Part 1 Global Financial Environment1

Project 1 International Monetary System1

Task 1 Overview of International Monetary System2

1.1History of the International Monetary System2

1.2The Creation of the Euro9

1.3Currency Turmoil and Crises Post-now10

Task 2 Contemporary Currency Regimes11

2.1IMF’s Exchange Rate Regime Classifications11

2.2Fixed Versus Flexible Exchange Rate12

2.3Distinction Between Fixed Exchange Rate and Flexible Exchange Rate14

2.4Emerging Markets and System Choices14

Task 3 European Monetary System16

3.1From the Treaty of Rome to the Werner Report, 1957—1970 16

3.2From the Werner Report to the European Monetary System��1970—1979 17

3.3From the start of EMS to Maastricht, 1979—1991 17

3.4From Maastricht to the Euro and the Euro Area, 1991—2002 17

3.5The Largest-ever Currency Changeover18

Task 4 Exchange Rate Regimes: What Lies Ahead?19

Mini Case20

The Revaluation of the Chinese Yuan20

Key Terms27

Summary29

Exercises31

Project 2 Balance of Payment Accounting34

Task 1 Balance of Payment Accounts34

1.1Definition of the Balance of Payment34

1.2The Importance of BOP36

1.3Fundamentals of Balance of Payment Accounting36

1.4Accounts of the Balance of Payment38

Task 2 Disequilibrium of Balance of Payment47

Task 3 Trade Balance and Exchange Rate49

3.1The Balance of Payment Interaction with Key Macroeconomic Variables49

3.2Trade Balance and Exchange Rate52

3.3Capital Mobility53

Mini Case55

Global Remittances55

Key Terms60

Summary62

Exercises63



Part 2 Foreign Exchange Markets67

Project 3 The Foreign Exchange Market67

Task 1 Function and Structure of the Foreign Exchange market68

1.1Geographical Extent of the Foreign Exchange Market68

1.2History of Foreign Exchange68

1.3Functions of the Foreign Exchange Market69

1.4Market Participants70

1.5Transactions in the Interbank Market72

1.6Size of the Market74

Task 2 Foreign Exchange Rates and Quotations76

2.1Currency Symbols76

2.2Interbank Quotations77

2.3Direct and Indirect Quotes78

2.4Bid and Ask Quotations79

2.5Forward Quotations in Percentage Terms80

2.6Cross Rates81

2.7Intermarket Arbitrage82

2.8Measuring a Change in Spot Exchange Rates84

Mini Case86

The Saga of the Venezuelan Bolivar Fuerte86

Key Terms90

Summary91

Exercises92

Project 4 Futures and Options on Foreign Exchange95

Task 1 Foreign Currency Futures95

1.1Contract Specifications96

1.2Currency Futures Markets97

1.3Using Foreign Currency Futures98

Task 2 Foreign Currency Options100

2.1Currency Options100

2.2Currency Options Markets102

2.3Currency Futures Options103

2.4Basic Option Pricing Relationships at Expiry104

2.5American Option Pricing Relationships107

2.6European Option Pricing Relationships109

Mini Case112

Warren Buffett’s Love-Hate Relationship with Derivatives112

Key Terms117

Summary118

Exercises119



Part 3 Foreign Exchange Exposure122

Project 5 Management of Transaction Exposure122

Task 1 Types of Foreign Exchange Exposure123

1.1Transaction Exposure123

1.2Translation Exposure123

1.3Operating Exposure123

Task 2 Hedge124

2.1Hedge Definition124

2.2Advantages and Disadvantages of Hedging124

Task 3 Ways of Hedging Transaction Exposure126

3.1Forward Market Hedge126

3.2Money Market Hedge129

3.3Options Market Hedge130

3.4Comparison of Alternatives132

Task 4 Should the Firm Hedge?134

Mini Case135

Banbury Impex��India��135

Key Terms141

Summary141

Exercises142

Project 6 Management of Operating Exposure145

Task 1 Operating Exposure��Definition145

1.1Attributes of Operating Exposure146

1.2Operating and Financing Cash Flows146

1.3Expected Versus Unexpected Changes in Cash Flow147

Task 2 Measuring Operating Exposure148

2.1Short Run149

2.2Medium Run��Equilibrium149

2.3Medium Run��Disequilibrium150

2.4Long Run150

Task 3 Management of Operating Exposure150

3.1Strategic Management of Operating Exposure150

3.2Proactive Management of Operating Exposure152

Mini Case156

Toyota’s European Operating Exposure156

Key Terms159

Summary160

Exercises160

Project 7 Management of Translation Exposure163

Task 1 Overview of Translation Exposure164

1.1Subsidiary Characterization165

1.2Functional Currency165

Task 2 Translation Methods166

2.1Current Rate Method166

2.2Temporal Method167

2.3U.S. Translation Procedures168

2.4Distinction Between the Foreign Exchange Exposures169

2.5Measurement of Translation Exposure170

Task 3 Managing Translation Exposure171

3.1Balance Sheet Hedge Defined171

3.2Balance Sheet Hedge Determination172

Mini Case173

LaJolla Engineering Services173

Key Terms178

Summary178

Exercises180



References184