/sell currency c Monetary policies coordinated ALTERNATIVE EXCHANGE RATE SYSTEMS E Current System freelyand rate A hybrid system a Major currencies: use floating method b Other currencies move in out of various fixedsystems PART II A BRIEF HISTORY OF THE INTERNATIONAL MONETARY SYSTEM I THE USE OF GOLD A Desirable properties B In short run: High production costs limit changes C In long run: Commodity money insures stability 10 PART III THE EUROPEAN MONETARY SYSTEM I INTRODUCTION A The European Monetary System (EMS) A target-zone method (1979) 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 26 THE EUROPEAN MONETARY SYSTEM Exchange rate mechanism (ERM) - each member determines mutually agreed upon central cross rate for currency 27 its THE EUROPEAN MONETARY SYSTEM Member Pledge: to keep within 15% margin above or below the central rate 28 THE EUROPEAN MONETARY SYSTEM D EMS ups and downs Foreign exchange interventions: failed due to lack of support by coordinated monetary policies 29 THE EUROPEAN MONETARY SYSTEM Currency Crisis of Sept 1992 a System broke down b Britain and Italy forced towithdraw from EMS 30 THE EUROPEAN MONETARY SYSTEM G Failure of the EMS: members allowed political priorities to dominate exchange rate policies 31 THE EUROPEAN MONETARY SYSTEM H Maastricht Treaty Called for Monetary Union by 1999 (moved to 2002) Established a single currency: the euro 32 THE EUROPEAN MONETARY SYSTEM Calls for creation of a single central EU bank Adopts tough fiscal standards 33 THE EUROPEAN MONETARY SYSTEM I Costs / Benefits of A Single Currency A Benefits Reduces cost of doing business Reduces exchange rate risk 34 THE EUROPEAN MONETARY SYSTEM B Costs Lack of national monetary flexibility 35 PART IV EMERGING MARKET CURRENCY CRISES I Transmission Mechanisms A Trade links contagion spreads through trade B Financial System -more important transmission mechanism -investors sell off to make up for losses 36 EMERGING MARKET CURRENCY CRISES II Origins of Emerging Market Crises A Moral hazard B Fundamental Policy Conflict 37 EMERGING MARKET CURRENCY CRISES III Policy Proposals for Dealing with Emerging Market Crises A Currency Controls B Freely Floating Currency C Permanently Fixed Exchange Rate 38