The trade of goods and services for other goods and services.
Companies can deal with the nonconvertibility problem by engaging in countertrade. Countertrade refers to a range of barter-like agreements by which goods and services can be traded for other goods and services. Countertrade can make sense when a country’s currency is nonconvertible. For example, consider the deal that General Electric struck with the Romanian government when that country’s currency was nonconvertible. When General Electric won a contract for a $150 million generator project in Romania, it agreed to take payment in the form of Romanian goods that could be sold for $150 million on international markets. In a similar case, the Venezuelan government negotiated a contract with Caterpillar under which Venezuela would trade 350,000 tons of iron ore for Caterpillar heavy construction equipment. Caterpillar subsequently traded the iron ore to Romania in exchange for Romanian farm products, which it then sold on international markets for dollars.25 Similarly, in a 2003 deal, the government of Indonesia entered into a countertrade with Libya under which Libya agreed to purchase $540 million in Indonesian goods, including textiles, tea, coffee, electronics, plastics, and auto parts, in exchange for 50,000 barrels per day of Libyan crude oil.26
How important is countertrade? Twenty years ago, a large number of nonconvertible currencies existed in the world, and countertrade was quite significant. However, in recent years many governments have made their currencies freely convertible, and the percentage of world trade that involves countertrade is probably significantly below 10 percent.27
• QUICK STUDY
1. What are the main differences between the efficient market and inefficient market schools of exchange rate forecasting?
2. Explain the difference between fundamental analysis and technical analysis with regard to exchange rate forecasting.
3. Why would international businesses engage in countertrade?
Focus on Managerial Implications
LEARNING OBJECTIVE 6
Compare and contrast the differences among translation, transaction, and economic exposure, and what managers can do to manage each type of exposure.
This chapter contains a number of clear implications for business. First, it is critical that international businesses understand the influence of exchange rates on the profitability of trade and investment deals. Adverse changes in exchange rates can make apparently profitable deals unprofitable. As noted, the risk introduced into international business transactions by changes in exchange rates is referred to as foreign exchange risk. Foreign exchange risk is usually divided into three main categories: transaction exposure, translation exposure, and economic exposure.
The extent to which income from individual transactions is affected by fluctuations in foreign exchange values.
Transaction exposure is the extent to which the income from individual transactions is affected by fluctuations in foreign exchange values. Such exposure includes obligations for the purchase or sale of goods and services at previously agreed prices and the borrowing or lending of funds in foreign currencies. For example, suppose in 2004 an American airline agreed to purchase 10 Airbus 330 aircraft for €120 million each for a total price of €1.20 billion, with delivery scheduled for 2005 and payment due then. When the contract was signed in 2004 the dollar/euro exchange rate stood at $1 = €1.10, so the American airline anticipated paying $1 billion for the 10 aircraft when they were delivered (€1.2 billion/1.1 = $1.09 billion). However, imagine that the value of the dollar depreciates against the euro over the intervening period, so that a dollar only buys €0.80 in 2008 when payment is due ($1 = €0.80). Now the total cost in U.S. dollars is $1.5 billion (€1.2 billion/0.80 = $1.5 billion), an increase of $0.41 billion! The transaction exposure here is $0.41 billion, which is the money lost due to an adverse movement in exchange rates between the time when the deal was signed and when the aircraft were paid for.