INTERNATIONAL FINANCIAL MARKETS
ARIZONA STATE UNIVERSITY
OMT 440 - INTERNATIONAL BUSINESS
WEEK 4
This chapter discusses the concept of inter-national financial markets. The discussion
starts with the development of international financial markets. It then discusses two types of
markets that play an important role in international financial markets. These are the capital
market and the foreign exchange market. The capital market then consists of the bond market
and the equity market. Finally, there is a discussion on the role of government in the foreign
exchange market.
11.1 International Money Market Development :
As the flow of international trade in goods and services grows, so does the flow of
capital. Companies have two alternative sources of funds that come from internal (company
business operations) and external (transactions in financial markets). Companies can use
financial markets as a source of short-term funding (less than one year), or long term. In this
case, short-term funding sources are known as money markets and long-term funding sources
are known as capital markets.
The international money market is commonly known as the Eurocurrency market.
Eurocurrency has no relation to the Euro or currencies in Europe. This name is given because
the international money market consists of deposits or accounts denominated by foreign
currencies. As such, not only currencies originating from countries in continental Europe can
be referred to as Eurocurrency. For example, Japanese Yen deposited in Singapore would be
referred to as Euroyen. Activity in the international money market is driven by a lack of
government regulation or intervention. There are many different types of interest rates that
can be used depending on the financial center involved such as London, New York,
Singapore or Hong Kong. A frequently used interest rate is the LIBOR or London interbank
offered rate set by the British Bankers Association. There are many short-term loans that are
set based on LIBOR.
Companies from different countries may engage in international money markets for
various financial and non-financial reasons. Financial reasons may include obtaining funding
sources at lower costs outside the borders of the country in which the company operates. In
addition, companies tend to use external funding sources to undertake projects that are large
in scale or require significant amounts of funds. On the other hand, non-financial reasons may
include the desire to maintain financial relationships with many countries. The company can
also expand its shareholder base to different people or institutions from different countries.
11.2 Bond Market and Equity Market
The international bond market consists of all debt securities (bonds) issued by
companies, governments or other organizations outside the borders of a particular country.
Issuing bonds in the international market can be a source of financing. Some of the parties
that generally purchase bonds are banks, pension fund management institutions, and
government agencies that have a large amount of reserve funds. One of the instruments that
companies can use to enter the international bond market is Eurobond. Eurobonds are a type
of bond issued outside the country in which the currency is denominated. For example, a
company in Switzerland issues bonds denominated in US Dollars and sells these bonds in the
UK, Netherlands and Germany and are not available in the US. There are also foreign bonds,
which are bonds sold outside the country of issuance and denominated in the currency of the
country where the bonds are sold. For example, a company in France issues bonds
denominated in Australian Dollars and sells the bonds in Australia.
The international equity market consists of all forms of shares that are traded outside of
the issuing country. Companies often sell shares on international equity markets. Some of the
parties that generally act as buyers are other companies, banks, mutual funds, pension fund
management institutions and individual investors. There are four factors that drive the
development of international equity markets. First, the development of international equity
markets is strongly influenced by privatization activities. Furthermore, economic growth in
emerging market countries has also contributed to the development of international equity
markets through increased investment flows. Global investment activities carried out by
banks are also contributes to the development of international equity markets. In addition, the
development of cybermarkets that assist the transaction process between buyers and sellers
has also contributed to the development of international equity markets. These cybermarkets
allow companies to list their companies through electronic devices.
Many researchers predict that the COVID-19 pandemic is likely to impact financial
systems, institutions and markets to an unprecedented degree in the future. There are
many reasons to expect COVID-19 to change financial market dynamics, both during
the pandemic, and in the future as a result of changes in attitudes and behaviors. With
uncertainty shocks, there is considerable interest in how assets behave. In investing,
investors will generally diversify their portfolios in case something goes wrong. Prior to
the COVID-19 pandemic, there were a number of investors who wondered about the
potential for cryptocurrencies to become safe haven assets like gold. Tether has a
different behavior than most cryptocurrencies. Tether's movements were negatively
correlated with equity indices and its value became prominent during COVID-19. This
behavior lends support to the notion of tether's potential to be a safe haven asset that
stands out during extreme downturns. The key factor that makes tether a safe haven
asset is the quality of the stable coin's link to the US dollar. Investors in tether are
attracted to its stability and structural link to the US dollar.
Study 11
Diversify Equity with Cryptocurrency during
Covid 19 Pandemic
11.3 Main Functions of the Foreign Exchange Market
Unlike domestic transactions, international transactions involve two or more currencies.
This means that to conduct international transactions, companies need a mechanism known as
the foreign exchange market. This foreign exchange market is a type of market that trades
various types of currencies. Financial institutions perform currency conversions using the
exchange rate, which is the rate at which one currency is exchanged for another. The
exchange rate can be influenced by various factors such as the size of the transaction,
economic conditions, including government policies.
There are four main functions of the foreign exchange market. First, companies can
utilize the foreign exchange market for currency conversion. This is important for companies
that make foreign investments (PMA) in certain countries. Secondly, companies can also
utilize the foreign exchange market for currency hedging. Currency hedging aims to protect
companies from potential losses caused by movements in exchange rates. Third, companies
can also conduct currency arbitrage through the foreign exchange market.
Currency arbitrage is the buying and selling of currencies in different markets with the
aim of making a profit. Companies can also conduct interest arbitrage, which is the activity
of buying and selling securities that provide interest payments and are denominated in
different currencies. Fourth, companies can utilize the foreign exchange market to conduct
currency speculation, which is the activity of buying and selling currencies with the hope that
the value of the currency will increase in the future so that it can generate profits.
11.4 Foreign Exchange in Various Values
Each foreign exchange has a different value. One of the factors that cause differences in
the value of foreign exchange is the economy of the country concerned. If the economic
performance of a country improves, then the value of the country's currency tends to
strengthen. Conversely, when economic conditions decline, the value of the currency will
also weaken. For example, when Indonesia experienced a crisis in 1997-1998, the value of
the Rupiah experienced a drastic decline against the US Dollar. The value of this currency
will also continue to fluctuate. Not only Indonesia, the currencies of various other countries
will also continue to change. For example, Table 11.1 shows the exchange rate of the Rupiah
against different types of foreign exchange.
Table 11.1 shows the selling and buying rates of various foreign currencies on October
8, 2021. The Australian Dollar (AUD) buying rate of 10321 means that it takes IDR10,321 to
buy 1 AUD. On the other hand, the AUD selling rate of 10427 means that 1 AUD can be sold
or exchanged for as much as IDR10,427.
11.5 Foreign Exchange Market Instruments
The various benefits and roles of the foreign exchange market require businesses to
know how exchange rates are set. These businesses need to be aware of the financial
instruments available that can help them carry out various activities in the foreign exchange
market. The following is a description of some of the instru- men in the foreign exchange
market.
1. Quoting Currencies
There are two important components in setting a currency rate, the quoted currency and
the base currency. In determining the rate, the quoted currency is always in the numerator
and the base currency is always in the denominator. For example, if a certain exchange rate
indicates the amount of Rupiah needed to buy one US Dollar, then the Rupiah acts as the
quoted currency and the US Dollar acts as the base currency. To buy 1 US Dollar, it takes
14,500 Rupiah. Since the Rupiah acts as the quoted currency, in this case we do a direct
quote for the Rupiah and an indirect quote for the Dollar.
If the direct quote value of a currency is known, then finding the indirect quote value
can be done by dividing 1 by the value of the direct quote. In addition, international transactions
between two currencies without involving the US Dollar often use the Dollar as an intermediary. For
example, a consumer in Indonesia purchases goods from a company in Japan. In this case, the buyer
can convert Rupiah to US Dollars to carry out payment activities. Furthermore, the company in Japan
that receives payment in US Dollars will convert the currency into Yen. In this transaction process,
both the buyer and the company must know the exchange rate of the Dollar against the Rupiah and
Yen. The process of calculating the rate of one currency using the rates of two other currencies is
known as cross rates.
2. Spot Rates:
Spot rates are exchange rates that require the delivery of the traded currency within two
business days. In this case, currency exchange activities occur in the spot market which has
three functions. First, the spot market can be used to convert a company's revenue in another
country. Second, a company can convert its home currency into another currency to pay
international suppliers. Thirdly, a company can convert currency to make investments in
other countries. This spot rate is only available for trade transactions that involve a sufficient
amount of currency large. This is why spot rates are only available to banks or foreign
exchange brokers.
3. Forward Rates:
Forward rates are used when a company needs a certain foreign currency at a certain
period in the future. Forward rates are the exchange rates when two parties agree to
exchange a certain currency at a certain period in the future. Forward rates reflect the
expectation of the spot rate of a particular currency in the future. These expectations also
include economic conditions, as well as political and economic situations. Transactions that
use forward rates are known as forward markets. Companies can use forward rates to protect
themselves from the risk of future exchange rate movements.
Forward rates can be used for various types of transactions that require the use of
foreign currencies in trading activities. In this case, companies can use forward contracts,
which are contracts where buyers and sellers agree to trade currencies at an agreed amount
and exchange rate. Forward contracts belong to the group of derivatives, which are financial
instruments whose value is derived from commodities or other financial instruments.
4. Swaps, Options, and Futures
Apart from future contracts, there are three other instruments that can be used in future
markets, namely currency swaps, currency options and currency future contracts. Currency
swaps are the buying and selling of foreign currencies that occur at two specific time periods
simultaneously. For example, an Indonesian consumer buys or imports a car from a company
in Indonesia Australia. In this case, the consumer will have to pay a certain amount of Australian
Dollars when the car is received. Likewise, the company in Australia will also receive some money
within 40 days. The Indonesian customer will exchange some Rupiah in the spot market to pay the
Australian company. At the same time, the consumer enters into a future contract to sell some Rupiah
and buy some Australian Dollars in the next 40 days. In this case, the customer uses a swap
instrument to reduce exchange rate risk and lock in future exchange rates. In addition to currency
swaps, there are currency options that give the right or option to exchange a certain amount of
currency at a certain rate and period. Currency options are different from forward contracts because
they do not require a currency exchange transaction to take place within a certain period of time. On
the other hand, currency future contracts are contracts that require the exchange of currencies at a
certain rate and period. In this case, any conditions that have been set cannot be changed.
11.6 Government Intervention in the Foreign Exchange Market:
Currencies that are traded freely on the foreign exchange market where the price level is
determined by the interaction between supply and demand are known as convertible (hard)
currencies. This type of currency is generally owned by countries that have a stable financial
position and a large amount of foreign exchange reserves. In developing countries,
governments generally intervene to limit the level of currency convertibility (currency
restriction).
This government intervention has several objectives. One of the objectives of
government intervention is to improve the quality of the government's services maintain the
amount of foreign exchange reserves to service the country's debt. Without sufficient
liquidity reserves, there is a high risk of default and this in turn affects future investment
flows. Another objective of currency restriction is to maintain the amount of foreign
exchange reserves to finance import activities and trade deficits. Furthermore, government
intervention also aims to protect the currency from speculators in times of crisis. In addition,
currency restriction policies can also aim to inhibit investment activities in other countries.
Government intervention to limit currency convertibility can be done through various policy
instruments. One of them is by requiring all foreign exchange transactions to obtain a license
from the central bank. The same can also be done for import activities by requiring an import
license for all import activities carried out. The government can also implement a multiple
exchange rate system, which is the setting of high exchange rates on several types of
imported goods originating from certain countries. By doing so, the government can reduce
the number of imported goods. In addition, the government can also issue import deposit
requirements that require businesses to deposit a certain amount of foreign exchange in order
to obtain an import license. In this case, the government can also impose quantity restrictions
that limit the amount of imported goods outgoing foreign exchange.
11.7 Conclusion:
Increased trade flows of goods and services as well as capital flows have driven the
development of international financial markets. Various types of international financial
markets, ranging from money markets, capital markets and foreign exchange markets have a
significant role for transactions international business. In particular, the foreign exchange
market has functions as currency conversion, hedging, arbitrage and currency speculation.
Various instruments in the foreign exchange market consist of spot rates, forward rates,
swaps, options and futures. Furthermore, in its operation, the foreign exchange market is also
inseparable from government intervention. One of the objectives of government intervention
is to limit the convertibility of currencies.
11.8 Important Terms
⚫
Bond market
⚫
Equity market
⚫
Exchange rate
⚫
Eurobond
⚫
Foreign bond
⚫
Cybermarket
⚫
Foreign exchange market
⚫
Currency hedging
⚫
Currency arbitrage
⚫
Currency speculation
⚫
Quoted currency
⚫
Base currency
⚫
Forward contracts
⚫
Currency swaps
⚫
Currency options
⚫
Currency future contracts
⚫
Spot rate
⚫
Forward rate
⚫
Spot market
⚫
Forward market
⚫
Convertible (hard) currency
⚫
Currency restriction
⚫
Multiple exchange rates
⚫
Import deposit requirements
⚫
Quantity restriction
11.9 Review Concept
1. Explain what is meant by the bond market!
2. What is the difference between the bond market and the equity market? Explain!
3. Explain the difference between spot rate and forward rate!
4. What is a Eurobond? Explain!
5. Explain the difference between future contracts and currency options!
6. Why does the government intervene in the foreign exchange market? Explain!
7. What are the instruments of government intervention? Explain!
8. What is a convertible (hard) currency? Explain!
9. Explain the purpose or function of the foreign exchange market!
10. What are the factors that drive the development of the foreign exchange market?
Explain!
11.10 Problem- Problem
1. What is the role of international financial markets on economic growth in developing
countries? Explain specifically the role of international financial markets for Indonesia's
economic development!
2. What is the role of bond and equity markets for international business development? Also
explain the role of capital markets for investment flows in emerging market countries!
3. Explain the motive behind government intervention in the foreign exchange market!
INTERNATIONAL MONETARY SYSTEM
This chapter continues Chapter 11 by expanding the understanding of the international
financial system. In the first part, various domestic and foreign activities that can affect the
foreign exchange market will be explained. Next, the various factors that affect the value of
foreign exchange as well as the various methods used to predict exchange rates are explained.
Finally, the evolution of the international monetary system is explained.
12.1 Domestic and Foreign Activities that Can Affect the Foreign Exchange Market
The operation of the foreign exchange market, including the value of foreign exchange,
is inseparable from various activities carried out, both domestic and foreign activities. For
example, companies that conduct export and import activities can affect the value of foreign
exchange through demand and supply the amount of foreign exchange. An increase in the
amount of imports in a country will increase the demand for a particular foreign exchange
(US Dollars). This is because companies need a certain amount of foreign exchange to
finance the imported goods. The increase in the amount of demand will then encourage the
strengthening of the value of the foreign exchange in the market. The same thing also applies
to export and import activities carried out by companies or business people in various
countries.
Various policies set by the government also affect the foreign exchange market. These
policies can be in the form of monetary policy or fiscal policy. This is because various
policies set by the government affect interest rates and inflation rates which in turn affect the
value of certain currencies in the foreign exchange market. Government policies in the form
of devaluation and revaluation affect the foreign exchange market through changes in
currency values.
Devaluation is a government policy that aims to lower the value of a country's currency.
On the other hand, revaluation is a government policy that aims to increase the value of a
country's currency. Devaluation can lower the price of exports from a country and increase
the price of imports as the value of the currency becomes lower in the international market.
The opposite is true for revaluation policies, which increase export prices and decrease a
country's import prices. Various foreign policies, especially those set by economically
powerful countries such as the United States and China can greatly affect the foreign
exchange market, including the economies of other countries.
Study 12
The Effect of Devaluation on the Balance of Trade in Uganda
Uganda has seen its currency, the Ugandan Shilling (UGX), lose value in recent years. This
has led to public outrage, due to a spike in the prices of most products. With this public
outcry, as well as looming strikes, the government and key government officials argue that
depreciation is good for Ugandan products. Countries that devalue their currency have the
hope that by weakening the domestic currency against the currencies of trading partners or
foreign currencies, their exports will become cheaper abroad, while imports will become
expensive. Subsequently, the country's export demand will increase while import demand
will decrease.
The issue of devaluation has sparked debate, does devaluation improve or worsen the trade
balance? To date, the dominant school of thought is that devaluation is expected to improve
the trade balance in the long run; however, in the short run, the trade balance first declines
and then improves.
Devaluation may not be the right approach to sustainably improve the trade balance in
Uganda. Data shows that devaluation does not necessarily increase exports, or reduce
imports, in Uganda. With an increase in the real exchange rate, devaluation will lead to
reduced domestic output in the country. This can be partly explained by the fact that a
devaluation will make imports expensive; as a result, domestic demand will increase,
increasing the price of domestic goods and lowering the price gap between previously
expensive imported goods and now expensive domestically produced goods. The increase in
the price of domestic goods, however, will offset the desired positive effects of devaluation.
12.2 Factors Affecting the Value of Foreign Exchange and Its Impact on International
Business Activities
To understand the various factors that affect the value of foreign exchange, it is
necessary to understand the concepts of the law of one price and purchasing power parity.
The following is an explanation of these two concepts and the factors that affect the value of
foreign exchange.
1. Law of One Price
The exchange rate shows how much of a certain currency must be paid to obtain a
certain amount of another currency. It does not describe the price level of a particular product
in different countries. In other words, the exchange rate does not guarantee the purchasing
power of a particular currency. The law of one price states that the same product should have
the same price level in different countries. The law of one price helps determine which
currencies are undervalued and overvalued. This in turn affects international business
activities through product pricing in different countries. If there is a difference in the price of
products in different locations, then this will lead to an arbitrage opportunity, which is the
opportunity to buy a certain product in one country and sell it in another country at a higher
value or price.
2. Purchasing Power Parity (PPP)
Under purchasing power parity (PPP) theory, various factors or economic forces will
push the actual exchange rate to the value determined by PPP. If this does not happen, there
will be an arbitrage opportunity.PPP theory applies to products traded in international
markets that are not restricted by trade barriers and have low transportation costs. In this case,
businesses acting as arbitrageurs must ensure that goods purchased at a low price in a
particular country can still have a lower price in another country after taking into account
transportation costs, taxes, tariffs and other costs. In this case, price levels can be used to
adjust the value of the two currencies. In the context of exchange rates, the PPP principle can
be interpreted as the exchange rate between two currencies being equal to the ratio of the
price levels of goods in the two countries.
Inflation results from the interaction of the supply and demand of currency. If the
government increases the amount of money in circulation, but the amount of output remains
the same, then people will have a greater ability to buy the same product. This will lead to an
increase in the price of the product leading to inflation. Thus, inflation can cause changes in
purchasing power. Since inflation can damage the purchasing power of the people, the
government generally implements various policies to maintain price stability. These policies
can be in the form of fiscal policy or monetary policy. Monetary policy aims to influence
interest rates and the money supply. Fiscal policy, on the other hand, regulates the amount of
government spending and tax rates to indirectly influence the money supply.
In the previous section, it was explained that people's purchasing power is affected by
the inflation rate. Furthermore, the inflation rate is influenced by the unemployment rate and
the interest rate. If there is a low unemployment rate, then this illustrates the low availability
of labor so that companies tend to offer high wage rates to attract workers. Furthermore, to
maintain the amount of profit earned, the company will increase the price level of the
product. On the other hand, interest rates affect the cost of borrowing funds. A low interest
rate will encourage people to borrow for investment purposes. In other words, a high interest
rate will reduce the amount of loans and the amount of money in circulation.
12.3 Exchange Rate Prediction Methods
Exchange rate movements play a significant role in business activities. The higher the
uncertainty of exchange rate movements, the greater the costs associated with exchange rate
risk. A stable and predictable exchange rate can improve the accuracy of future financial and
cash flow plans. There are two techniques commonly used to predict exchange rates, namely
fundamental analysis and technical analysis. Fundamental analysis predicts exchange rates
using statistical models that are based on fundamental economic indicators. The technique
can be very complex as there are various indicators that describe different economic
conditions. Some commonly used indicators are economic variables such as inflation rates,
interest rates, money supply, tax rates and government spending. Fundamental techniques can
also use the situation or condition of a country's balance-of-payments which has the potential
to affect the economy affect the value of the country's currency.
Technical analysis, on the other hand, uses various types of charts that are formed from
past trends in currency price movements as well as other factors that affect exchange rates.
By using statistical models and charts formed from past data, an analyst is able to Find the
conditions that cause changes in the exchange rate. It is then possible to estimate the timing
and direction of future exchange rate movements. Fundamental and technical analysis can be
used simultaneously to obtain accurate prediction results.
Predicting exchange rates is not an easy task, even with the use of sophisticated
statistical tools and models. This is because almost no prediction result is completely accurate
throughout the prediction period. One of the factors that make it difficult to predict exchange
rate movements is changes in government policy.
12.4 Evolution of the Monetary System International:
The international monetary system is a set of agreements and institutions that govern the
movement of exchange rates. There are two monetary systems that are commonly used,
namely the fixed exchange rate system and the floating exchange rate system. The following
describes the evolution or development of the exchange rate system since the beginning of
international trade transactions.
1. The Gold Standard:
At the beginning of international trade, gold was used as a means of payment for in-
ternational transactions of goods and services. The use of gold as a means of international
transactions has several advantages. First, the limited amount of gold can cause a high level
of demand for gold. Second, gold is made of rust-proof material so it can be easily stored for
a long period of time. Third, gold can be used for both small and large transactions because it
can be easily formed into coins or gold bars. However, the use of gold as a transaction tool
also has various disadvantages. One of them is its large size leading to high gold
transportation costs. In addition, there was a risk of gold loss during transportation, especially
by sea. To overcome this problem, countries adopted the gold standard, an international
monetary system in which the value of countries' paper currencies was directly linked to a
certain value of gold.
The gold standard requires a country to set the value of its currency in units of one
ounce of gold. The value of the currency expressed in units of gold is known as the par value.
The calculation of par value is based on the concept of purchasing power parity. Since all
countries must fix their currencies to units of gold, it indirectly links their currencies. As such,
the gold standard is a fixed exchange-rate system, where the conversion of one currency into
another is set by international government agreement.
The gold standard has several advantages. First, the use of this monetary system can
reduce the risk of exchange rate movements. In addition, the gold standard also sets a firm
monetary policy for all countries participating in the system. The gold standard also helps
countries to overcome the problem of trade imbalances. However, despite its many
advantages, the onset of World War I led to the demise of this monetary system. This was
because the countries involved in World War I needed a huge amount of money to fulfill their
needs and equipment. To fulfill this need, these countries printed paper currency in large
quantities. This of course violated the basic principles of the gold standard, causing many
countries to abandon this system.
2. Bretton Woods Agreement
In 1944, 44 countries met in New Hampshire, precisely in the city of Bretton Woods.
This meeting became the foundation for the establishment of a new monetary system based
on the value of the United States Dollar. Unlike the gold standard, this system provides
flexibility for countries to overcome monetary difficulties in their respective countries. This
system has several characteristics. First, the Bretton Woods Agreement uses a fixed exchange
rate system by tying or fixing the value of the US dollar directly to the value of gold and
fixing the value of other currencies to the value of the dollar. Second, this system has built-in
flexibility. This is because it allows for devaluation under conditions of fundamental
disequilibrium, which is an economic condition characterized by a trade deficit that causes a
permanent shift in a country's balance of payments. Third, the system established the World
Bank to assist economic development in various countries. Fourth, the Bretton Woods
Agreement also established the International Monetary System (IMF) to regulate the fixed
exchange rate system and enforce the various regulations set. However, this system was also
abandoned when the United States experienced large trade and budget deficits.
3. Floating Exchange Rate System
The Bretton Woods Agreement was abandoned because of the high reliance on the
stability of the dollar. This system could not work well if the value of the dollar weakened.
To overcome this shortcoming, a new monetary system emerged known as the floating
exchange rate system. In January 1976, world leaders met to draft the Jamaica agreement
among IMF members to establish a floating exchange rate system as the new monetary
system. The Jamaica Agreement has several provisions. First, it is a managed float system,
which is an exchange rate system where one currency floats against another. In this case,
governments can intervene to stabilize the value of their currency against a certain exchange
rate. Secondly, this system no longer considers gold as the main reserve in the IMF. In
addition, this system also establishes the IMF as the lender of the last resort for countries
with balance of payments difficulties.
Furthermore, between 1980 and 1985, the value of the dollar increased dramatically
against other currencies. This led to an increase in export prices which again led to a trade
deficit. In this regard, five countries known as the G5 formed the Plaza Accord in 1985 to
lower the value of the dollar. The five countries were the United Kingdom, France, Germany,
Japan and the United States. In 1987, there were again concerns that the value of the dollar
was at too low a level. This prompted a meeting in Paris by the G7 (G5 members plus Italy
and Canada) to form a new agreement. This meeting established the Louvre Accord which
intervened in order to stabilize the value of the dollar. Today, most international monetary
systems use a managed inflation exchange rate system.
12.5 Conclusion
This chapter discusses the concept of the international monetary system, particularly the
foreign exchange market and exchange rates. Various government policies, including
monetary and fiscal policies, are important factors that affect the exchange rate foreign
policy. This is because this policy has a major influence on various economic indicators,
especially interest rates and inflation. Furthermore, foreign exchange has a constantly
fluctuating value. These fluctuations in currency values can cause uncertainty which further
affects international business activities. However, currency value movements can be
predicted using two methods known as fundamental analysis and technical analysis.
Furthermore, this chapter also discusses the development or evolution of the international
monetary system, which includes the fixed exchange rate system and the floating exchange
rate system.
12.6 Important Terms
⚫
Devaluation
⚫
Revaluation
⚫
Fiscal policy
⚫
Monetary policy
⚫
Purchasing power parity
⚫
Opportunity arbitrage
⚫
Law of one price
⚫
Inflation
⚫
Fundamental analysis
⚫
Technical analysis
⚫
The gold standard
⚫
Bretton Woods Agreement
⚫
Floating exchange rate
⚫
Managed floating system
12.7 Review Concept
1. What is a floating exchange rate? Explain!
2. What is a managed floating system? Explain!
3. What is the effect of purchasing power parity to the exchange rate? Explain!
4. Explain the difference between fundamental and technical analysis!
5. What is an arbitrage opportunity?
Explain!
6. How purchasing power parity raises
arbitrage opportunity? Explain!
7. Explain the development of the international monetary system!
8. How does inflation affect purchasing power parity? Explain!
9. Why can't a floating exchange rate system be used when the value of the dollar
weakens? Explain!
12.8 Problem- Problem
1. Explain the development of monetary systems since the beginning of international trade!
Also explain the advantages and disadvantages of each monetary system that has been used!
2. Can future exchange rate movements be predicted? What methods can be used to predict the
exchange rate? Explain why more sophisticated technology and statistical models do not
guarantee the accuracy of the prediction results!
INTERNATIONAL STRATEGY
In carrying out business activities, both in the domestic and international environment,
companies are faced with various aspects related to the preparation of business strategies.
These aspects relate to the type of products produced, the location of production as well as
the location and method of marketing the products. The main difference between business
practices in domestic and international environments lies in the level of complexity. This is
because international companies have to choose production locations among different
countries. In addition, companies operating in international markets also have a wider market
scope. All these factors will affect the complexity of planning and developing business
strategies. This chapter discusses the various stages of international strategy identification.
The discussion in this chapter also includes various types of international strategies as well as
various important factors that affect the choice of organizational structure. Finally, there is a
discussion of the types of international organizational structures.
13.1 Stages of Strategy Identification International:
Formulating a business strategy can help managers to know the direction of the
company's operations, both now and in the future.
Figure 13.1 shows the various stages of formulating an international strategy. There are
three stages that a company must go through to formulate its business strategy, namely
identifying the company's mission and objectives, identifying its core competencies and
formulating a strategy. The following is an explanation of each of these stages.
1. Identify Company Mission and Goals:
The first stage of formulating a company's strategy is to identify the company's mission
and goals. Every company has certain goals that are described by the company's mission
statement. The mission statement is a written statement of the purpose of a particular
company or business and the plan that the company wants to achieve. The mission of the
company is then influences the company's decisions regarding the type of industry and
market segmentation it wants to enter. Every company has a different mission statement.
Some companies aim to build a brand name. Others may focus on other things such as
returns, market share or corporate social responsibility. In general, a company's mission
describes how its operations affect stakeholders, i.e. all parties affected by the company's
activities such as consumers, employees, suppliers, and so on.
2. Identify Core Competencies and Value-Creating Activities:
After identifying the company's mission and objectives, the next step is to identify the
core competencies of the company. The determination of core competencies includes the
internal capabilities and activities of the company, the type of industry, and the business
environment in which the company operates. A core competency is a special ability of the
company that is very difficult to imitate by other companies. This ability is different from the
skills possessed by certain individuals. A company's core competencies include a variety of
skills and abilities that are coordinated in the form of specific technologies. Although
expertise or skills can be achieved through training programs, these core capabilities develop
over a long period of time and are very difficult to teach.
The company's strategy must be in accordance with the company's strengths and market
conditions. Thus, the company must conduct a value-chain analysis, which is the process of
dividing the company's activities into primary activities and support activities. Figure 13.2
shows the various activities of a company that are classified as primary and support activities.
Primary activities include logistics activities, production of goods and services, marketing and selling
of products, and customer service. In other words, these primary activities include the creation,
suggestion, and distribution of products and sales services. On the other hand, support activities
include business infrastructure, human resource management, technology development, and
procurement activities. All these support activities provide the inputs and infrastructure needed by the
primary activities.
National distinctiveness consisting of language, religion, culture, customs and climate
also influences the formulation of corporate strategy. Language differences can increase
operating and administrative costs. Marketing activities can also be fatal without taking into
account local cultural characteristics. Differences in political and legal systems also
complicate international strategy formulation. This is because companies are obliged to fulfill
all forms of regulations and rules set by the local government. The behavior of local
communities towards investment flows also has a great influence on the formulation of
international business strategies.
3. Formulate Strategies
After knowing the company's goals and mission and the various core competencies and
capabilities of the company, the company's business strategy can then be formulated. there
are various types and levels in the company's business strategy. For companies operating in
the international market, they can enter the market by using an international strategy. In
addition, companies must also strategize at the corporate, business and departmental levels.
The discussion of each type of strategy will be explained in the next section.
13.2 International Strategy and Firm-Level Strategy
There are two types of international strategy, which consist of multinational strategy and
global strategy.
1. Multinational Strategy:
Some companies decide to use a multinational strategy or what is known as a
multinational (multidomestic) strategy. This multinational strategy entails customizing
products and marketing activities to suit the preferences of specific local markets. In other
words, multinational strategy is the use of different strategies according to the country
characteristics of the company as well as marketing their products. The implementation of
this strategy requires the establishment of new subsidiaries in each market. Subsidiaries This
company will carry out product development, production and marketing activities.
The main benefit of a multinational strategy is that it allows the company to monitor
consumer preferences directly in each local market. Thus, the company can respond quickly
and effectively to changes in consumer preferences. On the other hand, the main drawback of
this strategy lies in the use of a multinational strategy that does not allow the company to
utilize economies of scale in product development, including manufacturing and product
marketing. This strategy is commonly used by companies operating in industries where
consumer preferences differ. One example is the food and beverage (F&B) industry.
2. Global Strategy:
Global strategy is a type of strategy that is characterized by offering the same type of
product and marketing style in all types of markets. Companies that use this type of global
strategy can generally take advantage of economies of scale characterized by the production
of products in the most profitable locations. This global strategy can be used by companies
operating in industries that have a high level of competition and pressure to reduce
production costs.
The main benefit of using a global strategy lies in cost savings due to the standardization
of products and marketing systems. These production cost savings can help the company
achieve a large market share. On the other hand, the use of a global strategy also has its
drawbacks. One of the main drawbacks is that the use of this strategy ignores the differences
in consumer preferences in different types of markets.
To determine whether the company should use a multinational strategy or a global
strategy, the company must formulate strategies at the corporate level, business level and
department level. The discussion on business and department level strategies will be
discussed in section 13.3. On the other hand, corporate-level strategy involves the
formulation of corporate objectives and the roles of each corporate unit to achieve these
objectives.
Figure 13.3 shows the four approaches of firm-level strategy, which consist of growth
strategy, retrenchment strategy, stability strategy and combination strategy. The following
describes each of these approaches.
1. Growth Strategy:
Growth strategies are designed to increase the scale or scope of a company's operations.
Scale can be interpreted as the size of the company's activities, while scope can be interpreted
as the size of the company's activities. The scope includes various types of activities that the
company undertakes. Company growth can be achieved through internal growth (organic
growth). In addition, company growth can also be achieved through mergers and acquisitions,
joint ventures, and strategic alliances. In these, companies can cooperate with various parties,
including competitors, suppliers and buyers with the aim of reducing the level of competition
and expanding production lines.
2. Retrenchment Strategy:
Retrenchment strategy is the opposite of growth strategy, which is a type of strategy that
aims to reduce the scale or scope of the company's business. Companies generally reduce the
scale of production when economic conditions worsen or there is a high level of competition.
This can be done by closing the company's factory and laying off some employees. On the
other hand, companies can also reduce the scope of their business activities by selling
unprofitable business units.
3. Stability Strategy:
Stability strategy is aimed at protecting the company against various changes.
Companies generally use this type of strategy to avoid increasing or decreasing the scale and
scope of the company. In this case, the company has achieved the set goals and is satisfied
with its condition. The company believes that its strengths have been maximally utilized and
all of its weaknesses have been protected. Thus, they tend not to want to expand sales,
increase profits, market share or customer base.
4. Combination Strategy
Combination strategy aims to combine growth, retrenchment and stability strategies
across the company's business units. For example, companies can use growth strategy in
promising business units that have great profit opportunities, and use retrenchment and
stability strategy in other business units. This combination strategy is generally most often
used by most companies.
13.3 Business Level Strategy and Department Level Strategy
In addition to strategizing at the corporate level, managers must also develop different
strategies for each business unit. However, there are some companies that only have a single
strategy, both at the corporate level and at the business level. The key to corporate-level
strategizing lies in decisions regarding competitive advantage in a particular market.
Figure 13.4 shows the three types of strategies a company can use to strategize at the
level of business. The three strategies consist of low-cost leadership, differentiation, and
focus strategy. The following describes each of the three types of strategies.
1. Low-Cost Leadership:
Low-cost leadership strategy is a strategy where the company utilizes economies of scale
to achieve the lowest cost structure. Companies that implement this type of strategy generally
seek to save on administrative costs, marketing costs, advertising and distribution costs. Low-
cost leadership strategy can be used for product categories that have consumers with a high
degree of sensitivity to price. This strategy is also suitable for companies that have
standardized products and marketing promotions.
2. Differentiation Strategy
Differentiation strategy is a type of strategy where a company creates a product that is
unique to all buyers in a particular industry. This product uniqueness allows the company to
set a higher price level and can increase customer loyalty. However, the perception of
exclusivity generally encourages companies to reduce their market share. Companies using
this strategy must build a loyal customer base to cover higher production and marketing costs
and compensate for a small market share. Companies can differentiate their products by
enhancing their reputation for product quality. In addition, the company's products can also
be differentiated based on different brand names or images and unique product designs.
3. Focus Strategy
Focus strategy is a type of strategy where a company focuses on meeting the needs of a
particular market segment, either through product differentiation, low-cost leader, or both.
The high level of competition requires companies to differentiate their products, either based
on product quality, design, or price. Focus strategy is often aimed at consumers who are
dissatisfied with existing products or want something different. In this case, companies can
design products and marketing systems that are unique and in accordance with the desires and
preferences of consumers in certain market segments.
Department-level strategy focuses on specific activities that transform existing resources
into products. The formulation of department-level strategy is linked to core competencies,
which consist of primary and support activities. After these two types of activities, the
company can strategize by utilizing the company's superior strengths. Each department of the
company involved in primary activities has an important role in creating value for consumers,
either through lowering production costs or product differentiation. Manufacturing strategies
play an important role in reducing production costs and improving product quality. In
addition, marketing strategies also affect the company's image and customer loyalty. In
addition to manufacturing and marketing activities, there are also logistics activities in
primary activities that aim to provide production factors and various elements needed.
Support activities also play an important role in creating value for consumers. R&D
activities can help companies identify consumer needs in specific market segments.
Similarly, human resources (HR) managers can help improve efficiency by recruiting capable
and well-trained employees. Further, the accounting and finance department can assist with
efficient information systems to assist managers in the decision-making process and financial
monitoring.
13.4 Important Factors in Organization Structure Selection :
The organizational structure describes the way the company groups the company's
various activities into different units and coordinates between the various units. An
organizational structure that is in accordance with the company's strategic plan can help the
company achieve its goals. There are various important factors that influence the choice of
organizational structure as follows.
1. Centralization versus Decentralization
An important thing that managers consider in forming an organizational structure relates
to the level or degree of centralization or decentralization in terms of decision making.
Centralized decision making is described by the decision-making process carried out by
corporate executives at the top level of the organization and carried out by the main corporate
office (headquarter). Decentralized decision making, on the other hand, focuses on the
spread of decision-making activities across lower levels of the company and can be carried
out by subsidiaries in different countries.
Centralized decision making assists companies in coordinating the company's operations
from various subsidiaries spread across various countries. This system is generally used by
companies that have various business lines spread across various international markets. This
system is also important when the output of a particular subsidiary acts as an input for the
production activities of its subsidiaries other companies. The company can maintain control
over financial resources by requiring the distri- bution of profits earned by all subsidiaries to
the ultimate parent company. In addition, the company can also establish policies, procedures
and standards that support a single global organizational culture.
Decentralized decision making can be used when companies operate in a business
environment that is constantly changing. Decentralized decision making can produce
products that meet the needs and preferences of local consumers. This is because managers in
local subsidiaries understand consumer characteristics better than managers in the main
parent company.
2. Coordination and Flexibility:
In choosing an organizational structure, the company must also consider efficient
methods for coordinating each division of the company. Determining the method of
coordination, including the supervision mechanism is related to the issue of coordination and
flexibility. Each type of company must determine the organizational structure that suits the
existing business environment. This organizational structure will then explain the parts of
responsibility and lines of authority from the top management level to the employee level
(chain of command). In addition, each company must also develop an organizational structure
that supports a high level of cooperation between various divisions.
The company's organizational structure should also not be permanent, but can be
modified according to changes in the internal and external environment. The organizational
structure must also be adjusted to the strategy used by the company. This is because the
selection of organizational structure is generally adjusted to the company's strategy. Thus, if
changes in the environment lead to changes in the strategy used by the company, then this
will further affect the organizational structure of the company.
13.5 Types of Organizational Structures International
There are various types of organizational structures that can be used by companies.
However, there are generally four types of organizational structures that are often used by
international companies. The four types of organizational structures are division, area,
product and matrix structure. The following is an explanation of each type of organizational
structure.
1. International Division Structure
International division structure divides a company's domestic and international activities
by creating separate divisions for international business activities. In this case, the
international division is specifically divided by country, where the company conducts its
business operations. In each particular country, there is a general manager in charge of
organizing all the production and product-selling activities of the company in that country.
Thus, each subsidiary in different countries will carry out their own business activities
consisting of production, marketing, sales and financial activities.
Figure 13.5 shows an example of an international division structure. The figure shows
that international business activities have different divisions. The international divisions are
further subdivided into groups of divisions based on the countries where the company does
business. This organizational structure is generally used by companies that are new to
international business activities and only have a relatively small percentage of international
business activities. This is because by focusing international expertise on one particular
division, it can help companies reduce production costs, increase efficiency and protect
international business activities from various domestic disturbances.
However, this international division structure has two problems. First, international
managers must rely on managers in the parent company for financial resources and technical
know-how. This means that poor coordination between these managers can result in a decline
in the company's overall performance. Secondly, the general manager of the international
division is generally responsible for all business operations in all countries. This leads to a
reduced level of authority from managers in each country.
2. International Area structure
The international area structure divides the company's global operations by country or
geographic region, as shown in Figure 13.6. In this case, in each country or region there is a
general manager who manages the company's business operations in that country or region.
Each unit of the company consists of a specific set of departments such as purchasing,
production, marketing, sales, R&D, and accounting. In addition, each unit also tends to take
care of their own strategic plans. However, management executives at the parent company
still make decisions regarding the overall strategy of the company and coordinate activities
between the various units.
International area structure is suitable for companies that have unique markets in
various countries. This strategy is generally used when there are political, economic, and
cultural differences between different countries or regions. When managers have great power
over business activities in a particular environment, they tend to better understand the
uniqueness and characteristics of buyers in a particular market segment.
3. Global Product Structure
The global product structure divides the company's operations by product area. This
organizational structure is suitable for companies that produce various products in their
production line. For example, a company that manufactures electronic products produces
three types of electronics, namely computers, mobile phones, and televisions. Figure 13.7 is
used to show a simple illustration of a global product organization structure. The figure
shows that the parent company has three production divisions and in each division there is a
board of directors. In each division, for example, the mobile phone division heads a
production area, for example, Vietnam, Indonesia, Singapore and Thailand. In each of these
areas, there are marketing, human resources, research and development, and other
departments.
This global product structure has the main focus on the products produced. Since each
product has its own division and board of directors, each branch company has its own board
of directors overseas branches need to coordinate with the relevant product directors. Based
on the example in Figure 13.7, each product branch in Vietnam, Indonesia, Singapore and
Thailand needs to coordinate with the mobile phone product division at the head office.
4. Global Matrix Structure
The global matrix structure divides the chain of command system between product
divisions and regions. Chain of command can be defined as lines of authority (ranging from
top managers to individual employees) that describe internal reporting systems or
relationships. In this case each manager will report to two bosses, namely the president of the
product division and the president of the geographic region division. The main purpose of
this global matrix structure is to combine managers in product divisions and regions in terms
of decision making. This type of corporate structure is often used by companies that want to
reduce production costs and coordinate all their international business operations.
The global matrix structure can overcome many of the shortcomings of other types of
organizational structures, especially with regard to inter-divisional communication issues.
However, this structure has two drawbacks. First, the use of this organizational structure can
slow down the decision-making process. This is due to frequent meetings or gatherings for
the purpose of coordination. Secondly, individual responsibilities become unclear as
managers can blame each other in the event of poor company performance.
Study 13
Global Strategic Context and CEO Appointment: The Importance of a Global Mindset
Globalization has significantly changed the competitive context, with firms increasingly
exposed to global competition at home and when operating abroad and to a plethora of
institutional environments. Research has shown that an important determinant of a firm's
ability to successfully deal with such complexity lies in the global capabilities and
perspectives of its top executives, especially its CEO. Firms need a person with a managerial
cognitive orientation who can enhance the firm's capacity not only to integrate geographically
dispersed business operations but simultaneously be responsive to business at home. A
company operating in a country that is highly connected to the rest of the world implies that it
faces critical challenges such as increased foreign competition in its home market and
pressure to engage in international trade or FDI to remain competitive, in addition to the
difficulties of managing a multicultural and highly diverse workforce. Globalization places
important demands on managers and can have a significant impact on the types of skills and
capabilities sought in new CEOs. For example, facing foreign competition within a firm's
home market requires managers to respond to the competitive threat posed by foreign firms
through improving the efficiency of the firm, which often requires international expansion.
The global context of the company, in this case the globalization of the country, the
international diversification of the company and major cross-border acquisitions, influences
the board of directors to appoint a CEO with a global mindset. Items that may be considered
include the CEO's foreign nationality, the number of foreign higher education degrees, and
the level and diversity of international work experience.
13.6 Conclusion
In formulating a strategy, the company must go through three stages consisting of
activities to identify the company's goals and mission, identify the company's core
competencies and formulate strategies. In the first stage, the company sets the goals to be
achieved and reflected in the company's mission statement. In the second stage, the company
identifies its core competencies, which consist of primary and support activities. In the third
stage, the company formulates a strategy by considering the identification results in the two
previous stages. There are two types of international strategies that companies can choose
from, namely multinational strategy and global strategy. To determine the appropriate type
of strategy, the company must first formulate strategies at the corporate level, business level
and department level. This chapter also discusses the concept of corporate organizational
structure. Some of the factors that influence the selection of a company's organizational
structure are the degree of centralization or decentralization as well as the coordination
system and flexibility. In addition, there are four types of organizational structures that can be
used by international companies, namely international division structure, international area
structure, global product structure and global matrix structure.
13.7 Important Terms
⚫
Mission statement
⚫
Core competency
⚫
Primary activity
⚫
Support activity
⚫
Multinational strategy
⚫
Global strategy
⚫
Chain of command
⚫
Growth strategy
⚫
Retrenchment strategy
⚫
Stability strategy
⚫
Combination strategy
⚫
Low-cost strategy
⚫
Differentiation strategy
⚫
Focus strategy
⚫
Centralization
⚫
Decentralization
⚫
International division structure
⚫
Department-level strategy
⚫
International area structure
⚫
Global product structure
⚫
Global matrix structure
13.8 Review Concept
1. Describe the three stages in business strategy formulation!
2. What is the difference between primary and support activities?
Explain!
3. Explain the difference between multinational and global strategy!
4. What is a growth strategy? Explain!
5. What is a retrenchment strategy?
Explain!
6. Explain what is meant by international area structure!
7. Describe the characteristics of a focus strategy!
8. Explain the difference between centralization and decentralization!
9. Describe the characteristics of a global product structure!
10. What are the disadvantages of the international division structure? Explain!
13.9 Problem- Problem
1. Find an international company with operations in Southeast Asia. Identify the mission and
objectives of the company. Explain how the company's objectives influence the strategy used
by the company!
2. Describe the different types of company organizational structures! What are the advantages
and disadvantages of each type of organizational structure? Describe the characteristics of a
company that is suitable for each type of organizational structure!
3. Find an international company in Indonesia. Describe the organizational structure of the
company? What type of organizational structure does the company use? Also explain how the
organizational structure affects the company's operations!
