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Chapter Six: International Finance and Trade
Chapter 6
International Finance and Trade
CHAPTER PREVIEW
Today it is not possible for a developed country to operate in isolation from other countries.
Financial capital flows freely from country to country depending on interest rates, inflation,
and political stability. Individuals want to be able to purchase goods and services at the
lowest prices for a given quality wherever in the world where the goods and services are
available. This chapter begins with a discussion of international transactions from the
perspective of currency exchange rate relationships between countries. We then turn our
attention to the management of foreign exchange exposure by businesses. This is followed
by a discussion of how international trade is financed both by exporters and importers. We
also discuss how international trade is encouraged and stimulated. Our final focus is on the
characteristics of and the difficulty in achieving a balance in international payments.
LEARNING OBJECTIVES
• Explain how the international monetary system evolved and how it operates today.
• Describe the efforts undertaken to achieve economic unification of Europe.
• Describe how currency or foreign exchange markets are organized and operate.
• Explain how currency exchange rates are quoted.
• Describe the factors that affect currency exchange rates.
• Describe how the world banking systems facilitate financing of sales by exporters and
purchases by importers.
• Identify recent developments in the U.S. balance of payments.
CHAPTER OUTLINE
I. GLOBAL OR INTERNATIONAL MONETARY SYSTEM

A. Development of International Finance
B. How the International Monetary System Evolved
1. Before World War I
2. World War I through World War II: 1915-1944
3. Bretton Woods Fixed Exchange Rate System: 1945-1972
4. Flexible Exchange Rate System: 1973--Present
II. EUROPEAN UNIFICATION

A. European Union
B. Eurozone Members
C. The Euro
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Section Two Specific Suggestions by Chapter
D. European Union Financial Crisis
III. CURRENCY EXCHANGE MARKETS AND RATES

A. Currency Exchange Markets
B. Exchange Rate Quotations
C. Factors that Affect Currency Exchange Rates
1. Supply and Demand Relationships
2. Inflation, Interest Rates, and Other Factors
D. Currency Exchange Rate Appreciation and Depreciation
E. Arbitrage
F. Exchange Rate Developments for the U.S. Dollar
IV. CONDUCTING BUSINESS INTERNATIONALLY

A. Managing Foreign Exchange Risk
B. Ethical Considerations
V. FINANCING INTERNATIONAL TRADE

A. Financing by the Exporter
1. Sight and Time Drafts
2. Bank Assistance in the Collection of Drafts
3. Financing Through the Exporter’s Bank
B. Financing by the Importer
1. Financing Through the Importer’s Bank
2. Importer Bank Financing: An Example
C. Banker’s Acceptances
D. Other Aids to International Trade
1. The Export-Import Bank
2. Traveler’s Letter of Credit
3. Traveler’s Checks
VI. BALANCE IN INTERNATIONAL TRANSACTIONS GOAL

A. Nature of the Problem
B. Balance-of-Payments Accounts
VII. SUMMARY
LECTURE NOTES
I. GLOBAL OR INTERNATIONAL MONETARY SYSTEM
A general discussion of the nature of international trade and finance provides an

interesting opening for this material. Most students show interest in the subject and
usually there are some who have a career interest in international business. It is easy to
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develop illustrations of how various nations specialize in the activities best suited for
their productive capabilities. Products such as automobiles are manufactured
primarily in highly industrialized countries whereas inexpensive plastic toys are
generally manufactured in labor intensive countries. Other products also should lend
themselves to illustrate the discussion. It can then be emphasized that this vast
interchange of the world’s products can only be accomplished with the assistance of an
intricate and smoothly operating system of international finance.
An international monetary system is designed to foster world trade, manage the

flow of financial capital, and determine currency exchange rates. A gold standard
exists when currencies of countries are convertible into gold at fixed exchange rates.
The Bretton Woods system was formulated in mid-1944 and was an international
monetary system in which the U.S. dollars was valued in gold and other exchange
rates were pegged to the dollar. An international monetary system based on flexible
exchange rates is a system in which currency exchange rates are determined by supply
and demand. Today, a large number of countries allow their currencies to float against
other currencies.
(Use Discussion Questions 1 through 5 here.)
II. EUROPEAN UNIFICATION
Efforts to unify the countries of Europe began after World War II. While initial
progress was slow there now are 28 members of the European Union (EU) with 18 of
the countries joining to form the Economic and Monetary Union of the European
Union or European Monetary Union (EMU). These developments have resulted in a
major change in the international monetary system.
The European Union is an organization established to promote trade and economic

development among European countries. Its history can be traced back to 1957 when
a treaty was agreed to that established the European Economic Community. This
organization became the European Community in 1978 and the Economic Union in
1944. By 1995, there were 15 members of the European Union. Ten more members
were added in 2004, two also were added in 2007 and one in 2013 for a total of 28
current members.
The European Monetary Union is an organization of European countries that

agreed to have a common overall monetary policy and the euro as their common
currency. Eleven members initially agreed in 1998 to accept the euro as their new
currency. The euro became an official currency on January 1, 1999. However, euro
notes and coins were not introduced into circulation until January, 2002. The original
eleven members were Austria, Belgium, Finland, France, Germany, Ireland, Italy,
Luxembourg, Netherlands, Portugal, and Spain. Three members of the 15-member EU
existing in 1995 (Denmark, Sweden, and the United Kingdom) have not accepted the
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euro as their common currencies. Greece adopted the euro as its currency in 2001.
Then Slovenia joined in 2007, Cyprus and Malta in 2008, Slovakia in 2009, Estonia in
2011, and Latvia in 2014. The current 18 members of the EMU are a sub-set of the
28 current members of the EU.
The euro is the official currency of the countries in the European Monetary Union.
The euro includes “gates” and “windows” for the front of the bills. Designs of
“bridges” are included on the reverse of bills.
(Use Discussion Questions 6, 7, and 8 here.)
III. CURRENCY EXCHANGE MARKETS AND RATES
Changes in exchange ratios are caused by supply and demand. The U.S. institutions
that maintain accounts in foreign banks or have foreign branches attempt to maintain
their balances in some appropriate proportion. If the claims on those foreign
balances exceed the supply of funds moving into those accounts, the owners of the
balances will simply raise the price to customers. This has the effect of both
reducing the demand and increasing the supply. Demand decreases because foreign
purchases become more expensive and are reduced proportionately. Supply
increases as sellers in those foreign markets find their sales benefiting from the
higher value of the dollar. The actions of a single financial institution in managing
its foreign balances will not alter overall exchange rates, but in the aggregate, if
demand exceeds supply or supply exceeds demand the exchange rates will change.
The opportunity to take advantage of a disparity in exchange rates exists if
quotations differ among the markets. Selling in one market and simultaneously buying
in another market would produce a profit with no risk. This is the nature of arbitrage
and where the professionals enter the picture. If they detect even small disparities,
they take action that quickly eliminates the disparity.
Quoted exchange rates differ depending on the form of exchange requested. A
banker’s sight draft costs slightly less than a cable order since the sight draft will take
days or even weeks before it is deposited and reduces the balance on which it is
drawn. A cable order, on the other hand, reduces the balance immediately. A banker’s
time draft, payable at a future date, will cost less than either the sight draft or cable
order since the reduction in the account will not occur for some time.
Student interest in international finance may be developed by having them find the
exchange rates between the dollar and various types of foreign currency at
www.money.cnn.com and www.reuters.com, or from other financial publications.
Samples of various documents used in foreign trade may be obtained from local
banks. As an interesting class exercise, have the students take the position of the chief
financial officer of a multinational corporation. They can then try to determine how to
protect their company’s position against loss in the face of changing exchange rates.
(Use Table 6.1 and 6.2, Figures 6.1 and 6.2, and Discussion Questions 9 through
12 here.)
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IV. CONDUCTING BUSINESS INTERNATIONALLY
Firms that have foreign sales must be concerned with the stability of the governments
and changing values of currency in the countries in which they do business. While the
concept of acceptable ethical behavior differs across cultures and countries, to offer
“side” payments or bribes to government officials and officers to do business in a
foreign country is morally wrong. Such actions also may be illegal under the Foreign
Corrupt Practices Act.
Aside from the relationship of supply and demand, changes in exchange rates may
stem from certain circumstances that affect the monetary systems of the various
nations. Changes in political leadership, rumors of war, threats of devaluation, and
many other factors have an influence on exchange rates. Because of these
uncertainties, business activities involving international trade require astute business
management. This is especially true of multinational businesses that have personnel
responsible for dealing with these matters on a continuing basis.
Risk reduction is an important strategic goal for multinational firms. In some
cases, management may seize upon opportunities for speculation when conditions
seem appropriate. Moving balances from one country to another is the most obvious
maneuver to avoid losses that may occur as a result of anticipated changes in
exchange rates. Further, a number of sophisticated financial devices such as hedging,
futures contracts, and others can be used by managers of international balances.
V. FINANCING INTERNATIONAL TRADE
Financing an international transaction may fall upon either the importer or the
exporter. In some situations, the credit worthiness of the parties to the transaction may
affect the form of financial settlement. The text describes the various instruments that
may be used by either exporter or importer. Of special interest is the use of these
instruments and of certain financial institutions to limit the possibility of loss due to
the failure of one of the parties to the transaction to perform according to contract
terms. The special role of the financial institutions in this process should be
emphasized.
(Use Figures 6.3 through 6.6, and Discussion Questions 13 through 18 here.)
To encourage and stimulate foreign trade, the Export-Import Bank was authorized
in 1934 and became an independent agency of the government in 1945. The bank
obtains its funds from the U.S. Treasury. Its principal activity is lending to foreign
firms and governments to make purchases of our equipment, goods, and related
services. The Export-Import Bank also aids substantially in the economic development
of foreign countries. Emergency credits are provided to assist countries in maintaining
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the level of U.S. imports when they experience temporary balance-of-payments

difficulties.
The traveler’s letter of credit is issued by a domestic depository and is addressed
to a list of banks abroad. The listed banks agree to purchase upon sight the drafts
presented to them by persons displaying the document. This eliminates the dangers
of carrying currency and assures that funds will be available when needed at the
designated banks abroad.
Many students will be familiar with the use of travelers’ checks in this country.
They may be used to even greater advantage while traveling abroad. Since travelers’
checks may now be purchased in foreign currency denominations—for example,
British pounds—they decrease a traveler’s exposure to fluctuations in exchange rates.
(Use Discussion Questions 19 and 20 here.)
VI. BALANCE IN INTERNATIONAL TRANSACTIONS GOAL
The nations of the world strive to achieve international financial equilibrium by

maintaining a balance in their exchange of goods and services. In general,
international trade benefits both countries involved in an exchange. Problems arise,
however, if exports and imports are out of balance over a period of time. This is a
current problem for the U.S. and will undoubtedly continue for a long period of time.
Exports are sales to foreigners and represent a source of income to domestic
producers. Imports divert money to foreign producers and therefore represent a loss of
potential income to domestic producers. When the two are in balance there is no net
effect on total income in the economy. However, an increase in exports over imports
has an expansionary effect on the economy, as would an increase in investment or
government spending. An excess of imports causes contraction.
Since different countries use different currencies, the international financial
system needs a mechanism for establishing the exchange rates among currencies,
and for handling their actual exchange. During long periods in history, exchange
rates were fixed by central banking authorities. Since 1973, however, a system of
flexible exchange rates has existed. Under this arrangement, exchange rates are
determined by supply and demand in the foreign exchange market. Fluctuations in
exchange rates affect imports and exports and can thus have an effect on domestic
production, incomes, and prices. International financial markets significantly
influence domestic interest rates, and vice versa, so that domestic monetary policy
still involves inter-national considerations.
(Use Discussion Question 21 here.)
The U.S. balance-of-payments accounts involves all of its international
transactions including foreign investment, private and government grants, expenditures
of the U.S. military forces overseas, and many other items in addition to the purchase
and sale of goods and services. The single most important element of the balance of
payments is the current account balance, which is the net balance of exports and imports
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of goods and services. A more narrow view considers only the import and export of
goods and is termed the merchandise trade balance. It is clear that imports have
continued to exceed exports, at an increasing rate, in recent years.
The way in which this imbalance between exports and imports is brought into
balance in the total picture can be understood by studying Table 6.3. Deficits or
surpluses in the current account must be offset by changes in capital flows. That is, the
two must be equal except for statistical discrepancies due to measurement errors. The
capital account balance includes changes in foreign government and private investment
in the U.S. in such forms as bank deposits, government and corporate securities, loans,
and direct investment in land and buildings. Similar U.S. government and private
investments or holdings in foreign countries are netted against this amount. The final
adjusting factor would be a change in U.S. official reserve assets.
(Use Table 6.3, and Discussion Questions 22 through 24 here.)
DISCUSSION QUESTIONS AND ANSWERS
1. What is the purpose of an international monetary system?
An international monetary system is designed to foster world trade, manage the flow of
financial capital, and determine currency exchange rates.
2. What is meant by the statement that the international monetary system has operated
mostly under a “gold standard”? What are the major criticisms associated with being
on a gold standard?
A gold standard exists when currencies of countries are convertible into gold at fixed
exchange rates. A gold standard has been in use for long periods in the past.
Major criticisms of being on a gold standard are: (1) as the volume of world trade
increases, the supply of new gold will fail to keep pace, and (2) there is a lack of an
international organization to monitor and report on whether countries are deviating from
the standard when it is in their own best interests.
3. Describe the Bretton Woods system for setting currency exchange rates. What are special
drawing rights (SDRs) and how are they used to foster world trade?
The Bretton Woods system was formulated in mid-1944 and was an international
monetary system in which the U.S. dollars was valued in gold and other exchange rates
were pegged to the dollar.
Special Drawing Rights is a reserve asset, consisting of a basket of currencies,

created by the International Monetary Fund to be used to make international payments
involving world trade.
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4. What is an international monetary system based on “flexible exchange rates”?
An international monetary system based on flexible exchange rates is a system in which

currency exchange rates are determined by supply and demand
5. Describe the international monetary system currently in use.
Today, a large number of countries allow their currencies to float against other
currencies.
6. What is the European Union (EU)? How did it develop? Who are the current members of
the EU?
The European Union (EU) is an organization established to promote trade and economic
development among European countries. Its history can be traced back to 1957 when a
treaty was agreed to that established the European Economic Community. This
organization became the European Community in 1978 and the Economic Union in
1944.
By 1995, there were 15 members of the European Union. Ten more members were
added in 2004. Two new members were added in 2007 and one in 2013. A listing of all
28 current members is provided in the text.
7. What is meant by the term eurozone members? Which countries are eurozone members?
The European Monetary Union (EMU) is an organization of European countries that

agreed to have a common overall monetary policy and the euro as their common
currency. It is common practice today to refer to the EMU as eurozone members. The
initial twelve members have grown to currently 18 eurozone (or EMU) members and are
a sub-set of the 28 current members of the EU.
The twelve members that originally joined the EMU are: Austria, Belgium, Finland,
France, Germany, Greece, Ireland, Italy Luxembourg, Netherlands, Portugal, and Spain.
The other three members of the 15-member EU existing in 1995, Denmark, Sweden,
and the United Kingdom, did not accept the euro as their common currencies. Slovenia,
Cyprus, Malta, Slovakia, Estonia, and Latvia bring the Eurozone membership total to 18
members.
8. What is the euro? Identify some of its distinguishing characteristics.
The euro is the official currency of the eighteen countries in the European Monetary
Union referred to as Eurozone members. The euro includes “gates” and “windows” for
the front of the bills. Designs of “bridges” are included on the reverse of bills. The
paper currency uses multicolored ink, 3D holographic images, and watermarks, to
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thwart efforts to easily counterfeit the bills.
9. What types of financial crises have some countries in the EU faced in recent years?
The 2007-08 financial crisis impacted many European Union countries as it did the U.S.
However, the economies of many EU countries did not recover from the 2008-09
recession as the U.S. did, and high levels of unemployment remain. Because tax
receipts have lagged government expenditures, the national debt of many EU countries
has increased dramatically in recent years. Some EU countries (e.g., Greece) have been
forced into austerity government expenditure plans at a time when unemployment rates
remain high with the result being social unrest.
10. What are currency or foreign exchange markets?
Foreign exchange markets of the world consist of a group of telephone, cable, and
electronic systems connecting the major financial centers. As such, these markets cannot
be visualized in terms of a specific geographical location. In a very narrow sense,
however, a local depository can be considered the relevant foreign exchange market for
the individual or business in terms of day-to-day business activity.
11. Explain the role of supply and demand as it relates to the establishment of exchange rates
between countries.
Exchange rates reflect the forces of supply and demand. In a “free” market in which
governmental controls are absent, exchange rates tend to move upward in response to an
increase in net demand and vice versa. Demand exists whenever it becomes necessary
for an individual or an institution of this country to make a payment to a foreigner.
Supply exists when a foreigner must make a payment to this country.
12. Describe the activities and economic role of the arbitrageur in international finance.
Arbitrage may be defined as the simultaneous, or nearly simultaneous, purchasing of
commodities, securities, or bills of exchange in one market and selling them in another
where the price is higher. In international exchange, variations in quotations between
countries at any time are quickly brought into alignment through the arbitrage activities
of international financiers who buy currency in the market in which the price is low and
sell it in the market in which it is high.
13. What is meant by the statement that foreign exchange quotations may be given in terms of
sight drafts, cable orders, and time drafts?
The cable order costs more than a banker’s sight draft because it reduces the balance of
the bank’s foreign deposit almost immediately. Banker’s time drafts cost less than both
of these because they involve a reduction in the balance of the foreign branch or
correspondent only after a specified period of time.
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14. Describe the various ways by which an exporter may finance an international shipment of
goods. How may commercial banks assist the exporter in the collection of drafts?
Should an exporter have confidence in the foreign customer and be in a position to carry
sales to these customers on open book accounts, there is no reason why the arrangement
should not operate very much as it operates in domestic trade. There will, of course, be
the added complication involved when payment is made in a different currency. Goods
may be shipped by using a sight draft, requiring immediate payment, or a time draft,
which requires acceptance on the part of the importer and payment at a specified future
time. A draft is generally accompanied by an order bill of lading and papers such as
insurance receipts. The bill of lading gives title to the goods, and only its holder may
claim the merchandise from the transportation company.
A New York exporter who is dealing with a foreign importer with whom there has
been little relationship in the past may ship goods on the basis of a documentary draft
that has been deposited for collection with the local bank. That bank, following the
specific instructions set out regarding the manner of collection, then forwards the draft
together with the accompanying documents to its correspondent bank in the foreign
country involved. The correspondent bank is instructed to hold the documents until
payment is made if a sight draft is used, or until acceptance is obtained if a time draft is
used. Remittance is made to the exporter when collection is made on the sight draft.
15. How do importers protect themselves against improper delivery of goods when they are
required to make payment as they place an order?
When the importer is required to make payment with the order but wishes some protection
against the failure of the exporter to make shipment in accordance with the provisions of
the order, the payment may be sent to a representative bank in the country of the exporter.
The bank is instructed not to release payment until certain documents are presented to the
bank to confirm shipment of the goods according to the terms of the transaction.
16. Describe the process by which an importing firm may substitute the credit of its bank for
its own credit in financing international transactions.
The importing firm substitutes the credit of its bank for its own through the use of a
commercial letter of credit. The commercial letter of credit may be described as a
written statement on the part of the bank to an individual or firm guaranteeing
acceptance and payment of a draft up to a specified sum if it is presented to the bank in
accordance with the terms of the commercial letter of credit. Figure 6.5 provides an
illustration of a commercial letter of credit.
17. How may a bank protect itself after having issued a commercial letter of credit on behalf
of a customer?
After having issued a commercial letter of credit, the bank, for added protection, may
prefer to establish an agency arrangement between the firm and the bank whereby the
bank retains title to the merchandise. A trust receipt is utilized to retain title to the
goods. Under the trust receipt, as the merchandise is sold, the proceeds from the sale are
turned over to the bank until the acceptance has been paid.
6-10
18. Describe the costs involved in connection with financing exports through bankers’
acceptances.
Two charges are involved in an export transaction based on the bankers’ acceptance.
First, the exporter typically permits her or his bank, or a correspondent bank, to hold the
acceptance until it is to be presented to the importer’s bank for payment. The exporter’s
bank or correspondent bank discounts the acceptance and deposits to the exporter’s
account the face of the acceptance less the discount. The exporter, therefore, pays a fee
to his or her bank for the privilege of receiving immediate payment from the transaction.
Second, a commission charge is paid to the importer’s accepting bank.
19. Describe the ultimate sources of funds for export financing with bankers’ acceptances.
How are acceptances acquired for investment by these sources?
The ultimate sources of funds for export financing with bankers’ acceptances are
primarily foreign central banks and both foreign and domestic commercial banks. Non-
financial corporations also play a small role as a source of funds. There are relatively
few firms that deal in bankers’ acceptances. These dealers arrange nearly simultaneous
exchanges of purchases and sales.
20. Explain the role played by the Export-Import Bank in international trade. Do you
consider this bank to be in competition with private lending institutions?
The purpose of the Export-Import Bank is to aid in financing and to facilitate exports
and imports between the United States and other countries. The bank serves only to
supplement regular financial facilities and is not regarded as being in competition with
private lending institutions.
21. Commercial letters of credit, traveler’s letters of credit, and traveler’s checks all play an
important role in international finance. Distinguish among these three types of
instruments.
A commercial letter of credit is prepared by a bank and commits the bank to

acceptance and payment of a draft or order drawn on it up to a certain amount if the
terms of the letter of credit are met. In international trade, such letters of credit are
usually issued for a single transaction. The traveler’s letter of credit is similar except
the seller of the merchandise to be acquired is not known in advance. The traveler’s
letter of credit specifies a series of foreign banks against which the letter of credit may
be presented for acceptance. Again, a dollar limit is set for such letters of credit. The
traveler’s check is a convenience to individual travelers, although it may serve
commercial purposes as well. The traveler’s check is issued by an internationally
reputable financial institution, and the accepting party need only confirm the signature
of the person presenting the check. These checks are purchased at face value plus a fee
and are signed once when purchased and again in the presence of the institution
accepting the check.
6-11
22. Briefly indicate the problems facing the United States in its attempt to maintain
international financial equilibrium.
After World War II, the United States engaged in a massive program of international
aid. This, coupled with large military expenditures, more than offset a favorable U.S.
balance of trade (which existed until 1970). Competition in international markets in
terms of goods and services is intense, and since 1977 the balance of trade position of
the U.S. has become increasingly more negative (i.e., imports exceeding exports). The
heavy reliance on imported oil has been another major factor in the ongoing unfavorable
balance of trade position.
23. The U.S. international balance-of-payments position is measured in terms of the current
account balance. Describe the current account balance and indicate its major
components.
The current account balance for 2011 is shown in Table 6.3. It gives U.S. international
transactions in terms of receipts and expenditures and, thus, shows the flow of income into
and out of the U.S. over a year. The current account balance is comprised of: (a) the
merchandise trade balance (merchandise exports minus merchandise imports); (b) the net
position of various other goods and services, which include military transactions,
investment income, and other service transactions; and (c) other adjustments in the form
of remittances, pensions, and other transfers, plus U.S. government grants (excluding
military).
The balance on goods generally became increasingly negative as we moved from the
1980s through 2011. See the presentation under the “Balance-of-Payments” heading in
the chapter.
24. Discuss the meaning of the capital account balance and identify its major components.
The capital account balance, except for statistical discrepancies, must exactly offset
deficits or surpluses in the current account. That is, changes in investments must be
recorded to offset differences between the flow of income into and out of the country.
The capital account balance includes: (a) changes in foreign government and private
investment in the U.S.; (b) changes in U.S. government and private investments or
holdings in foreign countries; and (c) changes in U.S. official reserve assets. The capital
account involves changes in terms of bank deposits, the holding of government and
corporate securities, investment in plant and equipment, loans, and other liabilities
involving international transfers and transactions. U.S. official reserve assets include
gold, Special Drawing Rights, the reserve position in the International Monetary Fund,
and foreign currency holdings.
EXERCISES AND ANSWERS
1. You are the owner of a business that has offices and production facilities in several
foreign countries. Your product is sold in all of these countries, and you maintain bank
6-12
accounts in the cities in which you have offices. At present you have short-term notes
outstanding at most of the banks with which you maintain deposits. This borrowing is to
support seasonal production activity. One of the countries in which you have offices is
now strongly rumored to be on the point of a devaluation, or lowering, of their currency
relative to that of the rest of the world. What actions might this rumor cause you to
take?
You could try to hedge against your financial claims in that country losing value by
moving some of the funds in your bank account to another country. In anticipation of
moving the funds, you could try to accelerate the collection of your receivables. You
might also slow down your payments on liabilities with the expectation of moving funds
back into the country after devaluation, receiving more local funds in so doing. Other
devices, such as dealing in futures contracts, may also be available to you.
2. Explain the concept of “balance” as it relates to a nation’s balance of payments.
In one sense there is never a precise count that establishes a balance since it is
impossible to record all transactions that enter into the schedule. Hence, an item referred
to as statistical discrepancy solves that problem nicely. Aside from the practical matter
of counting, however, the schedule must always be in balance in a theoretical sense. For
example, while we can have deficits in our current account because our export of goods
and services are less than our imports, this difference must be made up in one or both of
the other parts of the schedule. It can be made up by a reduction in our gold reserves or
other reserve assets, or we can increase the amount that we owe abroad.
3. As an exporter of relatively expensive electronic equipment, you have a substantial

investment in the merchandise that you ship. Your foreign importers are typically small- or
medium-size firms without a long history of operations. Although your terms of sales
require payment upon receipt of the merchandise, you are concerned about the possible
problem of nonpayment and the need to reclaim merchandise that you have shipped. How
might the banking system assist and protect you in this situation?
As an exporter shipping merchandise to a little-known foreign customer, you can protect

yourself by forwarding certain documents to a bank in the town or city of the importer.
These documents provide for the foreign bank to release the merchandise at the shipping
terminal only when the importer provides the funds specified in the terms of sale. The
funds are then forwarded to you by the bank. Although you may consult a banking
directory to find a bank in the exporter’s community to direct the transaction, it is more
efficient to simply ask your banker for such information. Your banker is in a position to
not only provide a list of such banks but to identify one that he or she considers the most
appropriate.
4. As an importer of merchandise, you depend upon the sale of the merchandise for funds to
make payment. Although customary terms of sale are 90 days for this type of merchandise,
you are not well known to foreign suppliers because of your recent entry into business.
6-13
Furthermore, your suppliers require almost immediate payment to meet their own
expenses of operations. How might the banking systems of the exporter and importer
accommodate your situation?
This problem offers an excellent opportunity to describe the important role of banks in
international commerce. Before placing your order for merchandise you would obtain
from or through your local bank a commercial letter of credit. This letter of credit would
spell out the conditions under which the bank would accept a time draft drawn on it by
the exporter. Your order for merchandise along with the letter of credit would then be
forwarded to the exporter.
The exporter can, with confidence, ship the merchandise and submit to his or her
bank the time draft to be forwarded to the bank that issued the letter of credit. The
exporter’s bank “discounts” the draft, that is, deposits to the exporter’s account the
amount of the sale less an interest charge for the 90 days that this draft will be
outstanding, (As specified in the problem, terms of sale are customarily 90 days for this
type of merchandise.) The exporter’s bank will now forward the draft to the bank that
has issued the letter of credit. That bank, after satisfying itself that the merchandise has
been shipped according to terms of sale, will “accept” the draft which now becomes a
bankers’ acceptance.
The banker’s acceptance may then be returned to the exporter’s bank or it may be
sold upon instructions from the exporter’s bank in the open market. If it is held by the
exporter’s bank for the 90 days, that bank has financed the transaction. If the draft is
sold in the open market, the funds are returned to the exporter’s bank and it is the third-
party’s financial interest that has financed the transaction. Sales in the open market are
ordinarily made in the country of the bank issuing the letter of credit since the draft will
usually sell at a lower interest rate. As the importer, you simply sign a promissory note
in favor of the bank that has issued the letter of credit in the amount to which that bank
has committed itself, and you receive the documents necessary to claim the merchandise
at the transportation terminal. Your sale of the merchandise provides the funds to meet
the obligation to the bank under the terms of the promissory note. Your bank then
forwards payment to the exporter’s bank when the 90-day banker’s acceptance matures
and is presented for payment.
5. As a speculator in the financial markets, you notice that for the last few minutes Swiss
Francs are being quoted in New York at a price of $0.5849 and in Frankfurt at $0.5851.
a. Assuming that you have access to international trading facilities, what action might
you take?
Purchase Swiss Francs in New York at $0.5849 and simultaneously sell Francs in
Frankfurt at $0.05851 in order to “lock in” a profit of $0.0002 per Franc. Such an
arbitrage activity involving one million Francs would produce a profit of $200,000.
b. What would be the effect of your actions and those of other speculators on these
exchange rates?
6-14
The arbitrage actions in Part (a) would cause the Franc prices in New York and in
Frankfurt to converge to a “same” new price.
6. You manage the cash for a large multinational industrial enterprise. As a result of credit
sales on 90-day payment terms you have a large claim against a customer in Madrid. You
have heard rumors of the possible devaluation of the Spanish peseta. What actions, if any,
can you take to protect your firm against the consequences of a prospective devaluation?
You could hedge against the devaluation of the Spanish peseta by entering into a futures
contract (discussed in the Appendix to Chapter 11) for the delivery of an amount of
pesetas equal to the value of the credit sales at the existing exchange rate today.
7. Assume, as the loan officer of a commercial bank, one of your customers has asked for a
“commercial letter of credit” to enable his firm to import a supply of well-known French
wines. This customer has a long record of commercial success yet has large outstanding
debts to other creditors. In what way might you accommodate the customer and at the
same time establish protection for your bank?
The initial step in the process is for your customer (an importer) to substitute your
bank’s credit for its own through the use of a letter of credit issued by your bank. You
would not issue the letter of credit unless you are satisfied that your customer is in a
satisfactory financial condition. The letter of credit is sent to an exporter who draws a
draft on your bank for the price of the goods that are being sent to the importer. The
draft, shipping documents, etc., are forwarded to you. Once your bank is satisfied that
the terms of the letter of credit have been met, your bank accepts the draft which now
becomes a bankers’ acceptance. The shipping documents are transferred to your
customer who then acquires the goods that have been shipped by the exporter. For your
protection, the importer is required to deposit the proceeds from the sale of the goods in
its account at your bank until the amount of the bankers’ acceptance has been met. This
requirement provides some protection for your bank since funds are recovered as sales
are made.
8. For the entire year, the nation’s balance of trade with other nations has been in a
substantial deficit position, yet, as always, the overall balance of payments will be in
“balance.” Describe the various factors that accomplish this overall balance, in spite of
the deficit in the balance of trade.
Since the balance of payments must, by definition, always be in balance, any deficit in
the balance of trade must be offset by a surplus in the capital account balance. The
principal factor in the capital account is the net increase in investments in the U.S. by
foreign government and private investors.
9. Assume you are the international vice president of a small U.S.-based manufacturing
corporation. You are trying to expand your business in several developing countries.
You are also aware that some business practices are considered to be “acceptable” in
6-15
these countries but not necessarily in the United States. How would your react to the
following situations?
a. You met yesterday with a government official from one of the countries you would like
to make sales in. He said that he could speed up the process for acquiring the
necessary licenses for conducting business in his country if you would pay him for his
time and effort. What would you do?
We know that the concept of what is “acceptable” ethical behavior differs across
cultures and countries. In some countries it seems to be acceptable practice for
government officials and others to request “side” payments and even bribes as a
means for foreign companies being able to do business in these countries. Such
actions are morally wrong. Furthermore, with this said, the Foreign Corrupt Practices
Act prohibits U.S. firms from bribing foreign officials. Violators of this Act are
subject to fines, prison time, and lost reputation. Business-related bribes are both
illegal and unethical.
b. You are trying to make a major sale of your firm’s products to the government of a
foreign country. You have identified the key decision maker. You are considering
offering the official a monetary payment if she would recommend buying your firm’s
products. What would you do?
See the comments for (a.) above.
c. Your firm has a local office in a developing country where you are trying to increase
business opportunities. Representatives from a local crime syndicate have
approached you and have offered to provide “local security” in exchange for a
monthly payment to them. What would you do?
Extortion payments are morally wrong. Furthermore, paying organized criminals is

not different from paying corrupt government officials. See the comments for (a.)
above.
PROBLEMS AND ANSWERS
1. Exchange rate relationships between the U.S. dollar and the euro have been quite
volatile. When the euro began trading at the beginning of 1999, it was valued at 1.17
U.S. dollars. By late-2000, a euro was worth only $.83 and peaked at $1.60 in mid-2008.
Calculate the percentage changes in the value of a euro from its initial value to its late-
2000 value and to its high mid-2008 value.
Beg.-1999 to late-2000 percentage change = (.83 – 1.17)/1.17 = -.34/1.17 = -.2906 or

-29.06%
Beg.-1999 to mid-2008 percentage change = (1.60 – 1.17)/1.17 = .43/1.17 = .3675 or
6-16
36.75%
Late-2000 to mid-2008 percentage change = (1.60 - .83)/.83 = .77/.83 = .9277 or
92.77%
2. Over a two-year period, the U.S. dollar equivalent of a euro increased from $1.3310 to
1.4116. Using the indirect quotation method, determine the currency per U.S. dollar for
each of these dates.
Beginning (First) Date: Indirect Quotation = 1/$1.3310 = .7513 euros
Ending (Second) Date: Indirect Quotation = 1/$1.4116 = .7084 euros
3. Over a two-year period, the U.S. dollar equivalent of a euro increased from $1.3310 to
1.4116. Determine the percentage change of the euro between these two dates.
Percentage change = (1.4116 – 1.3310)/1.3310 = .0806/1.3310 = .0606 or 6.06%
4. A few years ago the U.S. dollar equivalent of a foreign currency was $1.2167. Today, the
U.S. dollar equivalent of a foreign currency is $1.3310. Using the indirect quotation
method, determine the currency per U.S. dollar for each of these dates.
A few years ago: Indirect Quotation = 1/$1.2167 = .8219 foreign currency
Today: Indirect Quotation = 1/$1.3310 = .7513 foreign currency
5. A few years ago the U.S. dollar equivalent of a foreign currency was $1.2167. Today, the
U.S. dollar equivalent of a foreign currency is $1.3310. Determine the percentage
change of the euro between these two dates.
Percentage change = (1.3310 – 1.2167)/1.267 = .1143/1.2167 = .0939 or 9.39%

The foreign currency has appreciated by nearly 9.4% relative to the U.S. dollar.
6. If the U.S dollar value of a British Pound is $1.95 and a euro is $1.55, calculate the
implied value of a euro in terms of a British Pound.
Implied value of a euro = 1.55/1.95 = .7949 British pounds
7. Assume a U.S. dollar is worth 10.38 Mexican Pesos and .64 euros. Calculate the implied
value of a Mexican Peso in terms of a euro.
Implied value of a Mexican Peso = .64/10.38 = .0617 euros
8. Assume that five years a euro was trading at a direct method quotation of $.8767. Also
assume that recently the indirect method quotation was .8219 euros per U.S. dollar.
6-17
a. Calculate euro “currency per U.S. dollar” five years ago.
1/$.8767 = 1.1406 euros
b. Calculate the “U.S. dollar equivalent” of a euro this year.
1/.8219 = $1.2167
c. Determine the percentage change (appreciation or depreciation) of the U.S. dollar

value of one euro between five years ago and this year.
% Euro Change = ($1.2167 - $.8767)/$.8767 = $.3400/$.8767 = 38.78%
d. Determine the percentage change (appreciation or depreciation) of the U.S. dollar

value of the euro currency per U.S. dollar between five years ago and this year.
(1.1406 - .8219)/.8219 = .3187/.8219 = 38.78%
9. Assume that last year the Australian dollar was trading at $.5527, the Mexican peso at
$.1102, and the British pound was worth $1.4233. By this year the U.S. dollar value of an
Australian dollar was $.7056, the Mexican peso at $.0867, and the British pound was
$1.8203. Calculate the percentage appreciation or depreciation of each of these three
currencies between last year and this year.
Australian dollar:
($.7056 - $.5527)/$.5527 = $.1529/$.5527 = 27.7%
Mexican peso:
($.0867 - $.1102)/$.1102 = -$.0235/$.1102 = -21.3%
British pound:
($1.8203 - $1.4233)/$1.4233 = $.3970/$1.4233 = 27.9%
10. Assume that the Danish krone (DK) has a current dollar ($US) value of $0.18
.
a. Determine the number of DK that can be purchased with one $US.
$1.00/$0.18 = 5.556 Danish krone (DK) per one $US
b. Calculate the percentage change (appreciation or depreciation) in the Danish krone

if it falls to $0.16.
($0.16 – $0.18)/$0.18 = –$0.02/$0.18 = –11.1%
c. Calculate the percentage change (appreciation or depreciation) in the U.S. dollar if

the DK falls to $0.16.
6-18
[($1.00/$0.16) – ($1.00/$0.18)]/($1.00/$0.18) = (6.250 – 5.556)/5.556 = .694/5.556

= 12.5%
Note: The percentage increase in the U.S. dollar is not the same as the percentage
decrease in the DK because the “bases” from which the calculations are made are not
the same.
11. Assume the U.S. dollar ($US) value of the Australian dollar is $0.73 while the U.S. dollar
value of the Hong Kong dollar is $0.13
.
a. Determine the number of Australian dollars that can be purchased with one $US.
$1.00/$0.73 = 1.370 Australian dollars per one $US
b. Determine the number of Hong Kong dollars that can be purchased with one $US.
$1.00/$0.13 = 7.692 Hong Kong dollars per one $US
c. In $US terms, determine how many Hong Kong dollars can be purchased with one
Australian dollar.
$0.73/$0.13 = 5.615 Hong Kong dollars per one Australian dollar
12. Assume one U.S. dollar ($US) can currently purchase 1.316 Swiss francs. However, it
has been predicted that one $US soon will be exchangeable for 1.450 Swiss francs.
a. Calculate the percentage change in the $US if the exchange rate change occurs.
(1.450 – 1.316)/1.316 = .134/1.316 = 10.2%
b. Determine the dollar value of one Swiss franc at both of the above exchange rates.
1/1.316 = $0.76
1/1.450 = $0.69
c. Calculate the percentage change in the dollar value of one Swiss franc based on the
above exchange rates.
($0.69 – $0.76)/$0.76 = –$0.07/$0.76 = –9.2%
13. Assume inflation is expected to be 3 percent in the United States next year compared
with 6 percent in Australia. If the U.S. dollar value of an Australian dollar is currently
$0.500, what is the expected exchange rate one-year from now based on purchasing
power parity?
6-19
FR1 = $0.500[(1.03)/(1.06)] = $0.500(.9717) = $0.486
14. Assume inflation is expected to be 8 percent in New Zealand next year compared with 4
percent in France. If the New Zealand dollar value of a euro $0.400, what is the
expected exchange rate one-year from now based on purchasing power parity?
FR1 = $0.400[(1.08)/(1.04)] = $0.400(1.0385) = $0.415
15. Assume the interest rate on a one-year U.S. government debt security is currently 9.5
percent compared with a 7.5 percent on a foreign country’s comparable maturity debt
security. If the U.S. dollar value of the foreign country’s currency is $1.50, what is the
expected exchange rate one year from now based on interest rate parity (IRP)?
FR1 = $1.50[(1.095/1.075)] = $1.50(1.0186) = $1.528
16. Assume the interest rate in Australia on one-year government debt securities is 10
percent and the interest rate on Japanese one-year debt is 5 percent. Assume the
current Australian dollar value of the Japanese yen is $0.0200. Using interest rate
parity (IRP), estimate the expected value of the Japanese yen in terms of Australian
dollars one-year from now.
FR1 = $0.0200[(1.10)/(1.05)] = $0.0200(1.0476) = $0.0210
17. Challenge Problem Following are currency exchange “crossrates” between pairs of
major currencies. Currency crossrates include both direct and indirect methods for
expressing relative exchange rates.
U.S. U.K. Swiss Japanese European

Dollar Pound Franc Yen Euro
European
Monetary Union 1.1406 ? 0.6783 0.0087 ---
Japan 130.66 185.98 77.705 --- 114.60
Switzerland 1.6817 2.3936 --- 0.0129 ?
United Kingdom ? --- 0.4178 ? 0.6162
United States --- 1.4231 ? 0.0077 0.8767
a. Fill in the missing exchange rates in the crossrates table.
European Union with UK Pound = 1/(United Kingdom with Euro) = 1/0.6162 =

1.6228
Switzerland with Euro = 1/(European Union with Sfranc) = 1/0.6783 = 1.4743
United Kingdom with $U.S. = 1/(United States Dollar with UK Pound) = 1/1.4231 =
.7027
6-20
United Kingdom with Yen = 1/(Japan with UK Pound) = 1/185.98 = 0.0054

United States with Sfranc = 1/(Switzerland with $U.S.) = 1/1.6817 = .5946
b. If the inflation rate is expected to be 3 percent in the European Monetary Union

(EMU) and 4 percent in the United States next year, estimate the forward rate of one
euro in U.S. dollars one year from now.
FR1 = SR0[(1 + US inflation rate)/(1 + EU inflation rate)] = $.8767(1.04/1.03) =

$.8767(1.010) = $.8855
c. If the one-year government interest rate is 6 percent in Japan and 4 percent in the
United Kingdom, estimate the amount of Yen that will be needed to purchase one
British pound one year from now.
Indirect Method:
FR1 = SR0[(1 + Japan inflation rate)/(1 + UK inflation rate) = (185.98 Yen)(1.06/1.04)
= (185.98 Yen)(1.019) = 189.51 Yen
d. Based solely on purchasing power parity (PPP), calculate the expected one-year
inflation rate in the U.S. if the Swiss inflation rate is expected to be 3.5 percent next
year, and the one-year forward rate of a Swiss franc is $.6100.
SR0 $U.S. value of a Sfranc is 1/1.6817 = $.5946

$.6100 = $.5946(x/1.035)
x = ($.6100)/($.5946/1.035) = $.6100/$.5745 = 1.062
The expected one-year inflation rate in U.S. would be: 1.062 – 1.0 = .062 or 6.2 %
Check: FR1 = $.5946(1.062/1.035) = $.5946(1.026) = $.61006
e. Assume the U.S. dollar is expected to depreciate by 15 percent relative to the euro at
the end of one-year from now and the interest rate on one-year government securities
in the EMU is 5.5 percent. What would be the current U.S. one-year government
security interest rate based solely on the use of interest rate parity to forecast forward
currency exchange rates?
Current Euro value in $U.S.: $.8767

$U.S. value after depreciation: -0.15 = (x - $.8767)/$.8767 = x = (1 – 0.15)$.8767 =
$.7452
Check: Percent Dollar Change: -15.00% = ($.7452 - $.8767)/$.8767 = -.1315/$.8767 =
-15.00%
$.7452 = $.8767(1.055/x)
x = ($.7452)/(1.055/$.8767) = $.7452/1.2034 = .900
The expected one-year U.S. interest rate would be: .900 – 1.00 = -.100 = -10.0%
Check: FR1 = $.8767(.900/1.055) = $.8767(.850) = $.7452
6-21
Of course it is not reasonable to have a negative one-year interest rate. Thus, interest
rate parity can not explain the expected 15% depreciation in the U.S. dollar.
SUGGESTED QUIZ
1. Define or discuss briefly:

a. European Union
b. Euro
c. Arbitrage in international exchange
d. Commercial letter of credit
e. The Export-Import Bank
f. Balance of trade
2. Briefly describe the European Union (EU) and indicate the number of founding and
current members.
3. Explain why members of the European Monetary Union (EMU) are also called eurozone
members.
4. Explain how purchasing power parity (PPP) and interest rate parity (IRP) are used to
forecast future or forward currency exchange rates between two countries.
5. List the major components involved in U.S. international transactions as contained in the
current account and capital account balances.
6-22
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SECTIONS OF DWELLING IN MATMATA WHERE I LIVED.
(Large-size)
PLAN.
(Large-size)
The courtyards measure, as a rule, between eleven and twelve

feet in depth and breadth.
The side caves are usually about twenty-seven feet long, but not
even half that in breadth; though I have seen them both larger and
smaller. These rooms are generally furnished with doors. The
passage also is, as a rule, closed at both the outer and the inner end
by means of a strong door or gate.
In the court is a fireplace intended for common use; in wet
weather the cooking is done in one of the underground rooms.
Further, there is often a tank into which water is conducted by pipes
from the earth’s surface. At the sides of the court stand large rush
baskets filled with corn, and sufficient space remains for fowls and
domestic animals, when, under special circumstances, such as
threatened danger, these are driven within.
Here and there in the passages are recesses for stabling horses
and donkeys, which stand therefore in utter darkness.
In a cave chamber it is dark when the door is closed, otherwise
there is sufficient light.
The accompanying sketch shows some of the dwellings inhabited
by the Khalifa and his nearest relatives.
From the flat, smooth, open space grown with olive and palm
trees, leads the passage to the courtyard.
Dwellings I. and II. are united, and have but one entrance.
Through the gate (A) is the entrance to a cave passage, and thereby
to the first courtyard. Here are to be found the following chambers:
One for the horses, one for the sheep, one containing a tank,
another is a kitchen, and, lastly, a store.
From the first courtyard one passes through another cave
passage into courtyard No. II. This provides dwellings for all the
Khalifa’s sons with their wives and children, and for the mothers of
these sons.
The Khalifa himself resides at night in an adjacent cave in
company with his third wife, but both spend the day with the rest of
the family in courtyard No. II., where they cook and eat in common.
As far as I could ascertain, no domestics live here.
This courtyard is furnished with rush baskets for corn, and with a
fireplace.
Amar has two chambers, one for each of his wives; and his
mother has another close by, so they occupy a whole side of the
court.
Two chambers are used as barley stores.
Fatima, Mohammed’s mother, has a room, and beside it is
another to which Mohammed’s second wife was brought. Exactly
opposite lives Mohammed’s first wife, and, on the same side,
Mansur and his only wife.
Last of all comes the kitchen.
I visited all these caves; each woman had her household pots and
pans prettily arranged on the inner wall of the chamber, as our cooks
do their brass utensils on their kitchen walls. Ranged on the sides
were various articles, while in the centre of the clay floor, adorned,
as a rule, with rush matting or with carpets, stood what appeared to
be a low table. This is the sleeping couch, on which carpets are
generally spread; on this the inmates sleep without undressing.
The whitewashed walls are bare but for the guns which are
sometimes hung there, as also keys, yarn, etc.
In Mohammed’s and Mansur’s rooms I saw some frightful framed
pictures, apparently supposed to represent the Prophet, and
evidently cheap rubbish bought at Gabés, corresponding in all
respects to the coloured prints of the Christ which we find in every
cottage in our country.
The comfortable cave rooms, and even the courtyard, were clean
and well kept. The fowls, indeed, had the run of yard No. II., but it
was evidently forbidden to cattle, which were restricted to the first
yard. By a long underground passage, provided with side recesses
for horses and donkeys, one entered yard No. III.; its chambers
included a large banqueting hall, the roof of which was composed of
two parallel vaults, supported where they met by a central row of
pillars. This hall occupied one entire side of the court, and opposite
to it were two rooms, used when I was there as guest-chambers; one
of these I occupied. They could also be utilised as corn stores; to this
end a shaft is dug from the surface, through the solid earth to the
dome, so that the corn may be poured down; and when the camels
bring the grain, it is unloaded near the mouth of the shaft.
Near the entrance to the passage are two rooms, also available
as stores for grain, but during my visit they were used as dwellings
for several male servants.
In yard No. IV. lived a negro family, who were entrusted with the
care of Mohammed’s and Amar’s two horses, and the two mules
belonging to the Khalifa and Mansur which were stabled there. There
was also a corn store, where the barley for the horses and mules
was kept, a writing-room, and a tank.
These four yards were used indiscriminately by the Khalifa and
his household.
Now we come to the two other dwellings—V. and VI. In one lived
a cousin of the Khalifa; the other was occupied by an old fellow
called Uncle Srair Feteish, under the same conditions as the courts
already mentioned.
A little farther off was the dwelling occupied by the Khalifa and his
third wife; this was also composed of subterranean rooms, two on
either side. One of these chambers was occupied by the Khalifa and
his third wife, one by an Arab servant, another was used to keep
clothing in, a fourth as a kitchen, two others as stores for dates, and
the last as a writing-room.
Owing to his official position, the Khalifa has a certain amount of
correspondence, and therefore requires a proper place in which to
preserve documents. These are all written in Arabic characters; the
Berber alphabet being unknown in Hadeij, and but little, I believe, in
the whole of Southern Tunisia. Though in many villages the Berber
language is spoken, it is not in Hadeij, where it appears to be
forgotten in spite of the natives being Berbers.
The above-mentioned dwellings are far from being the only ones
possessed by the Khalifa, for both in Hadeij proper and in the
environs he owns several houses occupied by his retainers. He also
owns caves, reserved for his occasional use, in the vicinity of his
distant groves of palms and olives, when, as in harvest time, the
trees have to be watched.
The caves that I saw in the Matmata mountains were, with few
exceptions, of the same description. Of these exceptions may be
mentioned the caves I found in Sid ben Aissa. To these led
uncovered ways, so that one had a direct view into the courtyards
from the outside. Also at Beni Sultan I observed steps that sloped
from the upper surface to the courtyard. The rooms in this instance
were not so symmetrical; many of them were not excavated on the
same level as the court, but were raised a few steps above it. This
very irregularity rendered these caves more picturesque and
interesting than those of Hadeij.
In the enclosures were several tanks, and in the rooms I saw
women spinning with wheels.
The approach to these houses was by means of steps cut in the
calcareous soil; where the steps terminated was a gate by which one
passed into a fine vaulted underground chamber, and thence into the
courtyard.
The Sheikh of Beni Sultan owned also an oil mill, erected in an
underground cave, that, with its vaults and colonnades, closely
resembled the crypt of a church. In one of these vaults I saw the mill,
which is worked by a donkey or a camel, and is composed of a large
round stone turning on a broad low stone cylinder. In a neighbouring
vault close by was erected a primitive oil press.
In Duirat, the most southern village of Tunisia, I found caves of a
rather different description. These were of the same dimensions as
the chambers already described, and were cut in the sides of cliffs.
Before the door of the caves an enclosure was frequently made, and
within this stood a house, through the centre of which was a passage
leading into the cave.
This style of building has the advantage that in summer the
natives can seek the shelter of the cave, where it is cooler than in
the house; and, again, should the house be attacked, they could
retire into the cave, the entrance being easy to defend.
That the dwellings are not all caves probably arises from the fact
that there is not always sufficient space in the mountains for the
many large chambers required to accommodate a number of people.
The cave is the original dwelling; the house followed as an
appendage. The hedged-in enclosure mentioned can be utilised as a
shelter for cattle.
Near Tatuin I noticed, in passing, a rock cave that was merely an
irregularly dug hole. It was inhabited.
In the mountains I discovered several of the same description, but
uninhabited; being occupied in harvest time, when the dates and
olives need guarding.
At Tujan I saw, excavated in the cliffs, several ancient caves with
small terraces in front of them; they had long been abandoned as
dwellings.
MEDININ.
Lastly, I must touch briefly on a mode of building found on the

plains, in the villages of Metamer and Medinin, and evidently deriving
its origin from the cave.
Small, oblong, domed houses are built side by side in a square,
thus forming a complete citadel of exactly the same form as a cave
dwelling; the plan of cave construction having been copied
aboveground.
BEDOUIN WOMEN GROUPED BEFORE THEIR HUT.
In Southern Tunisia there are numerous large villages, such as

Hadeij, Lasheish, Ben Aissa, besides some smaller, as, for instance,
Judlig, which are composed exclusively of cave dwellings.
Moreover, caves are found mingled with other dwellings in Beni
Sultan, Smerten, and Sguimi.
Cave dwellings therefore prevail in the valleys, and real houses
on the mountains.
Finally, the more primitive caves are found on mountain slopes,
as, for instance, at Duirat.
The villages that consist of houses are of stone or sun-dried
blocks of clay. They stand, as a rule, high on the mountains, and
much resemble those of the Kabail in Algeria, or the ancient French
villages on the mountains of Auvergne.
CHAPTER VII
From Gabés to the Oasis of El Hamma —
The Shotts
Just after I had changed my clothes, the hotel waiter announced

that a sheikh wished to see me, who, when ushered in, proved to be
Mansur; following him came Hamed. They both looked so very
serious that I feared something had gone wrong; but Hamed,
observing my puzzled expression, whispered to me that Mansur had
come to invite me to the wedding feast.
After I had returned Mansur’s greeting, we both sat down, he on
the bed cross-legged, I on a chair, while Hamed showed some tact
by placing himself behind me to serve as interpreter, for Mansur
understood little French.
After an interchange of compliments, which were indubitably
sincere on either side, Mansur came to the point. His father, the
Khalifa, had desired him to say, that if I would go to Hadeij and be
present at the last great feast on the fifth day, he would regard it as a
proof of my friendship for him and for the Matmata; that I should be
treated as a brother, and if I would remain there many, many years I
should be welcome.
Mansur came again the following day to see me; with him and
Hamed I visited the villages of Jara and Menzel, where I intended
making purchases for our National Museum, and therefore required
their help.
AT GABÉS.
In the great Sok (market-place) I bought agricultural implements,

hoes and spades,—which were made under my eye,—one of the
primitive ploughs and its harness of plaited esparto grass; and, lastly,
a collection of garments. Consequently there was much noise and
lively quarrelling, though it did not reach quite the same pitch as
recently in Lasheish.
In the afternoon I took a carriage with the British Vice-Consul
Galleja and his brother, Cesare Galleja, two exceedingly obliging
men, and drove to the village of Menzel, as I wished to obtain some
reliable information from an Arab there, about the marriage customs
of the country.
On our return we met the Khalifa of Gabés, who told us he was
also invited to the wedding at Hadeij, but had been obliged to refuse
as he could not leave Gabés, General Allegro being absent;
therefore in the interim, the government of the whole district fell
entirely on himself. He advised me to take with me a small bridal gift,
so the same evening I bought a fine haik.
The military officers at Gabés are nearly all unmarried. Those of
the same grade mess together—that is to say, they engage a cook
who provides for them.
The lieutenants of the 4th African Light Battalion and some other
officers invited me to dine at their mess. We were altogether a score
of men, and I spent a bright and pleasant evening amongst my new
African friends; and made acquaintances which were to be renewed
some days later in the south, whither several of them were
immediately proceeding.
This was the first, but not the last, time that I while in these
regions had the pleasure of replying to the toast of “To the Danish
soldier,” with “I drink long life to the French army,” with whom I
served eleven years ago when they were fighting in the south.
On the 22nd October, Hamed and I again left Gabés, starting with
the dawn at 5.30 a.m., and proceeding this time in a westerly
direction.
The Spahis had supplied me with a small but powerfully-built
brown horse, capable of pacing between five and six miles an hour
when so inclined. At first it wanted to hurry on, but I restrained it, and
we walked past the village of Menzel, and traversed the palm
groves, where the birds twittered, and the smoke from huts and tents
rose to the tree-tops. It was bitterly cold, and we wrapped our
burnouses closely about us. When we rode out of the oasis the sun
had risen, and cast our shadows in long lines on the undulating
golden-grey plain.
Far away to our right the rays of the sun were reflected from the
whitewashed walls of a Marabout’s tomb, built on a hillside. There
also stood the poste optique, which is in communication with another
on a mountain near Medinin, the southern military station.
We allowed our horses to break into a hand gallop that refreshed
us in the beautiful morning, as, with a keen sense of enjoyment, we
followed the tracks that, with countless windings, led towards the
west.
There was little vegetation; the land lay before us barren and
desolate.
IN THE MOUNTAINS—ON THE ROAD TO AIN

HAMMAM.
Before reaching the summit of a slight rise we pulled up our

horses to a walk, and presently looked back from the top of the
eminence.
A haze hung directly over Gabés; the palms of the oasis extended
as far as the sea, and behind them glittered the bright waves. Away
towards the south we could distinguish the blue peaks of the
Matmata mountains. Here and there on the plain blue-grey smoke
rose into the air.
The heat of the sun became scorching, so we allowed our horses
to go at foot’s pace during the remainder of the way. In Africa one
finds but two paces—a walk, or rather an amble, and a gallop; but on
a long summer journey the gallop or canter is rarely used; Berber
horses, therefore, are trained to walk fast. It is expected of a cheval
de la plaine that he should be un bon marcheur, that is to say, that
he can be depended on to cover his five or six miles an hour, and to
keep up this pace the whole day long.
When we had ridden about a third of the way, we crossed the
river; near it is an ancient well that has been used since the time of
the Romans.
From the level of the ground was constructed a walled, paved,
and inclined passage; this was covered in, and terminated at the
spring, from which were built upright walls to the surface of the earth,
forming the well. Thus the water can either be drawn from the top or
carried up the steps.
During the next couple of hours we met only a few riders and
pedestrians.
A mountain plateau of no great height now showed before us, but
a little to our left. Towards the north it lost itself in the plain in a level
slope, over which wound the track.
On the hill the soil was washed or blown away, leaving the barren
flat rocks naked, and the horses had difficulty in keeping their footing
amongst the large rough stones. In one place the path wound on
either side of a small pile of stones. This heap was the length of a
man, and lay east and west. Hamed informed me that it covered the
remains of one who had been murdered on this spot many years
ago.
After a time we reached the highest point of our day’s journey, and
came upon a magnificent view.
The foreground was composed of a level, stony slope of dull-
yellow soil. Where it ended we saw a long, narrow, grey strip with a
tufted border; this is part of the palm grove of El Hamma oasis.
Beyond it, to the left—therefore to the south-west—ran a mountain
ridge, and farther on the right was a shining level plain, somewhat
white in appearance. This is the “shott” of El Fejej. It resembled the
sea when dead calm, and seemed as though it had flowed thence to
lose itself far away in the western horizon.
North of the “shott” the mountains tower up in successive tiers,
the foremost, of a deep blue tint, contrasting sharply with the white
flat surface of the “shott.”
Beyond are paler blue peaks, and beyond them again the vague
outlines of far-distant mountains.
Shott Fejej is the most easterly of the “shotts” that extend in a
long line from the Sahara south of Biskra to the Mediterranean, thus
covering a track of between two and three hundred miles.
It is only separated from the Mediterranean by Le Seuil de Gabés,
a small strip of land about eleven miles wide.
A “shott” is low-lying land of which the soil is clay saturated with
salt; this in the rainy season is flooded by the overflow of the rivers,
and dries by evaporation. Seen from a distance, a shott has the
appearance of a lake, but on approaching it one is disappointed to
find that this glittering flat surface is only a crust of saltpetre.
Not only is travelling extremely dangerous on this sodden ground,
but the shott is stifling hot in summer, and in winter bitterly cold.
Drummond Hay told me that at the beginning of the year, he, with
only one servant and a guide, had ridden over Shott Jerid on his way
from Kebelli to Tozer. Though warmly clad, he was nearly frozen,
and his fingers could scarcely grasp the reins from the cold. The way
lay along a narrow path, and on either side was bog; a single false
step means death.
It is asserted that it is only in the centre of Shott el Jerid that there
is always water; but this is not apparent, as it is entirely covered by a
crust of salt, on which footsteps resound as they do when passing
over a vault. The water naturally flows to the lowest level; but when
the wind blows, it sweeps the water in various directions over the salt
crust; this breaks under the weight, and the level is thus altered. At
times there may be as much water in the shott as would reach to a
horse’s girths.
The crust is also occasionally forced up from below by water and
certain gases, and, rising, forms small conical mounds, giving the
impression of an impending volcanic eruption. These little mounds lie
like islands on the sea; but, in consequence of the reflection from the
surface, appear to be hills of some height, and are visible for many
miles around.
One of these, the largest, is called “Jebel el Malah” (the salt
mountain). It is only some twenty paces in diameter, and scarcely a
yard in height above the level of the shott, but looks from the
distance like a fair-sized hill. In the centre of this hill of salt was
formerly an old well, now filled up. It contained water of the same
quality as that still found in several other wells in the shott, which is
not more brackish than that found in the oases of the vicinity and
considered drinkable.
The caravan roads traverse the shotts, leading from verge to
verge amongst the oases. Some of these roads are very unsafe. The
traveller has to be most careful to avoid being bogged, or plunged
suddenly into a hole; as told of a whole Egyptian army, which,
according to tradition, found here its grave. Step by step must the
traveller work his way forward, perhaps through clouds of dust; whilst
a mirage may rise to tempt and deceive him. Should his guide make
the least mistake, or the camel or horse he rides step aside, all is
over.
According to custom, usage, and agreement betwixt the tribes,
the roads over the shotts are supposed to be defined by stones, or
felled palm trunks, placed at distances of about a hundred yards
apart; but in places these, which are called “Gmair,” are missing; in
others they are replaced by camel bones.
The Arabs relate frightful misfortunes that have befallen on these
tracks. Whole caravans have been known to have been swallowed
up by this treacherous earth crust, which at once closes over its
prey.
The land amidst the shotts is par excellence the home of the date-
palm. In the oases of Tozer and Nafta are found the best quality of
dates known. This clear transparent fruit is sold at £6 the
hundredweight. In El Hamma, on the other hand, the dates are not of
the best quality, the oasis being too near the sea, and the air,
therefore, too damp. This explains what one hears of the dates of
Gabés being sold at only twelve shillings the hundredweight, or one
tenth of the price of those from Nafta.
Many authors and explorers, both ancient and modern, have
imagined that in the basin of the shotts they had discovered the
Triton sea of Herodotus, believing the river bed of Wad Malah to be
the lower course of the Triton river, which connected that mysterious
lagoon with the sea.
Though this hypothesis has never been proved, Raudaire, captain
of the general staff, conceived in 1878 the bold project of
reconstructing the old Triton sea, by leading water into the immense
basin of the shotts. He thought it would be only necessary to dig
through the eleven miles of the wide chalky tract near Gabés to form
a large inland sea. From this scheme great advantages were to be
gained. The southern French frontier would be protected by a natural
barrier. The re-created Triton sea would soon be traversed by
shipping, thereby leading to mercantile relations being established
with regions and people hitherto unknown.
And what a change might result in the climate! The moisture
would create fruitful stretches of land, where colonists would flock in
numbers.
Alas! the project, vigorously supported at the outset by the
Government, proved untenable after further investigation in 1876.
Raudaire’s survey had not been accurate. The western shott did
indeed lie twenty metres below the sea-level, but the immense shotts
of “Jerid” and “Fejej” proved, on the other hand, to be as much
above it; so that the canal would have had to be prolonged nearly
one hundred and fifty miles, and even then only the first named of
these shotts would be submerged.
This unfortunate revelation did not dishearten either Raudaire or
his celebrated supporter, Lesseps; and, until the death of the former,
in 1885, he—Raudaire—defended his project with an energy and
determination worthy of a better cause, and in spite of the State
having wisely withdrawn its support. Lesseps still visited the ground
on several occasions, and positively asserted that at the cost of a
hundred and fifty millions of francs the scheme was feasible. From
past events it is sad to note that great minds like Lesseps’s often
have recourse to dubious expedients when they desire to lancer une
affaire.
All other learned authorities—geologists and scientific men, such
as Parnel, Letourneux, Doûmet-Adamson, and others—had, long
before, sharply criticised Raudaire’s fantastic project, and declared
that the sea had never in ancient times occupied the flats now filled
by the shotts. Indeed, Cosson further maintained that had this
proposed inland sea been successfully dammed, it would soon have
been imperatively necessary to fill it up again, so much opposed
would it have been to the general interest.
All were, moreover, agreed that it was highly improbable that the
climate would be influenced to any extraordinary degree; that, by
admitting the water, millions of date-palms would be destroyed, and
most of the springs which now fertilise the oases of the Jerid would
be tainted and spoiled by the salt water, thus causing the ruin of the
country; finally, the project would cost a thousand (in place of a
hundred and fifty) millions of francs.
Lesseps’s repeated assurances of the accuracy of his researches
were received very coldly, though this was before the occurrence of
the Panama affair.
Now the question is closed, and one hears nothing more of the
company formed in 1882 by the great Frenchman, pour la création
de la mer interieure. The old man’s prestige had been on the wane
for some years already. Yet the day will come when the memory of
his important works will obliterate the recollection of the errors of the
evening of his life, and history will again grant him the title which is
his due—that of “the great Frenchman.”
CHAPTER VIII
The Oasis of El Hamma
On the southernmost border of this oasis lies a village built of

sunburnt stones, and of which the narrow lanes were almost
deserted when we passed through it.
The Khalifa lived on the outskirts towards the south, and when we
arrived he was squatting on a stone bench that ran the whole length
of the outer wall of his house. The shade was delicious beneath the
eaves of the broad roof supported by two rows of felled palm-tree
stems. I cannot help thinking that these were the origin of the pillars
of the ancients, and suggested to the Egyptians the design for the
columns of their temples, and, through them, those of the Greeks
and Romans in their magnificent temple halls.
Around the Khalifa were sitting, standing, or lying, groups of loud-
voiced men, all talking. He was holding a court of justice, which was
attended with the wrangling, jostling and thrusting, usual on such
occasions.
Crouched in front of him was a man, near whom were a woman
and child, and around them was gathered an interested, excited
crowd.
The woman, with outstretched hands, addressed the Khalifa,
speaking in a subdued voice and with the striking gestures peculiar
to Orientals. She was immediately interrupted by the man, who
shouted and gesticulated. Other men joined in. I saw arms and
clenched fists in constant motion, and was deafened by the noise
rising from every side.
The Khalifa, a man of about fifty, sat, mild and amiable, gazing at
the crowd with his deep black eyes. His fine figure was slight and
noble, and his features refined, with a slightly hooked nose and a full
beard, through which his fingers were occasionally passed. Now and
then a hidden fire flashed from his expressive eyes as he made a
remark. Then the shouts of the crowd would moderate, but only for a
moment, and again the storm broke loose.
At last it really grew too bad, and what I had expected for some
time came to pass—one of the Khalifa’s men punished the crowd
with a stick. Some retreated a little, others remained calmly seated,
and the inquisition recommenced, until again the demonstrations
became too violent.
Our arrival interrupted this scene for a time. I was kindly received
and shown to a dwelling on the first floor of a side wing.
When my baggage had been brought in, at his invitation I seated
myself beside the Khalifa on his carpeted bench, where we partook
of the “welcome” of coffee in tiny cups, whilst we discussed my
journey and my motives in undertaking it.
The man, woman, and child remained unmoved all the time, and
stared at us from the same spot where, probably, they had been for
hours. She was old, ugly, and wrinkled, and gazed vacantly before
her. The child, a pretty ten-year-old boy, looked inquisitively at me
with his fine black eyes, whilst the man drew his hood over his head
and hid his hands under his burnous, so that he appeared to be a
mere white bundle.
Thus they sat, resigned to their fate, the men around keeping
moderately quiet. If one or another became noisy, he was silenced
by one of the Khalifa’s attendants.
I begged the Khalifa to continue his judicial proceedings, and,
after some hesitation, he did so, leaving me seated on his carpet,
and going aside a little took his place beneath one of the pillars.
Whilst the flies swarmed in myriads about me, and the hubbub of
men’s voices buzzed in my ears, I leant against the wall and gazed
before me. From the subdued light beneath the shade of the eaves
my eyes scanned the sunlit plain which extended to the mountains.
To the right the palm tops on the southern edge of the great groves

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Introduction to Finance Markets

Investments and Financial Management

Introduction to Finance Markets Investments and

Introduction to Finance Markets Investments and

Introduction to Finance Markets Investments and

Introduction to Finance Markets Investments and

Basic Finance An Introduction to Financial Institutions

Real Estate Finance and Investments 15th Edition

Introduction to Derivative Securities Financial Markets

Introduction to Derivative Securities Financial Markets

I. GLOBAL OR INTERNATIONAL MONETARY SYSTEM

II. EUROPEAN UNIFICATION

D. European Union Financial Crisis

III. CURRENCY EXCHANGE MARKETS AND RATES

IV. CONDUCTING BUSINESS INTERNATIONALLY

V. FINANCING INTERNATIONAL TRADE

VI. BALANCE IN INTERNATIONAL TRANSACTIONS GOAL

I. GLOBAL OR INTERNATIONAL MONETARY SYSTEM

A general discussion of the nature of international trade and finance provides an

An international monetary system is designed to foster world trade, manage the

(Use Discussion Questions 1 through 5 here.)

II. EUROPEAN UNIFICATION

The European Union is an organization established to promote trade and economic

The European Monetary Union is an organization of European countries that

(Use Discussion Questions 6, 7, and 8 here.)

III. CURRENCY EXCHANGE MARKETS AND RATES

IV. CONDUCTING BUSINESS INTERNATIONALLY

V. FINANCING INTERNATIONAL TRADE

the level of U.S. imports when they experience temporary balance-of-payments

VI. BALANCE IN INTERNATIONAL TRANSACTIONS GOAL

The nations of the world strive to achieve international financial equilibrium by

DISCUSSION QUESTIONS AND ANSWERS

1. What is the purpose of an international monetary system?

Special Drawing Rights is a reserve asset, consisting of a basket of currencies,

4. What is an international monetary system based on “flexible exchange rates”?

An international monetary system based on flexible exchange rates is a system in which

5. Describe the international monetary system currently in use.

The European Monetary Union (EMU) is an organization of European countries that

8. What is the euro? Identify some of its distinguishing characteristics.

thwart efforts to easily counterfeit the bills.

10. What are currency or foreign exchange markets?

A commercial letter of credit is prepared by a bank and commits the bank to

EXERCISES AND ANSWERS

2. Explain the concept of “balance” as it relates to a nation’s balance of payments.

3. As an exporter of relatively expensive electronic equipment, you have a substantial

As an exporter shipping merchandise to a little-known foreign customer, you can protect

See the comments for (a.) above.

Extortion payments are morally wrong. Furthermore, paying organized criminals is

PROBLEMS AND ANSWERS

Beg.-1999 to late-2000 percentage change = (.83 – 1.17)/1.17 = -.34/1.17 = -.2906 or

Beginning (First) Date: Indirect Quotation = 1/$1.3310 = .7513 euros

Ending (Second) Date: Indirect Quotation = 1/$1.4116 = .7084 euros

Percentage change = (1.4116 – 1.3310)/1.3310 = .0806/1.3310 = .0606 or 6.06%

A few years ago: Indirect Quotation = 1/$1.2167 = .8219 foreign currency

Today: Indirect Quotation = 1/$1.3310 = .7513 foreign currency

Percentage change = (1.3310 – 1.2167)/1.267 = .1143/1.2167 = .0939 or 9.39%

Implied value of a euro = 1.55/1.95 = .7949 British pounds

Implied value of a Mexican Peso = .64/10.38 = .0617 euros

a. Calculate euro “currency per U.S. dollar” five years ago.

1/$.8767 = 1.1406 euros

b. Calculate the “U.S. dollar equivalent” of a euro this year.

c. Determine the percentage change (appreciation or depreciation) of the U.S. dollar

% Euro Change = ($1.2167 - $.8767)/$.8767 = $.3400/$.8767 = 38.78%