International Finance British Monetary System
BRITISH MONETARY SYSTEM 7
Prior to 15th of February, 1971, the British monetarysystem was known as shillings, pence, and pounds. From the systemused at that time, 12 pennies equaled one shilling,and 20 shillings equaled one pound. After 1971,the United Kingdom adopted a new system called decimalization andwith that, it brought the currency to be in line with the metricsystems that were used in Europe based on logical system of ten andfactors of ten. With decimalization, it introduced a system ofpence and pounds and thus doing away with the shillings altogether.The United Kingdom currency is known asBritish Sterling (Davies, 2009)
Evolution of British Monetary System
In Britain, the monetary system mainly evolved with activeintervention from the government. In 1694, the Bank of England wasfounded as a private institution and later adopted a role as a lenderfor itself as a last resort over the course of the 19thcentury. During that period, the British monetary system was greatlytransformed. The first half of the century saw the country populatedby small banking systems. Until 1825, when joint-stockbanking system was allowed for the first time, other banks apart fromthe Bank of England were restricted to small partnerships (Madura,2010). Through mismanagement or fraud, many financial systems failedwhile every other national or local crisis led to spatecollapses. Unlike the Bank of England, these banks lacked thecapacity to withstand any form of adverse circumstances.
At the onset of the First World War, themonetary system in Britain had become a global envy by withstandingthe financial crises and executing trade policies that affected othercountries. The British monetary system thenwithstood the effects of both the worldwars and global crisis of 1930-1933 (Click & Coval, 2002). Thisstability continued even after the World War Two when secondarycrisis of 1974 left the British banks and trade policies unscathedand unattended. From 1974 to 2007, the British monetary system hassince reverts the model that served it well in the past. The banks’oversight currently lies with the Bank of England where stabilitycould not be disregarded.
Components of the Monetary System in Britain
A central bank, the monetaryauthority, and reserve bank are institutions that help to manage thestate’s currency, interest rates, and money supplies. Central banksare also responsible for overseeing thecommercial monetary systems of their respective country. A centralbank in contrast with the commercial banks possesses monopoly byincreasing the monetary base in the respectivestate, and in addition prints the country’s legal tender (Cappie &Wood, 2012). Examples include the Bank of England, the EuropeanCentral Bank, and Federal Reserve of the U.S.
In this case, the Bank of England is the centralbank of Britain and its primary function is to manage the centralgovernment’s money policy (money supply) by active duties forexample, managing the interests’ rates, acting as the last resort’slender to the banking sector, setting of the reserve requirementduring financial crisis. The Britishmonetary system has a supervisory power that intends to prevent therun of banks and also to reduce the risk organizations, financialinstitutions, and the commercial banks often engage in fraudulent orreckless behavior (Davies, 2009). In Britain, its monetarysystem is institutionally designed for it to be independentfrom political influence. Again, the legislative and executivebody that exists has limited control (Cappie & Wood, 2012). Inaddition, the British central bank chief executive is normallyreferred to as the President, Governor or the Chairman.
Currency Exchange Rates and its Impact
According to Click & Coval (2002), the British exchange ratesmeasures the real value of the currency against other currencies bytaking into account the changes in relativity prices and describeswhat can be bought. For example inSeptember 2014, the nominal exchange rate for the sterling poundmeasures the value of the current currency against the othercurrencies. For instance, 1 dollar equaled 0.62 pounds.
Effective rates of exchange often measurethe said currency, in this case, the poundagainst a basket of different currencies, which is often tradeweighted. For example, without paying attention tothe Sterling pound exchange rate, the British banks compares thevalue of the pound against other currencies depending on how ittrades with other country partners (Dow & Saville, 1988).The Euro, the Yen, and the Dollar provides a weighting that dependson the manner the country trades with other countries, for example,Euro zone is 60%.
The United Kingdom exchange rate has been impressive butjeopardizing at the same time. This is due to the effect of globalmelt down and recession globally. One ofthe pivotal features is the floating exchange rate of the monetarysystem in the UK. One impact that comes with the exchange rates isthe weak relation that exists between the exchange rate and theinflation due to integration of the pricing across the market models.The exchange rates according to the market have not been takenconsiderably when import price settlers create impact on theaggregated inflation level of the United Kingdom. Ultimately, theimpact has been finalized that the exchangerates and inflation do get influenced bythe value of UK’s currency rates and monetary value.
According to Madura (2010), some of the MonetaryPolicy Committee members like Bernanke, Vickers, and Gertler haveplayed a very important role in framing short term exchange rates andthat their belief in the exchange rates impact lies in monetarypolicy. After the exchange rates had beencalculated, it was discovered that connections betweenexchange rates and retail price is very weakwhen compared. On the other hand, the relation between exchange ratesand import size maintains a comparative closer relationship (Madura,2010).
Issues Surrounding Economic, Transaction and Transaction Exposure
An example of the manner in which aninternational transaction exposes a firm to the risk of changes inexchange rates is supposedly working in an organization based in theUnited States and the organization is interested in commercial realestate in the United Kingdom. The property agent wouldconsider substantial offers on the property for a two-month period,the time that they will organize the sale of propertyto the party offering the highest bid. The employer would takeapproximately two months to conclude the transaction and assumeproperty possession.
From the above scenario, there are a number of issues that arises asa result of foreign exchange risk exposures. The first foreignexposure risk that the scenario highlightsis the costs or revenues of a transaction may change in response todomestic currency (Dow & Saville, 1988). The issue of transactionexposure results when the firm agrees to complete a foreign currencydominated with exchange amounts in the future.
Transaction exposure is the second type of foreignexchange that arises when converting foreign values’ currencydominated assets and liabilities into a single value currency(Davies, 2009). It is easier to understand translation exposure byconsidering sheet balance of a multinational corporation. Theliabilities and assets for example British Multinational Corporationare dominated by many different currencies.As the exchange value of British sterling pounds changes, so does theliabilities and assets dominated in foreign currencies. The company’snet worth could be reported in the sheetbalance, which also changes (Click & Coval, 2002).
The final one is the economic exposure thatis an issue that affects the exchange rate on the firm’s currentvaluation of the future income streams. The economic exposure affectsthe liability of a firm to compete in acertain market calculated over an extended period.According to Cappie & Wood (2012), some economists believe theleast portion of the foreign direct investments could resultin the firm’s efforts to avoid the effects of economic exposure. Byowning a firm in a foreign location, it could have a financial effectif all its plants avoid some foreign exchange risks that may havebeen incurred if all the offices and firms were located within thecountry.
Sterling Pounds’ Futures or Options for the Investors
After a close examination of the exchange rates on SterlingPounds, I could recommend the investors to buy futures inthe currency. This is because the economy experiences a dire effecton credit rating downgrade by the ratingagency in mid-February, 2014, thus recessionary concerns plagued theeconomy. However, all this factors coupled with the escalationin European foes at the beginning of 2015 saw a sense ofresponsibility for performance dismissal of the pound versus that ofU.S dollar. This vicious currency sells off has made the currencyless expensive for the investors at this time. itbecomes true to consider current level as a proposition at this time,which is relatively true thus it is perfect for the investors toseek exposure in the British Pound, thus providing them with anexcellent time for investing in buying futures in the British market.
Capie, F., & Wood, G. E. (2012). Money overtwo centuries: Selected topics in British monetary history.Oxford: Oxford University Press.
Click, R. W., & Coval, J. (2002). Thetheory and practice of international financial management.Upper Saddle River, N.J: Prentice Hall.
Davies, B. (2009). The United Kingdom and the world monetarysystem. London: Heinemann Educational.
Dow, J. C. R., & Saville, I. D. (1988). A critique of monetarypolicy: Theory and British experience. Oxford: Clarendon Press.
Madura, J. (2010). International corporate finance. Mason,Ohio: South-Western.