Foreign Exchange and the Global Capital Markets
Read this chapter to learn about currencies, foreign exchange rates, and global capital markets. It gives us a real-world example of a company that has to deal with different currencies. Small changes in the daily foreign currency market can significantly affect a company's costs and profitability. At the end of the chapter, read the ethical dilemmas. What would your responses be? Would you recommend that Walmart set up an offshore company? Why or why not?
Introduction
What's in It for Me?
- What do we mean by currency and foreign exchange?
- How do you determine exchange rates?
- What are the global capital markets?
- What is the impact of the global capital markets (particularly the venture capital and global capital markets) on international business?
This
chapter explores currencies, foreign exchange rates, and how they are
determined. It also discusses the global capital markets - the key
components and how they impact global business. Foreign exchange is one
aspect of the global capital markets. Companies access the global
capital markets to utilize both the debt and equity markets; these are
important for growth. Being able to access transparent and efficient
capital markets around the world is another important component in the
flattening world for global firms. Finally, this chapter discusses how
the expansion of the global capital markets has benefited
entrepreneurship and venture capitalists.
Opening Case: Why a Main Street Firm, Walmart, Is Impacted by Foreign Exchange Fluctuations
Most
people in North America are familiar with the name Walmart. It conjures
up an image of a gigantic, box-like store filled with a wide range of
essential and nonessential products. What's less known is that Walmart
is the world's largest company, in terms of revenues, as ranked by the
Fortune 500 in 2010. With $408 billion in sales, it operates in fifteen
global markets and has 4,343 stores outside of the United States, which
amounts to about 50 percent of its total stores. More than 700,000
people work for Walmart internationally. With numbers like this, it's
easy to see how important the global markets have become for this
company".
Walmart's
strength comes from the upper hand it has in its negotiations with
suppliers around the world. Suppliers are motivated to negotiate with
Walmart because of the huge sales volume the stores offer manufacturers.
The business rationale for many suppliers is that while they may lose a
certain percentage of profitability per product, the overall sales
volume of an order from Walmart can make them far more money overall
than orders from most other stores. Walmart's purchasing professionals
are known for being aggressive negotiators on purchases and for
extracting the best terms for the company.
In order to buy goods
from around the world, Walmart has to deal extensively in different
currencies. Small changes in the daily foreign currency market can
significantly impact the costs for Walmart and in turn both its
profitability and that of its global suppliers.
A company like
Walmart needs foreign exchange and capital for different reasons,
including the following common operational uses:
- To build new stores, expand stores, or refurbish stores in a specific country
- To purchase products locally by paying in local currencies or the US dollar, whichever is cheaper and works to Walmart's advantage
- To pay salaries and benefits for its local employees in each country as well as its expatriate and global workforce
-
To take profits out of a country and either reinvest the money in
another country or market or save it and make profits from returns on
investment
To illustrate this impact of foreign currency, let's
look at the currency of China, the renminbi (RMB), and its impact on a
global business like Walmart. Many global analysts argue that the
Chinese government tries to keep the value of its currency low or cheap
to help promote exports. When the local RMB is valued cheaply or low,
Chinese importers that buy foreign goods find that the prices are more
expensive and higher.
However, Chinese exporters, those
businesses that sell goods and services to foreign buyers, find that
sales increase because their prices are cheaper or lower for the foreign
buyers. Economists say that the Chinese government has intervened to
keep the renminbi cheap in order to keep Chinese exports cheap; this has
led to a huge trade surplus with the United States and most of the
world. Each country tries to promote its exports to generate a trade
advantage or surplus in its favor. When China has a trade surplus, it
means the other country or countries are running trade deficits, which
has "become an irritant to a lot of China's trading partners and those
who are competing with China to sell goods around the world".
For
Walmart, an American company, a cheap renminbi means that it takes
fewer US dollars to buy Chinese products. Walmart can then buy cheap
Chinese products, add a small profit margin, and then sell the goods in
the United States at a price lower than what its competitors can offer.
If the Chinese RMB increased in value, then Walmart would have to spend
more US dollars to buy the same products, whether the products are
clothing, electronics, or furniture. Any increase in cost for Walmart
will mean an increase in cost for their customers in the United States,
which could lead to a decrease in sales. So we can see why Walmart would
be opposed to an increase in the value of the RMB.
To manage
this currency concern, Walmart often requires that the currency exchange
rate be fixed in its purchasing contracts with Chinese suppliers. By
fixing the currency exchange rate, Walmart locks in its product costs
and therefore its profitability. Fixing the exchange rate means setting
the price that one currency will convert into another. This is how a
company like Walmart can avoid unexpected drops or increases in the
value of the RMB and the US dollar.
While global companies have
to buy and sell in different currencies around the world, their primary
goal is to avoid losses and to fix the price of the currency exchange so
that they can manage their profitability with surety. This chapter
takes a look at some of the currency tools that companies use to manage
this risk.
Global firms like Walmart often set up local
operations that help them balance or manage their risk by doing business
in local currencies. Walmart now has 304 stores in China. Each store
generates sales in renminbi, earning the company local currency that it
can use to manage its local operations and to purchase local goods for
sale in its other global markets.
Opening Case Exercises
(AACSB: Ethical Reasoning, Multiculturalism, Reflective Thinking, Analytical Skills)
- List two reasons a global company needs foreign exchange.
- Why is Walmart concerned about foreign exchange rates?
This text was adapted by Saylor Academy under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work's original creator or licensor.