BUSI 605 Week 4 Group DB Forum 4 Example

Group Discussion Board Forum 4: The International Monetary System and Exchange Rates

BUSI 605 Environment of International Business, Group Discussion Board Forum 4 (thread and 2 replies)

Thread by [Student Name]

The forum question, the exporter and the two classmates' threads are composites standing in for the course's own; the research cited is real, and the requirements follow Liberty's public course guide for BUSI 605.

Thread

A Wisconsin manufacturer of packaging machinery earns 40% of its revenue from European customers, invoiced in euros, while nearly all of its costs are in dollars. That mismatch exposes the firm in three ways. On booked sales, the euro could slide between the order date and the payment date, which is transaction exposure. Economic exposure is the longer-term risk that a stronger dollar makes the firm's machines less competitive against German rivals. Translation exposure affects the reported value of any assets the firm holds in Europe.

Research suggests that hedging works when it is aimed at real exposure. In a sample of large American companies outside the financial sector, Allayannis and Ofek (2001) found that firms with more foreign sales had greater exposure to exchange rates and that the use of currency derivatives significantly reduced that exposure, indicating that firms used derivatives to hedge rather than to speculate. Bartram et al. (2010) helped explain why measured exposure for most firms is small: companies combine several tools, letting prices absorb part of each currency swing, locating some costs in the countries where they earn revenue, and adding financial hedges such as forwards and options.

No single tool removes currency risk; a sensible program layers several. For this manufacturer, I would recommend three layers. First, hedge confirmed euro receivables with forward contracts as soon as orders are booked, which removes transaction exposure at a known cost. Second, build an operational hedge over time by buying some components from European suppliers, so that part of the firm's costs move with its euro revenue. Third, for long-term economic exposure, consider whether some European customers would accept dollar pricing or whether price adjustment clauses can be added to multiyear contracts.

Reply to Grace

Grace, your thread argued that a return to fixed exchange rates would make international business easier, since firms would no longer need to forecast or hedge currency movements. I understand the appeal, especially after reading about the stability of the Bretton Woods years in this module. But the research suggests fixed rates move risk around more than they remove it.

Obstfeld and Rogoff (1995) argued that, in a world of mobile capital, fixed exchange rates are a mirage for most countries: very few countries maintained a fixed rate against another currency for long without a crisis, because defending a peg requires a central bank to subordinate other goals, such as fighting unemployment, to the exchange rate. When markets doubt that commitment, speculative attacks can force a sudden, large devaluation. For a business, a peg that holds for years and then breaks can be more damaging than a floating rate that moves gradually, because firms stop hedging when the rate seems stable.

Ilzetzki et al. (2019) add an important detail. Classifying countries by how their exchange rates actually behave rather than by what governments declare, they found that many countries that officially float manage their currencies closely, and that the U.S. dollar remains by far the most important anchor currency in the world, more so than the euro. So the world already has a good deal of informal fixing, mostly against the dollar.

For a firm, the practical lesson is to read a country's actual exchange rate behavior, not its official label, when assessing currency risk. Do you think the stability of a pegged rate is worth the risk of a sudden break?

Reply to Malik

Malik, your thread explained how a strong dollar makes American exports more expensive abroad and imports cheaper at home, and your example of a Texas cotton exporter losing sales to Brazil illustrated it well. Research on currency invoicing suggests the dollar's influence is even broader than that.

Gopinath et al. (2020) showed how concentrated trade pricing is: exporters in many countries quote their prices in dollars even when selling to buyers who use neither the dollar nor the seller's currency. Because export prices tend to be sticky in the currency in which they are invoiced, movements in the dollar change the prices that importers around the world pay. The authors found that when the dollar strengthens, trade among other countries declines, not only trade with the United States. They called this pattern the dominant currency paradigm.

For American firms, the dollar's role is partly an advantage, since many can invoice in their home currency and push currency risk onto foreign buyers. But it also means that a strong dollar can weaken demand from customers worldwide at the same time, as their own costs for dollar-priced inputs rise. For your cotton exporter, invoicing in dollars protects against currency losses on each sale but not against lost orders when Brazilian cotton, invoiced in dollars too, becomes relatively cheaper as the real weakens and Brazilian growers can cut their dollar prices. Do you think smaller exporters should be willing to invoice in customers' currencies to keep sales when the dollar is strong, even though that means taking on currency risk they would then need to hedge?

References

Allayannis, G., & Ofek, E. (2001). Exchange rate exposure, hedging, and the use of foreign currency derivatives. Journal of International Money and Finance, 20(2), 273-296. https://doi.org/10.1016/S0261-5606(00)00050-4

Bartram, S. M., Brown, G. W., & Minton, B. A. (2010). Resolving the exposure puzzle: The many facets of exchange rate exposure. Journal of Financial Economics, 95(2), 148-173. https://doi.org/10.1016/j.jfineco.2009.09.002

Gopinath, G., Boz, E., Casas, C., Díez, F. J., Gourinchas, P.-O., & Plagborg-Møller, M. (2020). Dominant currency paradigm. American Economic Review, 110(3), 677-719. https://doi.org/10.1257/aer.20171201

Ilzetzki, E., Reinhart, C. M., & Rogoff, K. S. (2019). Exchange arrangements entering the twenty-first century: Which anchor will hold? The Quarterly Journal of Economics, 134(2), 599-646. https://doi.org/10.1093/qje/qjy033

Obstfeld, M., & Rogoff, K. (1995). The mirage of fixed exchange rates. Journal of Economic Perspectives, 9(4), 73-96. https://doi.org/10.1257/jep.9.4.73