CHAPTER 10 The Determination of Exchange Rates 1. The IMF's major objectives include _____. a. discouraging international monetary cooperation b. promoting exchange rate stability c. establishing a unilateral system of payments d. prohibiting expansion and balanced growth of international trade Answer: b. promoting exchange rate stability 2. Which of the following is one of the IMF's major objectives? a. to make its resources available to its members who are experiencing balance-of-payments difficulties b. to discourage exchange rate stability c. to interfere with international monetary cooperation d. to facilitate the contraction and unbalanced growth of international trade Answer: a. to make its resources available to its members who are experiencing balance-of-payments difficulties 3. In order to join the IMF, a country must contribute a certain sum of money, called a _____. a. special drawing right b. trade balance c. monetary reserve d. quota Answer: d. quota 4. Which of the following countries has the largest quota in the IMF? a. Japan b. Germany c. the United States d. the United Kingdom Answer: c. the United States 5. The SDR is _____. a. an international reserve asset created to supplement members' existing reserve assets b. the official currency of the World Bank c. a substitute for U.S. silver reserves d. equal to the average of the U.S. dollar and the euro Answer: a. an international reserve asset created to supplement members' existing reserve assets 6. SDRs serve as _____. a. the official currency for each central bank b. the IMF's unit of account c. a substitute for European gold reserves d. the primary reserve asset for each country Answer: b. the IMF's unit of account 7. The value of the SDR is based on _____. a. the U.S. dollar b. the euro c. a combination of the U.S. dollar, the euro, and the yen d. the weighted average of five currencies Answer: d. the weighted average of five currencies 8. The SDR _____. a. is based on the weighted average of the U.S. dollar and the euro b. is used only in the euro zone c. is used for IMF transactions and operations d. has taken over the role of gold as a primary reserve asset Answer: c. is used for IMF transactions and operations 9. A _____ currency is when countries lock the value of their currency onto another currency and allow the currency to vary by plus or minus 1 percent against that value. a. pegged b. crawling band c. free floating d. managed floating Answer: a. pegged 10. This type of exchange rate is adjusted periodically at a fixed pronounced rate or in response to changes in selective quantitative indicators. a. pegged b. free floating c. crawling band d. managed floating Answer: d. managed floating 11. _____ is a form of locking the value of a country's currency onto another currency. a. Anchoring b. Monetarization c. Dollarization d. Floating Answer: c. Dollarization 12. It is much easier to forecast a future exchange rate for a relatively _____ currency that is pegged to the U.S. dollar, such as the Hong Kong dollar, than for a currency that is _____, such as the Japanese yen. a. flexible; managed floating b. stable; freely floating c. stable; pegged to the dollar d. flexible; freely floating Answer: b. stable; freely floating 13. The _____ flexible a country's exchange rate arrangement, the _____ there will be a thriving black market. a. more; less b. more; more c. less; less d. a country's exchange rate arrangement has no impact on its black market Answer: a. more; less 14. A black market exists when _____. a. a country produces only black currency b. people are willing to pay more for dollars than the official rate c. a country is running a budget surplus d. a country is experiencing a recession Answer: b. people are willing to pay more for dollars than the official rate 15. In many countries that rigidly control their currencies, a black market parallels the _____ market and is aligned _____ closely with the forces of supply and demand than is the official market. a. official; less b. unofficial; more c. official; more d. unofficial; less Answer: c. official; more 16. The movement to floating rates _____ the need for a black market. a. increases b. lessens c. deepens d. eliminates Answer: d. eliminates 17. A central bank is responsible for _____. a. distributing money to foreign countries b. encouraging disorderly conditions in foreign exchange markets c. the policies affecting the value of its currency d. ignoring foreign exchange markets Answer: c. the policies affecting the value of its currency 18. The central bank in the United States is _____. a. the Federal Reserve b. the U.S. Treasury c. the Board of Governors d. the New York Board of Exchange Answer: a. the Federal Reserve 19. The Federal Reserve Bank of the New York _____. a. will never intervene in foreign exchange markets b. does not serve as fiscal agent for the United States c. acts as the primary contact with other foreign central banks d. holds approximately one-half of the world's known monetary gold reserves Answer: c. acts as the primary contact with other foreign central banks 20. If the Fed wants to counter upward pressure on the dollar, it will _____. a. buy dollars for foreign currency b. sell foreign currency for dollars c. do nothing—the Fed does not intervene in foreign-currency transactions d. sell dollars for foreign currency Answer: d. sell dollars for foreign currency 21. Central bank reserve assets are kept in which of the following forms: a. gold b. silver c. government bonds d. local currency only Answer: a. gold 22. The _____ is the most widely used currency as a reserve asset. a. euro b. Japanese yen c. U.S. dollar d. British pound Answer: c. U.S. dollar 23. In order to intervene in currency markets, a central bank _____. a. will enter the market passively to change attitudes about its views and policies b. may call for reassuring action to calm markets c. will always announce its policies d. never works with foreign central banks Answer: b. may call for reassuring action to calm markets 24. Intervention in currency markets has a _____ impact on the value of a currency. a. imperceptible b. lasting c. permanent d. temporary Answer: d. temporary 25. Currencies that float freely respond to _____. a. supply and demand conditions free from government intervention b. a government-determined exchange rate c. the black market d. a pegged exchange rate Answer: a. supply and demand conditions free from government intervention 26. In a two-country floating exchange rate model using the United States and Japan, the supply of yen is a function of _____. a. U.S. demand for Japanese goods and services b. Japanese demand for U.S. goods and services c. European demand for U.S. goods and services d. Japanese demand for Japanese goods and services Answer: b. Japanese demand for U.S. goods and services 27. The demand for yen is a function of _____. a. Japanese demand for U.S. goods and services. b. Japanese investment in U.S. factories. c. U.S. demand for Japanese goods and services. d. U.S. investment in Japanese factories located in the United States. Answer: c. U.S. demand for Japanese goods and services. 28. Currencies that respond to supply and demand conditions free from government intervention are known as _____. a. pegged regimes b. floating pegged regimes c. managed fixed rate regimes d. floating regimes Answer: d. floating regimes 29. In order to maintain a currency value in a managed fixed rate system, a central bank must hold foreign exchange _____. a. reserves b. goods c. rates d. bonds Answer: a. reserves 30. In a managed fixed rate regime, _____ determines the price of the currency. a. supply and demand b. the government c. a foreign central bank d. the consumer Answer: b. the government 31. Governments may use _____ to create a demand for their currency. a. open market transactions only b. monetary policy only c. fiscal policy only d. monetary and fiscal policy Answer: d. monetary and fiscal policy 32. If, in a managed fixed rate system, a central bank runs out of reserves or amasses too much foreign currency, it would be necessary to _____. a. remove the currency from the market b. print more foreign reserves c. change the exchange rate d. increase the interest rate Answer: c. change the exchange rate 33. If economic policies do not work, a country may be forced to _____. a. declare bankruptcy b. remove its currency from the open market c. revalue its currency d. print more foreign reserves Answer: c. revalue its currency 34. Formally changing the value of a currency is called _____. a. revaluation b. trading on the open market c. a fixed exchange rate d. economic expansion Answer: a. revaluation 35. A currency that is pegged to another currency is usually changed on a(n) _____ basis. a. informal b. formal c. supply-and-demand d. rational Answer: b. formal 36. Which of the following statements is true concerning intervention in currency markets? a. Intervention in currency markets never occurs. b. Countries work individually to manage their currencies. c. Intervention is the only way to determine the value of a currency. d. Often, a number of countries intervene in currency markets, sometimes in a coordinated way. Answer: d. Often, a number of countries intervene in currency markets, sometimes in a coordinated way. 37. The purchasing power parity theory claims that a change in relative _____ between two countries must cause a change in _____ in order to keep the prices of goods in two countries fairly similar. a. exchange rates; inflation b. inflation; exchange rates c. interest rates; inflation d. interest rates; exchange rates Answer: b. inflation; exchange rates 38. According to the PPP theory, if Japanese inflation were 2 percent and U.S. inflation were 3.5 percent, the dollar would be expected to _____ by the difference in inflation rates. a. fall b. rise c. not change d. reverse Answer: a. fall 39. The _____ theory seeks to define the relationship between currencies based on relative inflation. a. inflation growth rate b. revaluation c. purchasing power parity d. interest rate Answer: c. purchasing power parity 40. Most economists agree that PPP measures provide a _____ picture of the relative size of economies than market exchange rates. a. less realistic b. similar c. more understandable d. more realistic Answer: d. more realistic 41. Which of the following statements describes a limitation of the Big Mac Index? a. Profit margins vary by the strength of competition. b. The theory of PPP incorrectly assumes that there are barriers to trade and that transportation costs are infinite. c. The Big Mac represents all possible commodities and services. d. Taxes have no effect on Big Mac prices. Answer: a. Profit margins vary by the strength of competition. 42. The Big Mac Index is used _____. a. to rate which country has the best-tasting Big Mac b. to estimate the exchange rate between the dollar and another currency c. to estimate the difference in interest rates between two countries d. as one of the main tools McDonald's uses to rate its customer satisfaction Answer: b. to estimate the exchange rate between the dollar and another currency 43. According to purchasing power parity, if the domestic inflation rate is _____ than that in the foreign country, the domestic currency should be _____ than that of the foreign country. a. lower; weaker b. higher; weaker c. lower; stronger d. higher; stronger Answer: c. lower; stronger 44. PPP and the Big Mac Index would suggest that exchange rates should leave hamburgers costing _____ in the United States as(than) abroad. a. more b. less c. twice as much d. the same Answer: d. the same 45. The Fisher Effect _____. a. links inflation and interest rates b. links interest rates and exchange rates c. implies that the currency of the country with the lower interest rate will weaken in the future d. implies that the country with the higher interest rate should have lower inflation Answer: a. links inflation and interest rates 46. The International Fisher Effect _____. a. links interest rates and inflation b. implies that the currency of the country with the lower interest rate will weaken in the future c. implies that the country with the higher interest rate should have lower inflation d. links interest rates and exchange rates Answer: d. links interest rates and exchange rates 47. The International Fisher Effect implies that _____. a. the country with the higher interest rate should have lower inflation b. the currency of the country with the lower interest rate will strengthen in the future c. the currency of the country with the higher interest rate will strengthen in the future d. interest rates and inflation are not linked at all Answer: b. the currency of the country with the lower interest rate will strengthen in the future 48. Other key factors affecting exchange rate movements can include _____. a. confidence b. the weather c. the price of tea in China d. basic economic forces only Answer: a. confidence 49. _____ forecasting uses trends in economic variables to predict future rates. a. Fundamental b. Technical c. Application d. Economic Answer: a. Fundamental 50. When managers use past trends in exchange rate movements to spot future trends, this is called _____ forecasting. a. fundamental b. technical c. application d. economic Answer: b. technical 51. _____ forecasters, or chartists, assume that if current exchange rates reflect all facts in the market, then under similar circumstances, future rates will follow the same patterns. a. Economic b. Illusory c. Fundamental d. Technical Answer: d. Technical 52. A(n) _____ forecaster would use trends in economic variables to predict future exchange rates. a. application b. economic c. fundamental d. technical Answer: c. fundamental 53. Forecasting includes predicting the timing, direction, and _____ of an exchange rate change or movement. a. magnitude b. altitude c. depth d. length Answer: a. magnitude 54. Forecasters must predict the magnitude, direction, and _____ of an exchange rate change or movement. a. length b. timing c. altitude d. depth Answer: b. timing 55. Forecasting includes predicting the magnitude, timing, and _____ of an exchange rate change or movement. a. altitude b. depth c. length d. direction Answer: d. direction 56. When forecasting exchange rates, forecasters must predict the _____of the change or movement in exchange rates. a. timing, direction, and length b. direction, magnitude, and altitude c. magnitude, timing, and direction d. timing, magnitude, and depth Answer: c. magnitude, timing, and direction 57. Studying the foreign currency intervention practices of a country is an example of what type of factor? a. the institutional setting b. fundamental analysis c. cultural analysis d. technical analysis Answer: a. the institutional setting 58. Studying the cyclical nature of growth and employment as a part of the process to forecast exchange rates is an example of _____. a. the institutional setting b. fundamental analysis c. cultural analysis d. technical analysis Answer: b. fundamental analysis 59. In monitoring the fundamental analysis, which of the following factors should managers consider? a. possible under- or overvaluation of the currency b. regression factors c. debt policy of the MNE d. past trends in exchange rate policy Answer: a. possible under- or overvaluation of the currency 60. Examining market views and expectations of the political environment when forecasting exchange rate is an example of examining which types of factors? a. fundamental analysis b. cultural analysis c. confidence factors d. technical analysis Answer: c. confidence factors 61. How are marketers affected by exchange rate changes? a. Demand for domestic and imported products is not affected by exchange rate changes. b. Strengthening of a country's currency value could create problems for importers. c. Producers must decide whether to pass on higher prices to consumers. d. Marketers are not affected by exchange rate changes, so there is no need to predict them. Answer: c. Producers must decide whether to pass on higher prices to consumers. 62. Producers are affected by exchange rate changes because _____. a. They may decide to relocate production to a country with a stronger currency. b. If a manufacturing firm relocates to a country with a weak currency, it will be a good base for inexpensive importation. c. Goods manufactured in a country with a weak currency will be relatively cheap in world markets. d. A manufacturer with high operating expenses may relocate production to a company with a currency that is gaining value. Answer: c. Goods manufactured in a country with a weak currency will be relatively cheap in world markets. 63. Exchange rates can affect financial decisions in which of the following ways? a. A company might be tempted to borrow money in places where interest rates are highest. b. A company would want to convert local currency into its home country currency when exchange rates are most favorable. c. Exchange rate changes have no effect on the reporting of financial results d. Interest rate differentials are never compensated for in money markets through exchange rate changes. Answer: b. A company would want to convert local currency into its home country currency when exchange rates are most favorable. 64. Exchange rate changes affect which of the following business decisions? a. marketing, financial, and production b. financial decisions only c. production, marketing, and human resources d. production decisions only Answer: a. marketing, financial, and production 65. The IMF's only role is to identify exchange rate regimes. Answer: False 66. The IMF was established to promote exchange rate stability and facilitate the international flow of currencies. Answer: True 67. The SDR is equal in value to the U.S. dollar. Answer: False 68. The IMF's official unit of account is the SDR. Answer: True 69. Argentina's decision to peg its currency to the dollar is an example of dollarization. Answer: True 70. A free floating exchange rate is adjusted periodically at a fixed pronounced rate. Answer: False 71. Zimbabwe's informal foreign currency market where the Zimbabwe dollar is trading at a much higher rate than the official rate is an example of a black market. Answer: True 72. The movement to floating rates adds to the need for a black market. Answer: False 73. The Federal Reserve is responsible for intervening in foreign exchange markets to achieve dollar exchange rate policy objectives. Answer: True 74. Although central banks are responsible for foreign exchange policy, they have no power to intervene in exchange rate markets. Answer: False 75. Gold is the only form of assets that central banks hold. Answer: False 76. Intervention in currency markets has only a temporary impact on currency values. Answer: True 77. The U.S. exchange rate system is an example of a free floating exchange rate regime. Answer: True 78. Supply and demand for a currency are the main determinants of a currency's value in a floating regime. Answer: True 79. Fiscal policy is the only way to manage a country's currency in a managed fixed rate system. Answer: False 80. In a managed fixed rate regime, the currency's value is determined by the government. Answer: True 81. If economic policies fail to change the value of a currency, the government may elect to revalue its currency. Answer: True 82. A currency that is pegged to another currency is usually changed on a supply-and-demand basis. Answer: False 83. According to the purchasing power parity theory, a change in relative interest rates between two countries must cause a change in exchange rates. Answer: False 84. The purchasing power parity theory seeks to define the relationship between currencies based on relative inflation. Answer: True 85. The Big Mac Index suggests that exchange rates should leave hamburgers costing the same in the United States as abroad. Answer: True 86. The Big Mac Index perfectly explains the relative size of economies. Answer: False 87. Only interest rates affect exchange rates. Answer: False 88. The International Fisher Effect links interest rates and exchange rates. Answer: True 89. A fundamental forecaster would use trends in economic variables to predict future exchange rates. Answer: True 90. Fundamental forecasters assume that if current exchange rates reflect all facts in the market, then under similar circumstances, future rates will follow the same patterns. Answer: False 91. Forecasting predicts the timing, magnitude, and length of exchange rate movements. Answer: False 92. Although the direction of an exchange rate movement can probably be predicted for countries whose currencies are not freely floating, the timing is not as easy to predict. Answer: True 93. Market views and expectations are not important when trying to predict exchange rate movements. Answer: False 94. An under- or overvalued currency may influence movements in a currency's exchange rate. Answer: True 95. Only financial decisions are impacted by changes in the exchange rate. Answer: False 96. A company may want to relocate its production facilities in a country with a weak currency to take advantage of inexpensive exportation. Answer: True 97. What is the International Monetary Fund (IMF)? What are its objectives? Answer: In 1944, toward the close of World War II, the major allied governments met in Bretton Woods, New Hampshire, to determine what was needed to bring economic stability and growth to the postwar world. Twenty-nine countries initially signed the IMF agreement. There were 192 member countries at the end of 1999. The IMF's major objectives are: a. to promote international monetary cooperation b. to facilitate the expansion and balanced growth of international trade c. to promote exchange rate stability d. to establish a multilateral system of payments e. to make its resources available to its members experiencing balance of payment difficulties 98. What is a Special Drawing Right (SDR)? How is it used? Answer: The Special Drawing Right is an international reserve asset created to supplement members' existing reserve assets (official holdings of gold, foreign exchange, and reserve positions in the IMF). SDRs serve as the IMF's unit of account and are used for IMF transactions and operations. The value of the SDR is based on the weighted average of five currencies. On January 1, 1981, the IMF began to use a simplified basket of five currencies for determining valuation. At the end of 1999, the U.S. dollar made up 39 percent of the value of the SDR; the euro (Germany), 21 percent; the Japanese yen, 18 percent; and the euro (France) and the British pound, 11 percent each. The weights were chosen because they broadly reflected the importance of the particular currency in international trade and payments. Unless the executive board decides otherwise, the weights of each currency in the valuation basket change every five years. Although the SDR was intended to serve as a substitute for gold, it has not taken over the role of gold or the dollar as a primary reserve asset. 99. List and define the categories of exchange rate regimes. Answer: a. Exchange arrangements with no separate legal tender—The currency of another country circulates as the sole legal tender or the member belongs to a monetary or currency union in which the members of the union share the same legal tender. An example would be the countries in the euro area. b. Currency board arrangements—A monetary regime based on an implicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate, combined with restrictions on the issuing authority to ensure the fulfillment of its legal obligation. Two examples would be Argentina and Hong Kong. c. Other conventional peg arrangements—The country pegs its currency (formal or de facto) at a fixed rate to a major currency or a basket of currencies where the exchange rate fluctuates within a narrow margin of at most +/– 1 percent around a central rate. For example, China pegs it currency to the U.S. dollar. d. Pegged exchange rates within horizontal bands—The value of the currency is maintained within margins of fluctuation around a formal or de facto fixed peg that are wider than +/– 1 percent around a central rate. Many countries that used to be considered managed floating are in this category because they basically peg their currency to something else. e. Crawling pegs—The currency is adjusted periodically in small amounts at a fixed, preannounced rate or in response to changes in selective quantitative indicators. Costa Rica and Turkey are two examples. f. Exchange rates within crawling bands—The currency is maintained within certain fluctuation margins around a central rate that is adjusted periodically at a fixed preannounced rate or in response to changes in selective quantitative indicators. Hungary, Poland, and Chile are three examples. g. Managed floating with no preannounced path for the exchange rate—The monetary authority influences the movements of the exchange rate through active intervention in the foreign exchange market without specifying, or precommitting to, a preannounced path for the exchange rate. The Czech Republic is an example. h. Independent floating—The exchange rate is market determined, with any foreign intervention aimed at moderating the rate of change and preventing undue fluctuations in the exchange rate, rather than at establishing a level for it. Canada, the United States, and Mexico are three examples of countries in this category. 100. What is a black market? Answer: Of the 186 IMF member countries, 92 have currencies that are reasonably flexible, 40 of which float independently. Many of the others control their currencies fairly rigidly. In many of these countries, a black market parallels the official market and is aligned more closely with the forces of supply and demand than is the official market. The less flexible a country's exchange rate arrangement, the more there will be a thriving black market. A black market exists when people are willing to pay more for dollars than the official rate. The movement of floating regimes eliminates the need for a black market. 101. In a short essay, discuss the role of the Federal Reserve Bank of New York and the European Central Bank. Answer: The central bank in the United States is the Federal Reserve System (the Fed), a system of 12 regional banks. The New York Fed, representing the Federal Reserve System and the U.S. Treasury, is responsible for intervening in foreign exchange markets to achieve dollar exchange rate policy objectives and to counter disorderly conditions in foreign exchange markets. It makes such transactions in close coordination with the U.S. Treasury and Board of Governors of the Fed, and most often coordinates with the foreign exchange operations of other central banks. The Federal Reserve Bank of New York serves as fiscal agent in the United States for foreign central banks and official international financial organizations. It acts as the primary contact with other foreign central banks. In the European Union, the European Central Bank coordinates the activities of each member country's central bank to establish a common monetary policy in Europe, much as the Federal Reserve Bank does in the United States. Central bank reserve assets are kept in three major forms: gold, foreign exchange reserves, and IMF-related assets. 102. In a short essay, discuss purchasing power parity (PPP) and the short-run problems that affect PPP. Answer: Purchasing power parity (PPP) is a well-known theory that seeks to define relationships between currencies. It claims that a change in relative inflation between two countries must cause a change in exchange rates to keep the prices of goods in two countries fairly similar. According to the PPP theory, if for example, Japanese inflation were 2 percent and U.S. inflation were 3.5 percent, the dollar would be expected to fall by the difference in inflation rates. Then the dollar would be worth fewer yen than before the adjustment, and the yen would be worth more dollars than before the adjustment. The short-run problems that affect PPP include: a. the theory of PPP falsely assumes that there are no barriers to trade and that transportation costs are zero. b. the prices of the Big Mac in different countries are distorted by taxes. c. the Big Mac is not just a basket of commodities; its price includes nontraded costs such as rent, insurance, and so on. d. Profit margins vary by the strength of competition. The higher the competition, the lower the profit margin and therefore the price. 103. In a short essay, explain the International Fisher Effect. Answer: The International Fisher Effect is the theory that the interest rate differential is an unbiased predictor of future changes in the spot exchange rate. For example, if the International Fisher Effect predicts that nominal interest rates in the United States are higher than those in Japan, the dollar's value should fall in the future by that interest rate differential, which would be an indication of a weakening, or depreciation, of the dollar. That is because the interest rate differential is based on differences in inflation rates. According to the theory of purchasing power parity, the country with the higher inflation should have the weaker currency. Thus, the country with the higher interest rate (and the higher inflation) should have the weaker currency. During periods of general price stability, a country that raises its interest rates is likely to attract capital and see its currency rise in value due to the increased demand. However, if the reason for the increase in interest rates is because inflation is higher than that of its major trading partners and the country's central bank is trying to reduce inflation, the currency will eventually weaken until inflation cools down. 104. In a short essay, compare fundamental and technical forecasting. Answer: Fundamental forecasting uses trends in economic variables to predict future rates. The data can be plugged into an econometric model or evaluated on a more subjective basis. Technical forecasting uses past trends in exchange rates themselves to spot future trends in rates. Technical forecasters, or chartists, assume that if current exchange rates reflect all facts in the market, then under similar circumstances future rates will follow the same patterns. 105. In a short essay, list the various factors governments follow in an attempt to predict market value. Include in your answer the types of questions that would apply to each factor. Answer: a. The institutional setting—Does the currency float, or is it managed—and if so, is it pegged to another currency, basket, or other standard? What are the intervention practices? Are the credible, sustainable? b. Fundamental analysis—Does the currency appear undervalued or overvalued in terms of PPP, balance of payments, foreign exchange reserves, or other factors? What is the cyclical situation, in terms of employment, growth, savings, investment, and inflation? What are the prospects for government monetary, fiscal, and debt policy? c. Confidence factors—What are market views and expectations with respect to the political environment and the credibility of the government and central bank? d. Events—Are their national or international incidents in the news—possibly of crises or emergencies—or governmental or other important meetings coming up? e. Technical analysis—What trends do the charts show? Are there signs of trend reversals? At what rates do there appear to be important buy and sell orders? Are they balanced? Is the market overbought, oversold? What are the thinking and expectations of other market players and analysts? 106. In a short essay, discuss how exchange rate changes can affect companies' marketing, production, and financial decisions. Answer: a. Marketing decisions—Marketing managers watch exchange rates because they can affect demand for a company's product at home and abroad. b. Production decisions—Exchange rate changes affect production decisions. For example, a manufacturer in a country where wages and operating expenses are high might be tempted to locate production in a country with a currency that is rapidly losing value. The company's currency would buy a significant amount of the weak currency, making the company's initial investment cheaper. Furthermore, goods manufactured in that country would be relatively cheap in world markets. c. Financial decisions—Exchange rates can affect financial decisions, primarily in the areas of sourcing of financial resources, remittance of funds across national borders, and reporting of financial results. In the first area, a company might be tempted to borrow money where interest rates are lowest. In deciding about cross-border financial flows, a company would want to convert local currency into its home country currency when exchange rates are most favorable so that it can maximize its return. However, countries with weak currencies often have currency controls, making it difficult for MNEs to do so. Finally, exchange rate changes can influence the reporting of financial results. Test Bank for International Business: Environments and Operations John D. Daniels, Lee H. Radebaugh, Daniel P. Sullivan 9780131869424, 9780201846188, 9780130308016, 9780201566260, 9780201107135, 9780132668668
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