ECON RETAKE
Give four reasons why managing an international business is different from managing a domestic business.
-countries are different -the range of problems confronted by a manager in an international business is wider and he problems themselves more complex than those in a domestic business -an international business must find ways to work wihin he limits imposed by government intervention and in the international trade and investment system -international transactions involve converting money ino differen currencies
Why has it been so difficult for nations to agree on such a set of rules?
-how to tax profits earned in a supply chain that includes more than one nation -political challenge -limit ability of state to pursue independent industrial policies or policies to promote and subsidize approved firms.
Three main costs from inward FDI for the host country
-possible adverse effects of FDI on competition within the host nation -adverse effects on the balance of payments of the host country -perceived loss of national sovereignty and autonomy
What are the key determinants of economic growth?
1) Innovation and entrepreneurship are the engines of growth.-if the political system supports and sustains innovation and entrepreneurship, economic development is possible 2)Innovation and entrepreneurship require a market economy-market economies align the interests of producers (whose goal is to maximize profits) with the wants and needs of the consumers. 3)Innovation and entrepreneurship require strong property rights-if the law does not adequately protect the owner of the rights to intellectual property, there will be less chance of investment in new technological processes 4)Economic progress requires the optimal political system-only in a well functioning democracy are property rights usually secure over the long run.
What are the main uses of foreign exchange markets for international business?
1) he market is used to convert payments a company receives in foreign currencies into the currency of its home country 2) the market is used to convert the currency of a company's home country into another currency when the company must pay a foreign company for its products and services in the currency of the foreign company's country 3)international businesses may use foreign exchange markets when they have spare cash that they wish to invest for short terms in money markets (of another country) 4) the market is used for currency speculation
In a two-country, one-good model, Trinidad and Jamaica both produce only rum. The domestic price of one bottle of rum in Jamaica is 10 Jamaican dollars. The domestic price of one bottle of rum in Trinidad is 15 Trinidadian dollars. According to PPP, what will the exchange rate between the two countries be?
10 jamaican dollars/15 trinidadian dollars = 0.667 is the exchange rate
What is a capital market? Define market makers.
A capital market brings together those who want to invest money and those who want to borrow money. Those who want to invest money include corporations with surplus cash, individuals, and non-bank financial institutions. Those who want to borrow money include individuals, companies, and governments. Between these two groups are the market makers. Market makers are the financial service companies that connect investors and borrowers, either directly or indirectly. They include commercial banks and investment banks.
What is a currency board? Why do countries choose this type of system? What are the disadvantages of this type of arrangement?
A country that introduces a currency board commits itself to converting its domestic currency on demand into another currency at a fixed exchange rate. To make the commitment credible, the currency board holds reserves of foreign currency equal, at the fixed exchange rate, to at least 100% of the domestic currency issued. The system is attractive because it limits the ability of the government to print money and thereby create inflationary pressure. Under a strict currency board, interest rates will adjust automatically. However, critics point out that if local inflation rates remain higher than the inflation rate in the country to which the currency is pegged, the currencies of countries with currency boards can become uncompetitive and overvalued. Also, the system does not permit governments to set interest rates.
Compare and contrast currency crises, banking crises, and foreign debt crises.
A currency crisis occurs when a speculative attack on the exchange value of a currency results in a sharp depreciation in the value of the currency, or it forces authorities to expend large volumes of international currency reserves and to sharply increase interest rates to defend the prevailing exchange rate. In contrast, a banking crisis refers to a loss of confidence in the banking system that leads to a run on banks as individuals and companies withdraw their deposits. Finally, a foreign debt crisis is a situation in which a country cannot service its foreign debt obligations, whether private-sector or government debt.
What is the eurocurrency market, and why is it an attractive market to both lenders and depositors?
A eurocurrency is any currency banked outside of its country of origin. Eurodollars, which account for about two-thirds of all eurocurrencies, are dollars banked outside the United States. Other important eurocurrencies include the euro-yen, the euro-pound, and the euro-euro. A eurocurrency can be created anywhere in the world; the persistent "euro" prefix reflects the European origin of the market. The main factor that makes the eurocurrency market attractive to both depositors and borrowers is its lack of government regulation. This means that the spread between the eurocurrency deposit rate and the eurocurrency lending rate is less than the spread between the domestic deposit and lending rates. Companies have strong financial motivations to use the eurocurrency market. By doing so, they receive a higher interest rate on deposits and pay less for loans. Back
Explain how a firm or an individual can use forward exchange rates to reduce or eliminate foreign exchange risk.
A farmer selling his crops to the US in six months decides to lock in a forward exchange rate now so that in six months he knows how much his US dollars will transfer over to canadian dollars. instead of waiting until when he wants to sell the crops and taking a chance that the exchange rate is very bad and he looses money.
Under what circumstances might a firm prefer to engage in FDI rather than exporting or licensing?
A firm will favour FDI over exporting as an entry strategy when transportation costs or trade barriers make exporting unattractive. Furthermore, the firm will favour FDI over licensing(or franchising) when it wishes to maintain control over its technological know-how, its operations, or its business strategy or when the firms capabilities are simply not amenable to licensing.
When Hill writes "a fundamental shift is occurring in the world economy" he is referring to
the growing ecnonomic integration of many markets and, increasingly, production. Yet international trade, international finance, and the spread of cultural norms and ideas are not new. But we are becoming part of a fundamental shift and a single world economy, in which economic changes in one part of the wold have profound effects on others.
What are the advantages and disadvantages of licensing compared to FDI?
Advantages: licensor does not have to pay in terms of cost, time, or risk to open up a foreign market, as this has already been established by the license. Disadvantages: Licensing may require that a firm relinquish valuable knowledge or technology to a potential foreign competitor. Licensing does not give the firm adequate control over the manufacturing, marketing, and strategy making aspects of a business located in a foreign country. Firms providing the licence may not feel that the licensee is adequately exploiting all of the profit potential inherent in the foreign market.
What general concerns do critics of globalization raise?
Allowing firmss to relocate to countries that have little commitment to protect the environment. Undermining national sovereignty by creating a global economy too strong for any government to resist producing homogenized disney-like culture. increasing income inequality exploiing labour and producing poverty in the less developed regions of the world. allowing global firms to shift production to low-wage regions of the world. Destroying jobs in advanced countries and pushing wage down everywhere, particularly in developed countries
If current trends continue, China may emerge as the world's largest economy by 2020. Discuss the possible implications of such a development for each of the following: the business strategy of today's european and US-based global corporations
Already, annual foreign direct investment has jumped from less than $2 billion in 1983 to $100 billion in 2010.
What are the possible benefits of FDI for sending (home) countries?
Balance of payments benefits from the inward flow of foreign earnings. Employment effects, positive employment effects arise when the foreign subsidiary creates demand for home-country exports. When home country MNE learns valuable skills from it's exposure to foreign markets that can subsequently be transferred back to the home country. This amounts to a reverse resource-transfer effect.
What is meant by the term institutional arrangements, and why are these important to a country's prospects for economic growth?
Can be many forms such as a contract enforcement, private property protections, copyright, patent etc. Important for encouraging private-sector risk taking and investment in research and development. The institutional arrangements a country sets up, within which economic activity takes place, will determine the set of economic incentives facing firms and individuals. This largely determines the flow of investment and the pattern of growth.
What is meant by capital flight?
Capital flight is a large-scale exodus of financial assets and capital from a nation due to events such as political or economic instability, currency devaluation or the imposition of capital controls
Discuss the challenges that Starbucks faced as it attempted to expand into the Chinese market. Are there any potential costs to the Chinese economy that may arise as a result of widespread trademark violation?
Challenges: China had many copy cats to compete with, some that even copied their logo and name almost identically. Starbucks sued for trademark violation. China has a high rate of trademark violations and cracking down on this in China would greatly impact the Chinese economy negatively, as a large amount of money is made from selling "knock offs"
If current trends continue, China may emerge as the world's largest economy by 2020. Discuss the possible implications of such a development for each of the following: global commodity prices
China is also making waves in international markets as its firms like Hisense (see Management Focus: China's Hisense—An Emerging Multinational) prove to be world-class competitors.
If current trends continue, China may emerge as the world's largest economy by 2020. Discuss the possible implications of such a development for each of the following: the world trading system
China is continuing to move toward greater free market reforms, and if it stays on its present track, it could become an industrial superpower in the near future.
If current trends continue, China may emerge as the world's largest economy by 2020. Discuss the possible implications of such a development for each of the following: the world monetary system
China, with over 1.2 billion people, is a largely untapped market for firms. By some estimates, the Chinese economy could be larger than that of the United States on a purchasing power parity basis.
Name the three types of financial crisis and describe the characteristics of each.
Currency Crisis: happens when a country with a pegged exchange rate finds its currency being sold off in large volumes in foreign exchange markets to the extent that the ability of the government to maintain he peg is threatened. Can also happen when widespread selling is taking place and the value of the domestic currency is falling. Banking Crisis: happens when there is a widespead loss of confidence in the banking system. When depositors attempt to remove deposits on a large scale Foreign Debt Crisis: happens when a country either cannot service its foreign debt obligations or is in danger of not being able to service those debts.
What is meant by currency convertibility?
Currency convertibility is the ease with which a country's currency can be converted into gold or another currency.
What is the relationship between corruption and economic growth?
Firms need to know if they make investments their private property rights will be respected. If a government has a bad reputations of rewriting the rules by transferring profits from the firm to the government officials or politicians, investments will eventually dry up and disappear. Similarly, a firm contemplating investment knows that if officials must be bribed at every step to perform their regular duties, risks increase and costs rise.
What is the basic liberal argument in support of free trade? What are some limitations of this argument?
Free competitive markets lead to efficiencies in both employment of technology and location of production. If It is more efficient to organise production on an international basis, profit-seeking firms will attempt to do so. Free market and free consumers will ensure that goods are produced with the most efficient technology in the most efficient location. Limitations: markets may not provide for a clean environment, they will not likely provide for essential public goods such as national defence. We may also disapprove of the distribution of income produced by the market and adopt policies to tax those with high incomes and provide subsidies to those with low incomes.
What are the arguments in favour of developing a global set of rules governing MNC investment?
Efficiency could be enhanced globally if the word were able to develop a global investment regime based on "universal and neutral principles" analogous to he free trade principle. This would have the same advantages as a global free-trade agreement, in that investment and output would tend to move according to the dictates of comparative advantage, not according to which government was offering the largest subsidies at the moment.
What is the most common approach to exchange rate forecasting?
Fundamental Analysis- draws upon econmic theories to predict future exchange rates, including factors like interest rates, monetary policy, inflation rates, or balance of payments information
What is the difference between a green-field investment and acquiring or merging with an existing firm?
Greenfield: establishment of a new operation in a foreign country. Acquiring or merging: joining forces or buying an already existing firm in a foreign country.
Define performance requirements, and indicate when they might be used.
Host nations will attempt to maximize the external benefits that may arise. For example a government might seek to ensure that locals are employed, trained, and taught how to use specific technologies and this obligation would be considered a performance requirement.
Explain how currency swaps work and why a firm may engage in a currency swap.
the simultaneous purchase and sale of a certain amount of foreign exchange for two different valuation dates. This activity is conducted to eliminate foreign exchange risk. Swaps can be conducted between banks, between a firm and a bank, or between governments where large amounts of currency are moved from one location to another.
Free-market economies stimulate greater economic growth, whereas state-directed economies stifle growth. Discuss.
In a market economy private individuals and corporations are allowed to own property and other assets. These rights to ownership provide powerful incentive for people to work hard, introduce new product, develop better advertising campaigns, invent new products, etc. All in hopes of accumulating additional personal capital and wealth. The quest for individuals and companies to accumulate wealth enriches the entire economy and creates economic growth. In a command economy private individuals and corporations are not allowed to own substantial amounts of property and other assets. The objective of a command economy is for everyone to work for the good of society instead of working to build personal wealth. This does not provide people with great incentives to invent new things, be innovative, be more efficient, etc. In result command economies typically generate less innovation and are less efficient than market economies.
What are the benefits of a global capital market as compared to a purely domestic capital market?
In a purely domestic capital market, the pool of investors is limited to residents of the country. This places an upper limit on the supply of funds available to borrowers. In other words, the liquidity of the market is limited. A global capital market, with its much larger pool of investors, provides a larger supply of funds for borrowers to draw on. An important drawback of the limited liquidity of a purely domestic capital market is that the cost of capital tends to be higher than it is in an international market. In a purely domestic market, the limited pool of investors implies that borrowers must pay more to persuade investors to lend them their money. The larger pool of investors in an international market implies that borrowers will be able to pay less. Back
How might the Internet and the associated World Wide Web affect international business activity and the globalization of the world economy?
Internet has exploded over he last two decades. In 1990 fewer than 1 million people were connected to the internet. In 2015 this has risen more than 2.4 billion. One of the biggest implicaions of the internet is its role as an equalizer. Firms are no longer constrained by size, location, scale, and time zones. Instead, firms operate in a 24/7/365 world with real time access. In the US more than 365 billion in goods and services are sold online. Location is no longer an issue because the internet makes it possible to reach customers anywhere in the world.
What is a civilization, and why does Huntington fear growing conflict between civilizations?
Is a cultural grouping of people that are differentiated from each other by religion, history, language, and tradition. He fears that clash of civilizations will dominate politics and believes it will be the latest phase in evolution of conflict in the modern world.
What are the major functions of the World Bank
Less conterversial than IMF. Focused on making low-interes loans to cash-strapped governments in poor nations that wish to undertake significant infratructure investments (such as building a dam or road)
How has the composition of LDC exports changed over the past 25 years?
LDC exports have increased rapidly over the past 25 years, and the composition, or structure, of those exports has changed as well. Twenty-five years ago, most LDC exports consisted of raw materials such as lumber, tin, copper, oil, gold, and so on. Very few processed resources or manufactured goods were exported. The third wave of globalization has seen an explosion of manufacturing exports from LDCs. Much of this has been associated with MNC investment in LDCs.
What are the potential benefits to an LDC from out-migration? What are the potential costs to that LDC?
LDCs can benefit from out-migration in a number of ways. When unemployed workers leave to find employment elsewhere, the economic burden on families and the local government is reduced. If migrants move to regions where they are able to find employment, as they usually do, they will likely send funds back to their home country to help relatives. However, many countries, especially poorer countries, cannot afford to lose many of their skilled or professional workers. Yet these are often the workers that are able to secure the necessary permits, especially in the developed countries. A poor country may invest a significant amount in advanced education for an individual and then lose the benefits of this investment if that individual is able to migrate to a developed high-income country.
How did the Mexican peso crisis differ from the Iceland debt crisis?
Mexico: when inflaion and interest rates lose consistency with the exchange rate. Government permitted money supply to grow rapidly and prices were acceleratig much more than prices in the US. Mexicos trade deficit to rise as Mexican exports were priced out of foreign markets. Iceland: Banking sector went from localized to privitized and the three biggest bans adopted unstustainable business models that relied heavily on expansion of operations outside of iceland. Where higher leverage was possible and greater investment growth was realized.
Why does Gilpin (2002) regard the post-1980 era as the "era of the MNC"?
Multi-national corporations (MNC), post-1980, was a time of significant advances in technology, communications and transportation. As a result, these changes provided an opportunity for many facilities to conduct business around the world, much easier, faster and cheaper. The world has been exposed to and revolutionized as a direct result of these changes. Changes occurred in areas such as banking, insurance and retail and grew drastically over this time period. As a result of the internet and telecommunication drastic advances it has made it possible to conduct business and distribution from anywhere around the world
Why did Mutharika resist IMF calls for Malawi's currency devaluation? If he had lived and remained in power, what do you think would have happened to the economy of Malawi?
Mutharika thought that devaluing the currency would cause price inflation and hurt the country's already poor population. If he had remained in power, anti-government sentiment would have exploded, possibly leading to a civil war and great unrest within the country, as Mutharika had already alienated many foreign governments that were freezing financial aid to the country.
What political and economic factors explain Venezuela's and Nigeria's poor economic performances? What are the risks facing foreign firms that do business in both of these countries?
Nigeria: The country has several competing ethnic, tribal, and religious groups that conflict and give limited political stability. Poor leadership and a lot of corruption like leaders stealing oil profits. Venezuela: Collapse in oil prices which accounted for 70 percent of the country's exports left them with a large budget deficit and forced recession. Took various enterprises into state ownership. The states control over business activities gave officers a lot of opportunity to enrich themselves by demanding bribes in return for permission to expand operations. Risks of doing business in both firms are the government being so unstable and the high levels of corruption. It is risky to invest in business in a country with this much political uncertainty.
What are the major functions of the International Monetary Fund (IMF)
established to maintain order in the international monetary system. Set up to promote economic development. Seen as a lender of the last resort to naition states whose ecnomies are in turmoil and whose currencies are losing value against other nations. IMF loans come with strings attached, requring states to adopt specific ecnomic policies aimed at returning their troubled ecnomoies back to stability and growth.
From the perspective of international business, what is attractive about the Polish economy? What are the weaknesses and risks associated with doing business there?
Poland's transition from a communism country to a democracy is a work in progress. Steps are being taken to simplify tax laws, reduce tax rates, and remove bureaucratic hurdles to doing business in the country. The entrepreneurship law dramatically reduced the number of health, labour, and tax controls that companies had to comply with, making i much easier to start a business there. In addition the country continues to privatize state-owned enterprises, which has helped increase the country's GDP, making it more attractive for foreign investment.
Why is the transition toward a market-based economy often difficult ?
Privatization process could be dominated by a small number of people who buy public assets for a small price leading to corruption. Ex; Russia
Why might firms selling products with low value-to-weight ratios choose FDI over exporting?
Products with low value-to-weight ratios such as soft drinks or cement are frequently produced in the market where they are consumed. When transportation costs are added to production costs it becomes so unprofitable to ship such products over a long distance. For firms that can produce low value to weight products at almost any location, the attractiveness of exporting decreases and FDI or licensing becomes more appealing.
What is meant by the term globalization of production? Support your explanation with an example.
Refers to the sourcing of goods and servics from locations around the globe to take advantage of ecnonomies of scale and location economies. Location economies are the national differences in the cost and quantity of the factors of production. These economies have given many firms opportunity to lower their overll costs and/or improve the quality of their products or services therefor making them more competitive low-cost producers Example: A boeing aircrafts parts are manufactured in various countries around the world. They have found foreign suppliers who are the best in what they do.They can produce certain goods or services in large volumes so their per unit total costs of production come down, this is what "economies of scale" mean.
What are the main advantages of FDI for host (recipient) countries?
Resource Transfer Effects- Employment Effects- Balance of Payments Effects- Effects on Competition and Economic Growth-
Compare the three waves of globalization.
SEE PICTURE
Discuss Huntington's views on Islamic fundamentalism.
global terrorism is a product of tension between civilizations and the clash of value systems and ideology. He maintains that while many societies may be modernizing, they are not becoming more western. Modernization in non-western societies can result in retreat toward the traditional, such as the resurgence of Islam in many traditionally Muslim societies. According to him, the rise of Islamic Fundamentalism is a response to alienation produced by modernization.
Describe the trends in foreign direct investment and world trade over the last half century.
Since 1960 the volume of world merchandise trade has grown faster than the world economy. In particular world trade has accelerated since 1980. This trade and investment pattern implies that firms are dispersing parts of their production to different locations around the world to drive down production costs and increase product quality, that the economies of the worlds nation states are becoming more intertwined, that foreign direct investment is playiing an increasing role in the global economy as firms increase their cross-border investmens, and hat the word has become significiantly wealthier over the last 55 years.
What factors led to the breakdown in the fixed exchange regime between 1968 and 1972?
has a difficult time coping with major economic changes in important countries, especially when a major country is determined to introduce a monetary policy that will cause inflation to rise.
What is the difference between a spot exchange rate and a forward exchange rate?
Spot: is the rate a currency is converted into another on a particular day. Spot exchange rates are reported and change daily. They changed based upon supply and demand for that currency relative to others. Forward: when two parties agree to exchange currency and execute the deal at some specific date in the future. Can be quoted/agreed upon 30, 90, 120 days.
How did the political and economic policies implemented over the last 20 years help Ghana prosper? What does this mean for existing and potential investors in this country?
Strong demand for two major exports, gold and cocoa. Also the start of oil production. Liberalisation in the economy, privatizing state-owned enterprises, instituting market-based reform and opening Ghana up to foreign investors. This means investors will choose Ghana to conduct business in due to heir largely privately held economy and the new laws put in place to limit the ability for corruption.
What are the two major drivers of globalization? How have they contributed to globalization?
Technologicl Changes- changes in communications, transportation technology, and information-processessing. Wireless communication, world wide web, the internet. These have all dramatically reduced the cost of information procesing. Allows for firms to manage global enterprises as if they were local. How do they contribute? they drastically reduce the costs of managing, communicating, and shipping. This allows international businesses to search the globe to find the best price for an input or the most cost effective location for a certain part of producion process.Being a low cost producer is essential for establishing or maintaining market share and being competitive globally. Reduction of Barriers to Trade and Investment- Rapid growth in international trade and internaionl investment flows could not have taken place without he second driver; a dramatic reduction in government barriers to internaional trade and investment flows. With GATT and WTO the world has embraced market liberalization and firms are taking advantage of market opportuniies that these barriers had previously denied.
According to William Cline, which factor has contributed the most to rising inequality: technological change or globalization?
Technology is much more powerful of a driver for inequality. Study shows that technological change was five times more powerful in widening inequality in America between 1973-1993 than trade (including trade due to FDI)
What is the "grand bargain" that was struck at the Uruguay Round?
The LCDs agreed to lower their tariffs on manufactured goods and accept western approaches to recognizing intellecual property rights (IPRs) in exchange, rich countries agreed to include agriculture in the trade talks, to abolish quotas on textiles and clothing, and to abolish the use of voluntary exchange restrictions.
Debate the relative merits of fixed and floating exchange rate regimes. From the perspective of an international business, what are the most important criteria for choosing between the systems? Which system is more desirable for an international business?
The case for fixed exchange rates rests on arguments about monetary discipline, speculation, uncertainty, and the lack of connection between the trade balance and exchange rates. In terms of monetary discipline, the need to maintain fixed exchange rate parity ensures that governments do not expand their money supplies at inflationary rates. In terms of speculation, a fixed exchange rate regime precludes the possibility of speculation. In terms of uncertainty, a fixed rate regime introduces a degree of certainty in the international monetary system by reducing volatility in exchange rates. Finally, in terms of trade balance adjustments, critics question the closeness of the link between the exchange rate and the trade balance. The case for floating exchange rates has two main elements: monetary policy autonomy and automatic trade balance adjustments. It is argued that a floating exchange rate regime gives countries monetary policy autonomy. Under a fixed rate system, a country's ability to expand or contract its money supply as it sees fit is limited by the need to maintain exchange rate parity. In terms of automatic trade balance adjustments, under the Bretton Woods system, if a country developed a permanent deficit in its balance of trade that could not be corrected by domestic policy, the IMF would agree to a currency devaluation. Critics of this system argue that the adjustment mechanism works much more smoothly under a floating exchange rate regime. They argue that if a country is running a trade deficit, the imbalance between the supply and demand of that country's currency in the foreign exchange markets will lead to depreciation in its exchange rate. An exchange rate depreciation should correct the trade deficit by making the country's exports cheaper and its imports more expensive. Which system is better for an international business is a matter of personal opinion. We do know, however, that a fixed exchange rate regime modelled along the lines of the Bretton Woods system will not work. Nevertheless, a different kind of fixed exchange rate system might be more enduring and might foster the kind of stability that would facilitate more rapid growth in international trade and investment.
What is the relationship between civilizations and globalization?
The effects of Globalization reach every corner of the world in different scope and degree. ... It is important because civilization incorporate the essence of world order. Civilization contains and reflects both economic, social, cultural and political aspects and dimensions of the world order.
What are the major factors that account for the growth of the global capital market?
The growth in global capital market is due to advacements in information technology, widespread deregulation of financial services, relaxation of governing cross border capital flows.
What is meant by the term globalization of markets?
The merging of national marketplaces into one large global marketplace. This process has been facilitated largely since the late 1960's. Global market is for goods and some services, but also includes markets for financial services.
Explain how changes in transportation technology have aided globalization.
The most important are development of the commerical jet aircraft and superfreighters, and he introduction of containerization which simplifies transshipment from one mode of transportation to another. Containerization aided in globalization by making shipping goods more efficient, cost efffective, faster, and easier.
Huntington (1993) stated that "the conflicts of the future will occur along the cultural fault lines separating civilizations." In light of this statement, discuss the major aspects of recent conflict between parts of the Muslim world and the West.
The united states is turning a blind eye to legitimate palestinin grievances as it underwrite both israeli economy and army of occuptation in Gaza and the west bank. The US troops in Saudi Arabia, the harm to the civilian population caused by trade sanctions against countries in the region, and the war against iraq are all evidence of the bankrupt US policy toward the muslim world.
Consider the following scenario. The rate of inflation in Malaysia is 10 percent; in Singapore, it is 5 percent. The nominal rate of interest in Malaysia is 3 percent; in Singapore, it is also 3 percent. Is this a stable equilibrium position? If not, what will happen to capital flows, nominal interest rates, and the exchange rate between the two countries? Assume that both currencies are fully convertible.
This is not a stable equilibrium situation because the real interest rates are higher in Singapore than in Malaysia. This situation will lead to investors looking to take advantage of the higher rate of return in Singapore. Investors located in Malaysia will sell off their stocks, bonds, and other assets and then convert them to the Singaporean currency. This creates an increase in the demand for the Singaporean currency in the foreign exchange market, which leads to an appreciation of the currency as capital flows into Singapore. The demand for financial instruments will rise in Singapore, and the demand for financial instruments in Malaysia will fall. Conversely, as investors leave Malaysia, there is a capital outflow and greater supply of Malaysia's currency in the foreign exchange market, which leads to a depreciation of the currency. An opposing influence to all of this is that arbitrage will soon equalize the differences in real interest rates. Because the real interest rate is lower in Malaysia, investors will borrow money in Malaysia and invest it in Singapore, causing an increase in the demand for money in Malaysia. This has the effect of raising the real interest rate, while the increase in the supply of money flowing into Singapore will lower the real interest rate in Singapore. Equilibrium will be restored only when the real rates of interest are the same in both countries. Another issue to consider is the fact that the inflation rates are vastly different between Malaysia and Singapore. Inflation in Malaysia is double that of Singapore, which will put downward pressure on Malaysia's currency. To slow this trend, nominal interest rates have to rise. Back
You are the CEO of a company that has to choose between making a $100 million investment in Russia or Poland. Both investments promise the same long-run return, so your choice is driven by risk considerations. Assess the various risks of doing business in each of these nations. Which investment would you favour and why?
When assessing risks of investment one should consider the political, economic, and legal risks of doing business in both Russia and Poland. The political risk in Russia is still high, but the government continues to change under Putins leadership, and is courting foreign investment. Relatively speaking Poland is more stable than Russia, but it may have less potential. On the economic front, both countries have inflation and economic turmoil, as unproductive factories are still struggling in Russia, and migrant workers returning from Western Europe are increasing Poland's unemployment rate. From a legal perspective, Poland is making steady progress, while the situation in Russia is still unclear. At the time the risk in Russia would be higher.
Describe the growth of the global capital market over the past 15 years.
significant rise in the number of international bond and equity offerings in the global capital market.This market is seen as an extremely easy and effective mechanism to raise capital.
What is the International Fisher Effect?
summarizes the relationship between exchange rates, interest rates and inflation. It states that for any two countries, the spot exchange rate should change in an equal amount but in the opposite direction to the difference in nominal interest rates between two countries.
What kinds of policies might national governments use to attract MNC investment?
tariff policies, tax policies, regulatory environment, and so on.
What are the possible advantages to a nation of attracting MNC investment?
accelerate economic growth, especially in the less developed regions of the world and more countries have adopted MNC-friendly investment policies that are designed to attract, as opposed to repel, foreign investment.
What are location-specific advantages, and why might they be an important factor in explaining FDI?
advantages that arise from utilizing resource endowments or assets that are tied to a particular foreign location and a firm finds valuable to combine with its own unique assets. In order to exploit such foreign resources, a firm must undertake FDI.
Explain how a flexible exchange rate system operates. What are the advantages and disadvantages of this model?
allows exchange rate to be determined by supply and demand. Adv: can implement independent domestic monetary policies help adjust trade balances Disadv: add to uncertainty of currency movements and speculation
What are the main determinants of supply of a nation's currency in the foreign exchange market?
change in the amount of goods and services imported. Ex: as an economy's employment and output rises, there is a greater demand for foreign-produced goods and services, which leads o a greater supply of Canadian dollars and Canadians convert their currency into the foreign currency. This also is the case if there is a greater amount of FDI made by canadians to foreign markets or if more canadians are visiting international locations.
Globalization is a good example of Schumpeter's creative destruction. Explain.
creative destruction describes the impact of the evolution of change on an economy. Many changes benefit the society; however, there are also costs involved. As new products become available others become obsolete. For example when Henry Ford created the first automobile in time the horse and carriage became obsolete. In our globalized economy firms and workers must be flexible to changing market conditions in order to survive the remain competitive.
What is arbitrage?
the simultaneous buying and selling of currencies or commodities for profit in two or more markets with inconsistent prices.
Describe the difference between "hot money" and "patient money." Which of the two is preferable to enhance economic development and prosperity? Why?
hot money is short term capital flows and patient money is long term investments.
What were international policy makers most concerned about when they gathered in 1944 in Bretton Woods, New Hampshire?
how to devise a set of rules governing international monetary arrangments that all would agree to follow and tha would kee the world from falling back into the protectionist trend of 1930s.
What is the relationship between interest rates, the rate of inflation, and exchange rates?
if real interest rates are the same in two countries, then nominal interest rate will differ only because of differing rates of inflation. If the rate of inflation in one county is higher than it is in the other country, the value of the currency of the inflating country must fall.
Describe how a domestic capital market functions, and explain what is meant by cost of capital.
institutions where savers can direcly provide funds to borrowers or investors. Helps matches one persons saving to another persons investment. Cost of capital is the cost of raising or borrowing capital. Ex; a firm issues a bond at 8% interest. The 8% is the cost of capital
Explain the theory of purchasing power parity (PPP). Use an example to show how PPP can help explain exchange rates.
it states that given relatively efficient markets, the price of a basket of goods should be roughly equivalent in each country. Ex: If a basket of goods costs $200 in the united states and 20,000 yen in japan. PPP predicts that the dollar/yen exchange should be 200/20,000 or US $0.1 per Japanese yen.
What role does the IMF play in the international economy?
maintaining order in the IMF system. Nations would go to the IMF when they ran into difficulty maintaining a fixed exchange rate they had commited to keeping. They policed the nations to ensure they were following the policy
What is the role of commercial and investment banks?
mediate between savers and investors. A commerical bank will take deposites from firms and individuals that wish to save out of current income and lend to individuals and firms who wish to spend more than current income. Investment banks bring lenders and borrowers together directly.
What is meant by non-convertibility?
neither residents nor non-residents are permitted to convert the domestic currency to a foreign currency
What are the major function of the World Trade Organization
responsible for policing the world trading system and making sure nation-states adhere to he rules laid down in the trade treaties signed by WTO member states. Also responisble for facilitating the establishment of additional multinutional agreements between WTO member states. They have promot the lowering of barriers to cross-border trade and investment.
Why might PPP not be a good predictor of exchange rates in the short run?
this can happen for a number of reasons -PPP theory assumes no transportation costs or barriers o trade, but we know there are differences in transportation costs and trade barriers between countries. Government intervention in cross-border trade affects the efficient workings of the market, as price of goods and services are influenced. -Government intervention in the form of buying and selling currencies in the foreign exchange market further weakens the link between price changes and changes in exchange rates. The PPP theory tends to be less useful when applied to currencies of advanced industrialized nations that have small differences in inflation rates -The PPP theory also does not take into account the influence of the changes in investor psychology or perceptions that can lead to large changes in the exchange rates.
