Page 37 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes 2.5 Keywords

European Currency Unit (ECU): The ECU is a “basket” currency based on a weighted average of
the currencies of member countries of the European Union.

Exchange Rate Mechanism: It refers to the procedure by which the EMS member countries
collectively manage their exchange rates.
Flexible or Floating System: The market force, based on demand and supply, determines a
currency’s value.
International Monetary System: The international monetary system consists of elements such
as laws, rules, agreements, institutions, mechanisms and procedures which affect foreign exchange
rates, balance of payments adjustments, international trade and capital flows.

Limited Flexibility Exchange Rate System: Limited flexibility exchange rate system attempts to
combine the best of the fixed (pegged) period and floating rate (more flexible) systems.
Pegged Exchange Rate Systems: In this system, currency values are fixed in relation to another
currency such as the US dollar, Euro or to a currency basket such as the special drawing right
(SDR).
SDR: SDR are an international reserve created by the IMF and allocated to member countries to
supplement foreign exchange reserves.
Wide Band Scheme: Wide band scheme a country pursuing more inflationary policies will find
the prices of its international goods going up, necessitating a depreciation programme to correct
the country’s balance of payments in order to slow growth and curb inflation, while eventually
risking recession.

2.6 Review Questions

1. Explain how these exchange-rate systems function (a) gold standard (b) par value
(c) crawling peg (d) wide band and (e) floating.

2. Both fixed and floating rates claim to promote exchange rate stability while controlling
inflation. Is it possible for these two divergent systems to achieve the same goals?
3. Should the world adopt a basket of the five or ten leading currencies (e.g., US dollar,
Japanese yen, Swiss franc, etc.) as a global currency for international trade?
4. Briefly explain the changes in the present International Monetary System that you consider
likely to occur in the near future. Why?
5. Under the current system of managed floating, have the exchange rate movements been
excessive? Explain.
6. What lessons can economists draw from the breakdown of the Bretton Woods System?
7. What do you think were the major reasons for the currency ‘crisis’ of September 1992?
8. Trace the evolution of foreign exchange from fixed to floating exchange rates in the
International Monetary System.
9. Describe the exchange rate arrangements that are permitted by the International Monetary
Fund.
10. How are exchange rates determined in the following three systems: freely fluctuating,
manage-fixed exchange rate and automatic-fixed exchange rate?

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