Global Financing and Exchange Rate Mechanisms Paper

Global Financing and Exchange Rate Mechanisms Paper

Global finance operations include financial procedures, such as accounting, financial planning and analysis, strategic planning, treasury, investor relations, and financial compliance. Exchange rate is the existing market cost for which one currency can be exchanged for another (Moffatt, n.d.). For instance, when the U.S. exchange rate for the Japanese Yen is Ґ1.10, this means that 1 American Dollar can be exchanged for 1.1 Japanese Yen. The purpose of this paper is to analyze the exchange rate mechanism (Euro Currency Markets), to describe how this mechanism is used in global financing operations, and to analyze its importance in managing risks.

The Euro Currency Markets, specifically most of the countries in the European Union (EU), have adopted the euro, a new currency that was introduced in Europe on January 1, 1999, and introduced as physical coins and banknotes in 2002. The name, Eurozone, has been coined as those countries who have adopted the euro. The ECB, which is located in Frankfort, Germany, is the responsible financial institution to institute the monetary policy within the Eurozone. The European System of Central Banks (ESCB), which is comprised of the central banks of the member countries, is involved in the printing, minting, and distribution of the coins and banknotes to all participants and in the management the Eurozone payment system operations.

The evolution of the euro began in 1946 when Winston Churchill, then England's Prime Minister, and several other European leaders foresaw a United States of Europe. This eventually resulted in the formation of the 15-nation EU, which launched the euro. Belgium, Holland, Luxembourg, France, and Italy signed the Treaty of Rome in 1957 and formed the European Economic Community. Twenty-two years later (1979) the first single monetary system, the European Currency Unit (ECU), was created. In 1991, the European Monetary Unit (EMU) was formed by the Maastricht Treaty. This treaty also formed the European Central Bank (ECB) (in which political leaders have no authority) and one currency, the euro, to become effective January 1, 1999. In order for the member countries to participate in the EU, they had to have a budget deficit of less than three percent of their Gross Domestic Product (GDP), a debt ratio of less than sixty percent of GDP, low inflation and interest rates close to the EU average. One year later, in 1002, the Schengen Treaty provided for open trade borders between most European countries, allowing goods and services to move freely across treaty members borders, similar to how goods and services move freely in the United States.

Twelve EU countries (Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain) have switched to this new currency (IBM, n.d.). The remaining EU countries, Denmark, Sweden, and the United Kingdom, currently have not switched. However, other European countries, including the Vatican City, Andorra, Montenegro, Kosovo, Monaco, San Marino, and Liechtenstein, which have a strong relationship with the EU, have already switched their currencies to the euro. All EU members are eligible to join Eurozone if they comply with the monetary requirements; however, the use of the euro will be mandatory for those who join as new EU members. The euro is also legal currency in the Eurozone overseas territories of French Guiana, Rйunion, Saint-Pierre et Miquelon, Guadeloupe, Martinique, and Mayotte. The following countries are to adopt the euro by 2010: Slovenia, Estonia, Latvia, Malta, Cyprus, Lithuania, Slovakia, the Czech Republic, Hungary, Poland, Bulgaria, and Sweden.

However, the remaining two EU countries, Denmark and the United Kingdom, are in the process of deciding to change their currencies to the euro. A referendum was held in Denmark in September 2000 and was voted down 53.2% against joining the Eurozone. However, politicians in Denmark are trying to resurrect the referendum this year. In anticipation of changing, Denmark has a plan in place to convert their currency, the krone, to the euro.

The United Kingdom (UK) has political and public skepticism in changing to the euro. The country believes that the euro is just a stepping stone to the formation of a European super state; also, by changing to the euro, the UK believes it will lose the ability to set interest rates, thus having unfavorable effects on their economy. Another concern is that the UK currency, Sterling, is a major part of their heritage. Even though the UK government has set five economic tests to be passed before the UK will join the Eurozone, the likelihood of the country joining may be rejected because public opinion is strongly against participation.

As with any currency, there are advantages and disadvantages for the participating countries. Economically, the advantages of the euro include:

* Elimination of exchange-rate fluctuations - The euro eliminates the fluctuations of currency values across borders in those countries which have the euro as their currency.

* Price transparency - With price equalization between countries which have the euro as their currency, businesses can be more competitive.

* Transaction costs - With the euro, no exchanges are necessary within the Eurozone countries.

* Increased trade across borders - With elimination of exchange-rate fluctuations, price transparency, and the elimination of transaction costs, increase in trade is realized across borders of the Eurozone countries.

* Macroeconomic stability - Because of the ECB, having the euro as a single currency, inflation will be lower and can be controlled among the Eurozone countries.

* Lower interest rate - Having the euro among the Eurozone countries results in the decrease of the exchange-rate risk and promotes lower interest rates. Additional interest is charged