Exchange Rates and the Firm : Strategies to Manage Exposure and the Impact of EMU

## List of Figures 2.1 Pound price of one US dollar, 1993-8 2.2 Depreciation against relative inflation (against US$ 1973-96) 2.3 Nominal and real effective exchange rates, United Kingdom, 1990-7 4.1 Value of the firm and the exchange rate, linear relationship 4.2 Value of the firm and the exchange rate, concave realtionship 4.3 Utility and wealth, concave relationship 7.1 Operating profits as a share of turnover in Swedish manufacturing and real exchange rate, 1975-93 9.1 Profits and the exchange rate, examples of relationships 9.2 Swiss franc price of one US dollar, 9-month forward rate, 1993-8 9.3 Real exchange rate, Switzerland/USA, 1973-97 9.4 A stylized international trade transaction 9.5 Setting price in the importer's currency 9.6 Setting price in the exporter's currency 9.7 Deviation from the law of one price for Marlboro cigarettes (one carton of 200 cigarettes) in duty-free shop, 1990-6 9.8 Development of VAT-adjusted retail price of gasoline (RP) and costs, Sweden, fall 1995 11.1 French franc price of one dollar and one D-Mark, 1990-8 13.1 Price of Marlboro cigarettes (one carton of 200 cigarettes) in in-flight shop, 1994-8 14.1 Nominal and real exchange rate, Sweden 1980-97 14.2 Long-term government bond yields, Italy, Netherlands and Spain, 1990-8 ix ## Preface This book is the outcome of a large amount of research in the last few years focused on the connections between exchange rate variability and firm behavior. During these years, a great number of individuals have given comments at seminars, generously provided data, read and commented on work, and allowed me to use their time with questions and discussions. Unfortunately they are far too many to thank here. A couple of people nevertheless deserve special mention. The first is Anders Vredin with whom I first started working on these issues. We co-authored a background report for the Swedish Government Commission on EMU and this book bears a clear mark of the many discussions that we had and the issues that we wondered about then. Some of my work in the area covered in this book was done as part of my theses. I am grateful to Carsten Kowalczyk and Robert C. Feenstra for taking large slots of their time to act as discussants of my theses. A special thank you also to Bankforskningsinstitutet for financial support. The book has benefited greatly from comments and readings by Marcus Asplund, Stefan Nydahl, Mikael Sandström and by seminar participants at the Ministry of Finance. My greatest debt is to my wife Magda: partly for a careful reading of the manuscript but mostly for making life such a sweet experience. There are quite a number of references to internet sites in the book; links to these and others of relevance will be kept updated at my homepage http://www.hhs.se/personal/friberg. x Exchange Rates and the Firm Figure 2.1 Pound price of one US dollar, 1993-8 The recent strength of the pound, the launch of the EMU and the Southeast Asian crisis have highlighted the impact of exchange rates on firm profitability. Exchange Rates and the Firm is the first book to provide an integrated treatment of financial and operating strategies with respect to exchange rate variability. Theory and evidence on strategies for handling exchange rate variability from many areas of study in economics are assembled and assessed, with a focus on operating strategies. The choice of price setting currency, when and how to adjust prices, the limitations of hedging, and segmentation of national markets are some of the issues analyzed. Richard Friberg uses the developed framework to investigate the impact of EMU on exchange rate exposure. The non-technical presentation makes it well suited for advanced undergraduate and MBA students, practitioners and researchers who want an accessible synthesis of current research in this topical and important field of economic theory and practice Front Matter....Pages i-x Introduction and Scope of the Book....Pages 1-5 Front Matter....Pages 7-7 Setting the Stage....Pages 9-19 What are the Elements of Exposure?....Pages 20-22 Should a Firm Manage its Exposure?....Pages 23-32 The Instruments Commonly Used for Hedging....Pages 33-35 Front Matter....Pages 37-37 Economic Exposure....Pages 39-45 The Evidence....Pages 46-53 Contractual Exposure....Pages 54-56 The Mechanisms and What can be Done about Them — a Close Look....Pages 57-100 Front Matter....Pages 101-101 Accounting Exposure....Pages 103-108 Front Matter....Pages 109-109 A Brief Background....Pages 111-115 Accounting Exposure and EMU....Pages 116-118 Economic Exposure....Pages 119-140 Macroeconomic Issues and their Implications for Exposure....Pages 141-152 Back Matter....Pages 153-174 "This is a very timely volume. The creation of the EMU and the Asian currency crisis pose vast challenges to the conduct of international business. Where should a plant be located? When should a product be introduced in a new market? In which currency and how should prices be set? This volume presents the state-of-art answers to these important questions. Dr Friberg writes with great clarity and he illustrates throughout with important cases and insightful examples. The business, academic, and policy communities will find this small volume to be extremely valuable."--Carsten Kowalczyk, Associate Professor of International Economics, Tufts University, Massachusetts "Exchange Rates and the Firm is the first book to provide an integrated treatment of financial and operating strategies with respect to exchange rate variability. Theory and evidence on strategies for handling exchange rate variability from many areas of study in economics are assembled and assessed, with a focus on operating strategies. The non-technical presentation makes it well suited for advanced undergraduate and MBA students, practitioners and researchers who want an accessible synthesis of current research in this topical and important field of economic theory and practice."--BOOK JACKET. The first book to provide an integrated treatment of financial and operating strategies to exchange rate variability. The choice of price-setting currency, when and how to adjust prices, the limitations of hedging and segmentation of national markets are some of the issues analyzed. The book investigates the impact of EMU.