Money, Banking, and International Finance

Method 2: A foreign bank does business in the U.S. through a foreign bank branch. This
is a full fledge bank that accepts deposits and makes loans. Consequently, the foreign bank
branch must follow the U.S. banking regulations.
Method 3: A foreign bank enters the U.S. market through a subsidiary U.S. bank. Foreign
bank buys U.S. bank stock, becoming the majority shareholder. Thus, the foreign bank controls
the U.S. bank, converting it into a subsidiary. Many foreign banks use subsidiaries to enter the
U.S. banking market because the U.S. has an extremely complex legal system. Hence, the U.S.
bank employs staffs and experts who know the laws, rules, and regulations. If a foreign bank
opened a new branch, the managers and staff would spend time learning and complying with all
numerous rules and regulations.

Exchange Rate Risk

An exchange rate equals the ratio of one currency to another currency. We usually write an
exchange rate as Equation 1. For example, one U.S. dollar equals 1.5 euros.

$1 = 1.5 euros ( 1 )

For instance, you plan a trip to the United States, and want to convert 1,500 euros into U.S.
dollars. How many U.S. dollars would you have? We use a trick with exchange rates – retain the
currency units in the calculation. If you computed correctly, then only one currency unit would
remain after the calculation. We can form two ratios with the currency by dividing both sides of
the equation by one of the currency units. We show the two ratios in Equation 2:

1

1.5

1

=

euros

$ or

1

1.5

1

$

euros

= ( 2 )

Now multiply the ratios by 1,500 euros. We see the first ratio is correct in Equation 3
because one currency unit remains after the calculation. Ratio for Equation 4 is wrong because
the euro currency units become squared.

1,000

1.5

1

1,500 =$

euros

$

euros ( 3 )

 

1

2.25

1

1.5

1,500

2

$

euros

=

$

euros

euros ( 4 )

Exchange rates can fluctuate over time. If the exchange rate had changed to Equation 5,
subsequently, the U.S. dollar buys more euros. Thus, the U.S. dollar appreciated. If the U.S.
dollar appreciated, then the euro automatically depreciated. Consequently, appreciation means a
currency becomes worth more in terms of another currency, while depreciation implies the