MAN3600 Test 3

The Law of One Price

"The exchange rate based on just one good or service"

Examples of Countertrade Transactions

- Caterpiller recieved caskets from Columbian customers and wine from Algerian customers in return for selling them earthmoving equipment. - Goodyear traded tired for minerals, textiles and agricultural products. - Control Data Corporation accpeted Christmas cards from the Russians in a countertrade deal. - Pepsi-Cola acquired the rights to distribute hungarian motion pictures in the West in a countertrade transaction.

Foreign exchange quotations

- U.S. Terms - European Terms - Direct Quotation - Indirect Quotation - Cross Rates

Types of Countertrade: Counterpurchase

- also known as a back-to-back transaction or offset agreements - involves two distinct contracts

why do firms consider countertrade?

- better than no trade at all - firms get a foothold in new markets and help them cultivate new customer relationships - help develop new sources of supply - a way of repatriating profits frozen in a foeign subsidiary operation's blocked accounts

Types of Countertrade: Compensation Deals

- involve payment both in goods and cash

External factors

- market potential (size and growth) - market access (national controls) - competition - intermediaries available - shipping considerations

Terms of Shipment: Ex-Works (EXW)

- price quotes that apply only at the point of origin - the seller agrees to place the goods at the disposal of the buyer at the specified place on the date or within the fixed period

Countertrade

- refers to an international business transaction where all or partial payments are made in kind rather than simultaneously in exporting and importing - also known as a "two-way" or "reciprocal" trade, countrertrade operates on the principle of "I'll buy your products, if you buy mine" - goods and services are traded for other goods and services when conventional means of payment are difficult, costly or nonexistent. Thus, barter is a form of countertrade

Types of Countertrade: Barter

- refers to the direct exchange of goods without any money - involves a single contract

Terms of Shipment: Cost and Freight (CFR)

- seller quotes a price for the goods, including cost of transportation to the named port of debarkation - cost and insurance are left to the buyer

Terms of Delivery: Delivery Duty Unpaid (DDU)

- seller responsible for delivery to buyer, exluding customs duties and taxes

Types of Countertrade: Buy-back Agreement

- the seller agrees to supply technology or equipment to construct a facility and receives payment in the form or goods produced by the facility

Nature of Countertrade

- while the exact extent of countertrade is unknown, some observers estimate that it accounts for as much as 1/3 of all world trade. - countertrade occurs in response to two primary factors: 1. the chronic shortage of hard currency in developing economies 2. the lack of marketing expertise, adequate quality standards, and knowledge of western markets by developing-economy enterprises. Countertrade enables them to access markets that may otherwise be inaccessible and generate hard currency.

Convertible currencies

A currency that can be readily bought or sold without government restrictions, in order to purchase another currency

Foreign Exchange

All forms of internationally-traded monies including foreign currencies, bank deposits, checks, and electronic transfers

The Bretton Woods Agreement

Bretton Woods established the: - Parties agreed to fixed exchange rates (an "adjustable peg") among members. - International Monetary Fund (IMF): Agency that promotes exchange rate stability, monitors exchange systems, provides funding to developing economies. - World Bank: Agency that provides loans and technical assistance to combat global poverty around the world.

Which of the following statements is true about currencies?

Convertible currencies can be readily exchanged for other currencies.

In an export quote, the seller agreed to be responsible for the shipment of goods to the dock of a port in the buyer (importer)'s country EXCLUDING the costs of ocean shipping insurance. Which of the following incoterms do the seller and buyer use?

Cost and Freight (CFR)

Which one of the following international shipment terms imposes the highest level of responsibility in delivery to the seller?

Delivery Duty Paid (DDP)

Which strategy should be used?

Depends on: - Vision - Attitude toward risk - Available investment capital - Level of commitment (technology and management) - How much control is desired

If last year one dollar equaled one euro, and then the exchange rate shifted so that today one dollar equals two euros, which of the following would most likely NOT occur?

European firms would lower their prices on goods made with U.S. parts.

Which one of the following modes of foreign market entry offers the lowest level of risk and control for the firm?

Export mode

Globalization of Financial and Monetary Activities

Growing integration of financial and monetary global activity is due to: - Evolution of monetary and financial regulations worldwide. - Emergence of new technologies and payment systems in global finance, e.g., the Internet. - Increased global and regional interdependence of financial markets. - Growing role of single-currency systems, e.g., the Euro.

Letter of Credit Process

Step 1 - exporter/importer contract to sell / buy Goods. Step 2 - importer applies for letter of credit. Step 3 - importers Bank issues letter of credit to exporters bank on importers behalf. Step 4 - exporters Bank informs exporter of letter of credit Step 5 - exporter ship goods to importer Step 6 - exporter delivers documents to its Bank Step 7 - exporters bank checks documents and pays exporter Step 8 - exporters Bank delivers documents to importers Bank Step 9 - importers bank send payment to exporters bank Step 10 - importer pays its bank for value of goods Step 11 - importers Bank delivers documents to importer

Global Financial System

The collection of financial institutions that facilitate and regulate the flows of investment and capital funds worldwide. It includes the national and international banking systems, the international bond market, and national stock markets.

You are given an exchange rate of $1.40/GBP. Which of the following is true?

U.S. Terms and Direct Quotation for Dollar

Video Clip: Falling Dollar

WATCH

Video Clip: IMF vs. World Bank

WATCH

The key difference between indirect vs. direct export is whether or not a firm has ________ for its export activities.

an intermediary

Which of the following documents is the contract (receipt) between the shipping company and the exporter?

bill of lading

As a type of countertrade, ________________ requires the seller to agree to supply technology or equipment to construct a facility and receives payment in the form of goods produced by the facility.

buy-back agreement

According to the letter of credit process presented in the course materials, the final step is to ______.

collect the payment from the importer by the importer's bank

Floating Exchange Rates

exchange rates that respond quickly to currency market forces of supply & demand

Options (currency options)

give the holders the right but no obligation to buy or sell an underlying asset at a predetermined price at or until a certain time

Foreign exchange quotations: European Terms

give the price of a USD in terms of the foreign currency equivalent - Euro/USD or Euro/$ = .664 Euro

Foreign exchange quotations: U.S. Terms

give the price of a foreign currency in the units of USD needed to purchase one unit of foreign currency - USD/Euro or $/Euro = 1.5064 USD

Government Action

governments intervene to influence the value of their own currencies ex. The Chinese gov't regularly intervenes in the foreign exchange market to keep the renminbi undervalued, to help ensure exports

Interest Rates

high inflation forces banks to pay high interest - investors expect to be compensated for inflation-induced decline in the value of their money ex. if inflation is 10%, banks must pay more than 10% to attract deposits

In the beginning of international venture, a firm most likely experience_____________:

increasing risk and decreasing profits

The level of control a firm is seeking when deciding the mode of foreign market entry is ___________.

management factor

Inflation

refers to increases in the prices of goods and services; thus, money buys less than before - some countries (Argentina, Israel, Russia) have experienced hyperinflation - high inflation erodes a currency's purchasing power positively related to interest rates

Market Psychology

refers to investor behavior, such as herding behavior or momentum trading

Key Participants in the Monetary and Financial Systems: International Organizations for International Settlements

supervises Central Bank monetary policy and other activities

balance of trade

the difference between the value of a nation's exports and its imports

Video Clip: Sumitomo Corporation in Japan

watch

Percentage change formula

(current-previous)/previous

Types of exchange rates

*spot exchange rate *forward exchange rate *currency options

Development of the Modern Exchange Rate System

- After the Great Depression and World War II, the world economy and trading system were seeking stability. - 44 countries signed the Bretton Woods agreement. - Bretton Woods established a fixed exchange rate system in which the U.S. dollar was pegged to a set value for gold ($35 per ounce), and other major currencies were pegged to the dollar. - For nearly 30 years, the system kept exchange rates of major currencies at a fixed level.

Fixed Foreign Exchange Rates

- Also known as "Adjustable Peg" - Currencies were linked to each other based on the Gold Exchange Standard. - A system between participating countries. - "Money" issued by member countries had to be backed by reserves of gold. - Gold was the automatic adjustment for imbalances of trade and investment.

The Exchange Rate System Today

- Bretton Woods dissolved in 1971, as the world economy was evolving and governments could no longer maintain fixed exchange rates on the gold standard. - Today, advanced economy currencies (dollar, euro, pound, yen) float according to market forces, their value determined by supply and demand. - Conversely, most developing and emerging economies use fixed exchange rate systems. - In fixed regimes, the value of a currency is pegged to the value of another, or to a basket of currencies, at a specified rate.

Types of Export Payments: Letter of Credit

- Contract between the banks of a buyer and a seller that ensures payment form the buyer to the seller upon receiving an export shipment - A letter of credit may be either irrevocable or revocable. Once established, an irrevocable letter of credit cannot be cancelled without agreement of both buyer and seller. The selling firm will be paid as long as it fulfills its part of the agreement. - The letter of credit immediately establishes trust between buyer and seller

Currency (Financial) Risk

- Currency exposure - Asset valuation - Foreign taxation - Inflationary and transfer pricing

Factors influencing Supply and Demand of a Currency

- Economic growth - Interest rates and inflation - Market psychology - Government action - trade balance (ex. deficit or surplus)

Contractual Modes

- Licensing - Franchising - shared control and risk, split ownership - both externalized and internalized

Types of Export Payments: Cash in Advance

- Payment is collected before the goods are shipping to the customer. The exporter need not worry about collection problems and can access the funds almost immediately upon concluding the sale - From the buyer's standpoint, cash in advance is risky and may cause cash flow problems. The buyer may hesitate to pay cash in advance for fear the exporter will not follow through with shipment, particularly if the buyer does not know the exporter well - Cash in advance is unpopular with foreign buyers and tends to discourage sales. Exporters who insist on cash in advance tend to lose out to competitiors who offer more flexible payment terms

Example of the Impact of an Exchange Rate

- Say the current Euro-Dollar exchange rate is €1/$1. - Next year, the exchange rate goes to €1.5/$1. - How does this affect European's life? - Basically, the dollar becomes more expensive to the EU producers and consumers. For European consumers: 1. The cost of buying imported (American) goods goes up. up/down? 2. There are more/less? goods available for sale 3. The overall cost of living is (e.g., European oil imports) 4. The overall standard of living is 5. Less Europeans travel to or study in the US *****go back to this slide

The Gold Standard

- The gold standard began sometime in the 1880s - It was premised on three basic ideas: 1. A system of fixed rates of exchange existed between participating countries 2. Money issued by member countries had to be backed by gold reserves 3. Gold acted as an automatic adjustment - Under this standard, each country's currency would be set in value per ounce of gold.

Trading Companies as Intermediaries

- Trading companies help firms by importing, exporting, countertrading, investing an manufacturing - The sogashosha of japan are the most powerful trading companies in the world for four reasons: 1. their efficiently gather, evaluate, and translate market information into business opportunities 2. economies of scale give them preferential treatment 3. they operate around the world, not just in Japan 4. they have vast quantities of capital - In the U.S., export trading company legislation is designed to improve the export performance of small and medium-sized firms

International Shipment Documentation: Bill of Lading

- acknowledges receipt of goods - straight bills of lading vs. shipper's order

Investment Modes

- acquisition - create new subsidiary - high control, high risk, low flexibility - internalized

Terms of Shipment: Free Carrier (FCA)

- applies only at a designated inland shipping point - seller is responsible for loading goods into the means of transportation - buyer is responsible for all subsequent expenses

Terms of Shipment: Free Alongside Ship (FAS)

- applies only at a designated shipping point - seller is responsible for delivery of goods to the means of transportation - buyer is responsible for all subsequent expenses

Terms of Shipment: Free on Board (FOB)

- applies only to vessel shipments - seller quotes a price covering all expenses up to and including delivery of goods on an overseas vessel provided by or for the buyer

Exchange rates are:

- constantly fluctuating - the prices the firm charges can be quoted in the firm's currency or in the currency of each foreign customer - because several months can pass between placement and delivery of an order resulting in uncertainty - the firm and its customers can use the exchange rate as it stands on the date of each transaction, or they can agree to use a specific exchange rate

Management Commitment

- degree of risk/uncertainty acceptable - degree of control - degree of flexibility

Foreign exchange quotations: Cross Rates

- exchange rates stated without using U.S. dollar as a reference currency

Internal factors

- firm size, capabilities - international experience - product characteristics

Export Management Companies as Intermediaries (EMCs)

- firms that specialize in performing international business services for other companies Primary roles: - distributors: carrying title of merchandise for profits - agents: no title, commission-based

Export Modes

- indirect - direct - Low control, low risk, high flexibility - Externalized

Terms of Shipment: Cost, Insurance, and Freight (CIF)

- seller quotes a price including insurance, all transportation, and miscellaneous charges to the point of debarkation from the vessel or aircraft

Terms of Delivery: Delivery Duty Paid (DDP)

- seller responsible for delivery to buyer's premises, including payment or import duties and inland transportation - highest level of responsibility in delivery to the seller

Psychic/Psychological distance

- sometimes cultural variables, legal factors, and other societal norms make a foreign market that is geographically close seem closer in psychic distance. - the two major issues of psychic distance are: 1. some of the distance seen by firms is based on perception rather than reality 2. closer psychological proximity makes it easier for firms to enter markets

International Shipment Documentation: Commercial Invoice

- states basic information for the transaction including a description of the merchandise, total cost of the goods, and an invoice

Exporting as an entry strategy

- usually the firm's first foreign entry strategy low risk, low cost, and flexible - popular with SMEs - when we talk about trade, trade deficits, trade surpluses, etc., we're talking about exporting - most exports involve merchandise - export channels: 1. independent distributor or agent; or 2. firm's own marketing subsidiary abroad

Factors of Foreign Market Entry

- when companies make commitment to go international, they must choose an entry strategy - key factors influencing the choice: 1. internal factors 2. external factors 3. management commitment

Classification of Entry Methods

1. Export Modes 2. Contractual Modes 3. Investment Modes

International Market Entry Modes

Exporting - Direct - Indirect Importing - Direct - Indirect Licensing Franchising Interfirm Cooperation Foreign Direct Investment

Key Participants in the Monetary and Financial Systems: Commercial Banks

Lend money to finance business activity, play a key role in nations' money supplies, and exchange foreign currencies

Hard Currencies

Most convertible currencies universally accepted ex. U.S. Dollar, Japanese yen, Canadian dolloar, British pound, and the European euro

Assume that the price of Big Mac in Japan is Yen750 while that in the United States is $5.50. If the Yen-Dollar exchange rate is 125Yen/Dollar, what is the valuation of Japanese Yen?

Overvalued by 9.1%

International Monetary System

The institutional framework, rules, and procedures by which national currencies are exchanged for one another

Which of the following statements is most likely to be true regarding a currency's price if the supply of the currency increases?

The price of the currency lowers.

Big Mac Index

Tool for calculating purchasing power parity that compares prices of a Big Mac throughout the world.

If the Euro-Dollar exchange rate moves to $1.25/Euro from $1.10/Euro a year ago, what is the percentage change of Dollar? [Please remember that you have to convert the exchange rates into indirect quotes for Dollar in this case as one of the video lectures discusses. ]

Value decreased by 12%

Video Clip: Zimbabwe: the highest inflation country

WATCH VIDEO

Purchasing Power Parity

a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries

Exporting and Importing: Deciding on Indirect or Direct involvement

decided by implementing transaction cost theory

Trade surplus

exports exceed imports - may result when the exporter's currency is undervalued, as in China's official policy regarding its currency

The purpose of exchange rates

facilitate international purchases

Key Participants in the Monetary and Financial Systems: National Stock Exchanges and Bond Markets

facilities for trading securities and bonds

herding behavior

failing to correctly evaluate the value of the asset, and instead relying on other people's apparent evaluations

Spot Transactions (spot exchange rates)

for the exchange of currencies for immediate delivery

International Intermediaries

importers and exporters often use international intermediaries who provide assistance in: - documentation - financing - transportation - identification of foreign suppliers and trading companies - providing business contacts

Trade deficit

imports exceed exports - the government may devalue the nation's currency to correct a trade deficit

How exchange rates are determined

in a free market, the "price" of any currency (exchange rate) is determined by supply and demand -greater supply = lower price -lower supply = higher price -greater demand = higher price -lower demand = lower price

Profit Risk During Early Internationalization

in the short term, firms may experience increased risk and decreasing profits when going international

Key Participants in the Monetary and Financial Systems: The Firm

international transactions require firms to deal with huge sums of foreign exchange

Terms of Shipment and Sale

items to which the buyer and seller must agree: - what is not included in the price? - when does the seller's responsibility end? - when does the buyer's responsibility end? incoterms: "internationally accepted standard definitions for terms of sale by the International Chamber of Commerce (ICC)"

Exporting and Importing: Indirect Involvement

means that the firm participates in international business through and intermediary and does not deal with foreign customers or markets

Exporting and Importing: Direct Involvement

means that the firms works with foreign customers or markets with the opportunity to develop a relationship

Key Participants in the Monetary and Financial Systems: Central Banks

regulate money supply, issue currency, manage exchange rates, control national reserves

Non-convertible currency

the currency of a country that is not convertible on the international foreign exchange markets

Foreign exchange quotations: Direct Quotation

the direct quotation on any currency is the form when that currency is stated first - USD 1.245/Euro for US dollar

Forward Transactions (forward exchange rates)

the exchange of currencies on a future date at an agreed upon exchange rate

Foreign Exchange Market

the global marketplace for buying and selling national currencies

Economic Growth

the increase in value of the goods and services produced by an economy - measured as the annual increase in real GDP (in which the inflation rate is subtracted from growth) - driven by entrepreneurship and innovation - the nation's central bank regulates the money supply, issues currency and manages the exchange rate, to accomodate economic growth

Foreign exchange quotations: Indirect Quotation

the indirect quotation on a currency refers to when the subject currency is stated second - USD 1.245/Euro for Euro

Balance of Payments

the nation's balance sheet of trade, investment and transfer payments with the rest of the world. - it reflects the difference between the total amount of money coming into and going out of a country

Exchange rate

the price of one currency in terms of another affect the fortunes of the firm in various ways -- costs of inputs, sales performance, which market entry strategies to use, etc.

Which of the following is characteristic of the fixed exchange rate system?

value of currency is set relative to the value of another