International Finance from ch 4 onward

How does Changes in Restriction affect Capital Flows for DFI FDI?

New opportunities may arise from the removal of government barriers

Whats the difference between portfolio investment and direct investment?

Portfolio investment is usually only 10% of a company. Not controlling interest/

What is portfolio investment?

Portfolio investment refers to transactions between countries involving long-term financial assets (such as stocks and bonds) that do not affect the transfer of control.

Who created the Price-Specie flow Mechanism? What is it?

by David Hume Hume argued that when a country with a gold standard had a positive balance of trade, gold would flow into the country in the amount that the value of exports exceeds the value of imports. Conversely, when such a country had a negative balance of trade, gold would flow out of the country in the amount that the value of imports exceeds the value of exports. Consequently, in the absence of any offsetting actions by the central bank on the quantity of money in circulation (called sterilization), the money supply would rise in a country with a positive balance of trade and fall in a country with a negative balance of trade. Using a theory called the quantity theory of money, Hume argued that in countries where the quantity of money increases, inflation would set in and the prices of goods and services would tend to rise while in countries where the money supply decreases, deflation would occur as the prices of goods and services fell. The higher prices would, in the countries with a positive balance of trade, cause exports to decrease and imports to increase, which will alter the balance of trade downwards towards a neutral balance. Inversely, in countries with a negative balance of trade, the lower prices would cause exports to increase and imports to decrease, which will heighten the balance of trade towards a neutral balance. These adjustments in the balance of trade will continue until the balance of trade equals zero in all countries involved in the exchange.

How do financial institutions in serve MNCs?

by accepting deposits and offering loans in a variety of currencies

What is Acquisitions of existing operations?

in foreign countries allow firms to quickly gain control over foreign operations as well as a share of the foreign market.

What is appreciation?

increase in a currency's value

What did the Single European Act do?

industrialized countries in Europe agreed to make regulations more uniform and to remove many taxes on goods traded among themselves. The act allows firms in a given European country greater access to supplies from firms in other European countries.

What is international trade?

involves exporting and/or importing.

What is the balance of payments?

is a summary of transactions between domestic and foreign residents for a specific country over a specified period of time. It accounts for transactions by businesses, individuals, and the government.

What is Franchising?

obligates a firm to provide a specialized sales or service strategy, support assistance, and possibly an initial investment, in exchange for periodic fees.

What is a Eurocredit loan?

refer to loans of one year or longer extended by banks in Europe to foreign MNCs or government agencies.

What is the financial account?

refers to special types of investment, including DFI and portfolio investment.

What is the capital account?

represents a summary of the flow of funds resulting from the sale of assets between one specified country and all other countries over a specified period of time; thus, it compares the new foreign investments made by a country with the foreign investments within a country over a given time period.

What is factor income?

represents income (interest and dividend payments) received by investors on foreign investments in financial assets (securities).

What is a sterilized intervention?

the central bank simultaneously engages in offsetting transactions in the Treasury securities markets to maintain the money supply.

What is outsourcing? Why do this?

the process of subcontracting to a third party. Outsourcing allows MNCs to conduct operations at a lower cost.

What is the Goal of the MNC?

The commonly accepted goal of an MNC is to maximize shareholder wealth.

What are the components of the Financial Account?

(1) direct foreign investment, (2) portfolio investment, and (3) other capital investment.

What are the main components of the current account?

(1) merchandise (goods) and services, (2) factor income, and (3) transfers.

what is the formula for percent change in a currency's value?

(currentSpotRate - pastSpotRate)/pastSpotRate

What is Join Venture?

(joint ownership and operation) with firms that reside in those markets.

What are the factors that influence exchange rates?

1. Change in the relative inflation rate 2. Change in the relative interest rate 3. Change in the relative income level 4. Change in government controls 5. Change in expectations of future exchange rates

What are the negatives of Freely Floating Exchange Rate?

1.MNCs may need to devote substantial resources to managing their exposure to exchange rate fluctuations. 2.The country that initially experienced economic problems (such as high inflation, increased unemployment) may have its problems compounded.

What are the factors that affect international trade flow?

1. Cost of Labor 2. Inflation 3. National Income 4. Credit Conditions 5. Government Policies 6. Exchange Rates

What are the different transactions types between countries?

1. Trade 2. Income Receipts 3. Investment Sales & purchases

What is the impact of Government restrictions on Trade Flows?

1.A government may reduce its country's imports by imposing a tariff on imported goods, or by enforcing a quota. 2.Some trade restrictions may be imposed on certain products for health and safety reasons.

What are the advantages of trading ADRs as opposed to Direct investment in the company's shares?

1.ADRs are denominated in U.S. dollars, trade on U.S. exchanges and can be bought through any broker. 2.Dividends are paid in U.S. dollars.

What are some Key Board Committees of the MNC? What do they do?

1.Audit Committee: - Oversees financial reporting. 2. Executive Compensation Committee: - Approves compensation packages including bonuses, stock options, severance, loans, etc. 3.Nominations Committee: - Recruits and proposes new board members.

Why is a weak home currency not a perfect solution for Correcting a Balance of Trade Deficit?

1.Counterpricing by competitors 2.Impact of other weak currencies 3.Stability of intracompany trade

What is Direct Intervention?

1.Direct intervention refers to the exchange of currencies that the central bank holds as reserves for other currencies in the foreign exchange market. 2.Direct intervention is usually most effective when there is a coordinated effort among central banks and when the central banks have high levels of reserves that they can use.

What is dollarization?

1.Dollarization refers to the replacement of a foreign currency with U.S. dollars. 2.Dollarization goes beyond a currency board, as the country no longer has a local currency. 3.For example, Ecuador implemented dollarization in 2000.

What are the positives of a Freeley Floating Exchange Rate system?

1.Each country is more insulated from the economic problems of other countries. 2.Central bank interventions just to control exchange rates are not needed. 3.Governments are not constrained by the need to maintain exchange rates when setting new policies. 4.Less capital flow restrictions are needed, thus enhancing market efficiency.

What are the arguments in favor of flexible exchange rates?

1.Easier external adjustments. 2.National policy autonomy.

What are the frictions in International Trade?

1.Environmental restrictions 2.Labor laws 3.Bribes 4.Government subsidies 5.Tax breaks

What are arguments against flexible exchange rates?

1.Exchange rate uncertainty may hamper international trade. 2.No safeguards to prevent crises.

What are a bondholders objective?

1.Get money back on time 2.No increase in risk

dentify the factors that affect the current account balance between the U.S. and the U.K. Explain how each factor may possibly affect the British demand for the footballs that are produced by the Sports Exports Company.

1.High inflation in the U.K. could cause a shift in the demand for U.S. products instead of British products. However, at this time there is not a British producer of footballs, so that high British inflation will not cause an increase in the demand for U.S.-produced footballs. 2. High national income in the U.K. could increase the amount of spending by British consumers, and would therefore cause an increase in the demand for footballs produced by the Sports Exports Company. A lower national income in the U.K. would have the opposite effect. 3. Government restrictions could be imposed by the British government on goods (such as the footballs) exported by U.S. firms. However, footballs are not likely to be targeted by the British government as a product that should be subject to restrictions. 4. The exchange rate of the British pound will change over time. However, since the Sports Exports Company is willing to accept pounds when it sells footballs to the distributor, the distributor does not have to convert the pounds into dollars. Therefore, the British demand for footballs is not affected by changes in the value of the pound (unless this causes the Sports Exports Company to change the price it charges for the footballs someday).

What are the International Business Methods?

1.International Trade 2.Licensing 3. Franchising 4. Joint Venture 5. Acquisitions of existing operations 6. Establishing New Foreign Subsidiaries

why does production spread to other advanced countries?

1.Inventing firm wants production closer to consumers 2.Rival firms license or imitate or wait for patent expiration

What are the advantages of Cross-Listing?

1.It expands the investor base for a firm. A.Very important reason for firms from emerging market countries with limited capital markets. 2.Establishes name recognition for the firm in new capital markets, paving the way for new issues. 3.May offer marketing advantages. 4.May mitigate possibility of hostile takeovers.

What are the negatives of Currency Board?

1.It is effective only if investors believe that it will last. 2.Local interest rates must be aligned with the interest rates of the currency to which the local currency is tied. Note: The local rates may include a risk premium. 3.A currency that is pegged to another currency will have to move in tandem with that currency against all other currencies.

What are the negatives of Managed Float Exchange Rate System?

A government may manipulate its exchange rates such that its own country benefits at the expense of other countries.

How can the Agency problem be resolved?

1.Managerial compensation Incentives can be used to align management and stockholder interests The incentives need to be structured carefully to make sure that they achieve their intended goal 2.Corporate control The threat of a takeover may result in better management

What is the stockholders objectives?

1.Maximize value 2.Increase dividends 3.Take projects with big upsides

What cause the Collapse of the Bretton Woods Agreement?

1.Persistent US deficits of payments—oversupply of USD 2.Eliminate the convertibility of USD to gold 3.Establishment of 10% import surcharge 4.Wage and price controls to control inflation

Describe the Agency relationship.

1.Principal hires an agent to represent his/her interest 2.Stockholders (principals) hire managers (agents) to run the company

What is the international Product Life Cycle with regards to MNCs?

1.Product produced and consumed in the (advanced) inventing country. Other advanced countries import it. 2.Production spreads to other advanced countries. 3.Production re-locates out of advanced countries into a low-wage nation. A .Advanced countries import it. B. Next generation product invented.

What is the Bretton Woods (1944-1976)?

1.WSJ's Farney: "If time were a river, if history left high water marks, this grand hotel in the white mountains would mark America at the crest of the American Century...And then the statesman (Keynes) designated the dollar, pegged to gold at $35 a once, as the centerpiece of international exchange. Bretton Woods, an American triumph, sets the seal on America as the worlds leading financial superpower" 2.Under the Bretton Woods system, the U.S. dollar was pegged to gold at $35 per ounce and other currencies were pegged to the U.S. dollar. 3.Each country was responsible for maintaining its exchange rate within ±1% of the adopted par value by buying or selling foreign reserves as necessary.

International business usually increases an MNC's exposure to:

1.exchange rate movements 2.foreign economies 3.political risk

Agency costs are normally larger for MNCs than for purely domestic firms, due to:

1.the difficulty in monitoring distant managers, 2.the different cultures of foreign managers, 3.the sheer size of the larger MNCs, and 4.the tendency to downplay short-term effects.

Why do Central Banks manage exchange rates?

1.to smooth exchange rate movements, 2.to establish implicit exchange rate boundaries, and 3.to respond to temporary disturbances.

What is the Classic Gold Standard? When did it Start? What lead to its collapse?

1880-1914 Club began with UK 1816 The start of WWI lead to its collapse Defines each currency in terms of gold: The property of transitive therefore relates all currencies to each other

When did the Inception of the Euro happen? What did it do?

1999 This single-currency system, which applies in most of Western Europe, has led to more trade among European countries.

If a country imposes lower corporate income tax rates, does that provide an unfair advantage?

: Lower tax rates should not be viewed as unfair, unless the government only allows its exporting firms such a tax advantage.

What are the positives of a Currency Board?

A board can stabilize a currency's value.

How could a continued depreciation of the Thai baht affect Blades? How would it affect Blades' relative to U.S. exporters invoicing their roller blades in U.S. dollars?

A continued depreciation of the Thai baht would hurt Blades, especially because the firm invoices its roller blades in baht. A continued depreciation of the baht means that the baht-denominated revenue in Thailand will convert to fewer U.S. dollars. Blades also has some expenses in baht, but this amount is less than the revenue denominated in baht. Although Blades would be hurt by a depreciating baht because its exports are denominated in baht, the demand for Blades' products may increase relative to that of its U.S. competitors exporting to Thailand. This is because most of the U.S. firms exporting roller blades to Thailand invoice their products in U.S. dollars. If the baht depreciates, Thai importers will have to convert more baht to dollars in order to pay for the dollar-denominated exports.

How would a relatively high home inflation rate affect the home country's current account, other things being equal?

A high inflation rate tends to increase imports and decrease exports, thereby increasing the current account deficit, other things equal.

What is a Currency Board?

A currency board is a system for pegging the value of the local currency to some other specified currency.

It is sometimes suggested that a floating exchange rate will adjust to reduce or eliminate any current account deficit. Explain why this adjustment would occur.

A current account deficit reflects a net sale of the home currency in exchange for other currencies. This places downward pressure on that home currency's value. If the currency weakens, it will reduce the home demand for foreign goods (since goods will now be more expensive), and will increase the home export volume (since exports will appear cheaper to foreign countries).

What would a deficit in the balance of trade for the US mean?

A deficit in the U.S. balance of trade means that the value of merchandise and services exported by the United States is less than the value of merchandise and services that it imports.

How could a higher level of inflation in Thailand affect Blades (assume U.S. inflation remains constant)?

A high level of inflation in Thailand relative to the United States could affect Blades favorably. Generally, if a country's inflation rate increases relative to the countries with which it trades, consumers and corporations within the country will most likely purchase more goods overseas, as local goods become more expensive. Consequently, Blades' sales to Thailand may increase.

How does National Income impact Trade Flows?

A relative increase in a country's income level will decrease its current account, as imports increase.

How does inflation impact Trade Flows?

A relative increase in a country's inflation rate will decrease its current account, as imports increase and exports decrease.

Explain why a stronger dollar could enlarge the U.S. balance of trade deficit. Explain why a weaker dollar could affect the U.S. balance of trade deficit.

A stronger dollar makes U.S. exports more expensive to importers and may reduce imports. It makes U.S. imports cheap and may increase U.S. imports. A weaker home currency increases the prices of imports purchased by the home country and reduces the prices paid by foreign businesses for the home country's exports. This should cause a decrease in the home country's demand for imports and an increase in the foreign demand for the home country's exports, and therefore increase the current account. However, this relationship can be distorted by other factors.

What factors affect capital flows?

A. DFI, FDI 1.Changes in Restrictions New opportunities may arise from the removal of government barriers. 2.Privatization DFI has also been stimulated by the selling of government operations. 3.Potential Economic Growth Countries that have higher potential for economic growth are more attractive 4.Tax Rates Countries that impose relatively low tax rates on corporate earnings are more likely to attract DFI. 5.Exchange Rates Firms typically prefer to invest in countries where the local currency is expected to strengthen against their own. B.Portfolio Investment 1.Tax Rates on Interest or Dividends Investors will normally prefer countries where the tax rates are relatively low. 2.Interest Rates Money tends to flow to countries with high interest rates. 3.Exchange Rates Foreign investors may be attracted if the local currency is expected to strengthen

If Blades increases its business in Thailand and experiences serious financial problems, are there any international agencies that the company could approach for loans or other financial assistance?

ANSWER: An agency extending direct loans to corporations involved in international trade is the International Financial Corporation (IFC). Besides extending loans, the IFC may also purchase stock in a corporation, thereby becoming part owner.

How is the IMF involved in international trade?

ANSWER: The IMF in involved in international trade because it attempts to stabilize international payments, and trade represents a significant portion of the international payments.

Explain how the existence of the euro may affect U.S. international trade.

ANSWER: The euro allowed for a single currency among many European countries. It could encourage firms in those countries to trade among each other since there is no exchange rate risk. This would possibly cause them to trade less with the U.S. The euro can increase trade within Europe because it eliminates the need for several European countries to exchange currencies when trading with each other.

What is a residence test?

Are the permanent addresses ("centers of economic interest") for the buyer and seller in different countries?

How do Interest Rates affect Capital Flows for Portfolio Investment?

Money tends to flow to countries with high interest rates.

What is the Product Life Cycle theory?

As a firm matures, it may recognize additional opportunities outside its home country.

What did NAFTA do?

As a result of the North American Free Trade Agreement (NAFTA) of 1993, trade barriers between the United States and Mexico were eliminated.

How could a decreasing level of national income in Thailand affect Blades?

At first glance, it would appear that a decreasing level of national income in Thailand could hurt Blades financially, as Thai consumers will have less money to spend. Furthermore, this effect may be magnified because Blades manufactures a leisure product, which is probably one of the first products Thai consumers will stop buying. The arrangement Blades has with its primary Thai importer mitigates this effect somewhat, since the latter has committed himself to the purchase of a certain number of "Speedos" annually. Nevertheless, the importer may not offer to renew this arrangement in excess of the original three years if the Thai economy does not improve.

Why must financial managers of MNC's continue to monitor exchange rates?

Because their cash flows are highly dependent on them

How could competition from firms in Thailand and from U.S. firms conducting business in Thailand affect Blades?

Blades would be favorably affected relative to Thai roller blade manufacturers and relative to other U.S. roller blade manufacturers with operations in Thailand. Both groups of firms will likely be forced to raise their prices if they want to maintain the same profit margin should inflation in Thailand increase. This is especially true if both groups of firms source their supplies directly from Thailand, so that the prices of these supplies are subject to the higher inflation in Thailand. Conversely, Blades' cost of goods sold incurred in Thailand is relatively small. Consequently, costs will not be subject to the higher level of inflation in Thailand to a great extent and Blades will probably not have to raise its prices to the same extent as Thai roller blade manufacturers or U.S. manufacturers with operations in Thailand.

What is a Foreign Bond(Parallel bond)?

Bonds denominated in the currency of the country where they are placed but issued by borrowers foreign to the country are called foreign bonds or parallel bonds.

What is a Eurobond?

Bonds that are sold in countries other than the country of the currency denominating the bonds are called Eurobonds.

What do illiquid currencies tend to exhibit?

Conversely, illiquid currencies tend to exhibit more volatile exchange rate movements.

How does Potential Economic Growth affect Capital Flows for DFI FDI?

Countries that have higher potential for economic growth are more attractive

How do Tax Rates affect capital flows for FDI DFI?

Countries that impose relatively low tax rates on corporate earnings are more likely to attract DFI.

What is a Cross Rate?

Cross rate is the exchange rate between two countries inferred from each country's exchange rate with a third country. Example: On 29/10/2004 the spot exchange rates between GBR (£) and the Euro (€) and GBR (£) and the Japanese Yen (¥) were: 1.4353 €/£ and 194.46 ¥/£ respectively.

What is Cross-Listing?

Cross-Listing refers to a firm having its equity shares listed on one or more foreign exchanges.

How does privatization affect Capital Flows for DFI FDI?

DFI has also been stimulated by the selling of government operations

What is direct foreign investment?

Direct foreign investment represents the investment in fixed assets in foreign countries that can be used to conduct business operations.

What is a Direct quote?

Direct quotations state the number of dollars per foreign currency

What is a Managed Float Exchange Rate System?

Exchange rates are allowed to move freely on a daily basis and no official boundaries exist. However, governments may intervene to prevent the rates from moving too much in a certain direction.

What are the features of Eurobonds?

Features: Bearer bonds Annual coupon payments Convertible or callable

How do Exchange Rates affect Capital Flows for DFI FDI?

Firms typically prefer to invest in countries where the local currency is expected to strengthen against their own.

What are two benefits for MNC from International trade?

First, it has enabled some MNCs to obtain materials at lower prices. Second, it has allowed many MNCs to increase their sales and expand their operations.

Explain Credits and Debits.

For all three accounts, transactions that reflect inflows of funds generate positive numbers (credits) for the country's balance whereas transactions that reflect outflows of funds generate negative numbers (debits) for its balance.

What are the two types of bonds in the International Bond Market?

Foreign Bonds (Parallel bonds) or Eurobonds

How do Exchange Rates affect Capital Flows for Portfolio Investment?

Foreign investors may be attracted if the local currency is expected to strengthen

What is a American Depository Receipt?

Foreign stocks often trade on U.S. exchanges as ADRs. It is a receipt that represents the number of foreign shares that are deposited at a U.S. bank. The bank serves as a transfer agent for the ADRs

What are Exchange Traded Funds?

Funds that track a common index or Index.

What did GATT do?

General Agreement on Tariffs and Trade (GATT) It called for the reduction or elimination of trade restrictions on specified imported goods over a ten-year period across 117 countries.

why does production relocate to less developed countries?

Good answer: standardization changes factor intensities. skilled-labour (human capital) intensity falls as manufacturing process is "routinized" unskilled-abundant (human capital-scarce) countries gain comparative advantage because of factor advantages for unskilled-intensive activities.

How can government restrictions affect international payments among countries?

Governments can place tariffs or quotas on imports to restrict imports. They can also place taxes on income from foreign securities, thereby discouraging investors from purchasing foreign securities. If they loosen restrictions, they can encourage international payments among countries.

What are the negatives in Fixed Exchange Rate System?

Governments can revalue their currencies. Each country is also vulnerable to the economic conditions in other countries.

What is the impact of Exchange Rates on Trade Flows?

If a country's currency begins to rise in value, its current account balance will decrease as imports increase and exports decrease.

What is a Indirect quote?

Indirect quotations state the foreign currency per dollar

What is equilibrium exchange rate?

If the demand and supply of a currency is the same

Would the U.S. balance of trade deficit be larger or smaller if the dollar depreciates against all currencies, versus depreciating against some currencies but appreciated against others? Explain.

If the dollar weakens against all currencies, the U.S. balance of trade deficit will likely be smaller. Some U.S. importers would have more seriously considered purchasing their goods in the U.S. if most or all currencies simultaneously strengthened against the dollar. Conversely, if some currencies weaken against the dollar, the U.S. importers may have simply shifted their importing from one foreign country to another.

Factors influencing trade flow?

Inflation National Income Government Restrictions Exchange Rates

Why does the exchange rate not always adjust to a current account deficit?

In some cases, the home currency will remain strong even though a current account deficit exists, since other factors (such as international capital flows) can offset the forces placed on the currency by the current account.

Why do you think international trade volume has increased over time? In general, how are inefficient firms affected by the reduction in trade restrictions among countries and the continuous increase in international trade?

International trade volume has increased because of the reduction in trade restrictions over time. It may have also increased for many other reasons, such as increased information flow (via Internet etc.) between firms in different countries. Inefficient firms are adversely affected if they have to face tougher competition from foreign firms as a result of a reduction in trade restrictions.

What falls under the category of Income Receipts and Payments?

Investment income Employee Compensation

How do Tax Rates on Interest or Dividends affect capital flows for portfolio investment?

Investors will normally prefer countries where the tax rates are relatively low.

What is the J-Curve effect?

It is a continued downslope of the Trade Balance even after weakening the currency. It eventually turns back up. The reason why this happens is because traders typically have prearranged terms of sales which they can't go back on. Lag time is typically 18 months.

How is the price of a currency determined?

It is determined by the demand relative to the supply of that currency

What is a problem with outsourcing?

It may reduce jobs within the home country

What did the fall of the Berlin Wall do?

Lead to major reductions in trade barriers in Eastern Europe

Foreign Exchange rate volatility is greater during shorter or longer periods (horizons)?

Longer

Explain how low U.S. interest rates can affect the tendency of U.S.-based MNCs to invest abroad.

Low U.S. interest rates can encourage U.S.-based MNCs to invest abroad, as investors seek higher returns on their investment than they can earn in the U.S.

What are the positives of Fixed Exchange Rate Systems?

MNCs know the future exchange rates.

What are some of the major objectives of the IMF?

Major IMF objectives are to (1) promote cooperation among countries on international monetary issues, (2) promote stability in exchange rates, (3) provide temporary funds to member countries attempting to correct imbalances of international payments, (4) promote free mobility of capital funds across countries, and (5) promote free trade.

What falls under the category of Trade?

Merchandise Services Goods for processing

When South Korea's export growth stalled, some South Korean firms suggested that South Korea's primary export problem was the weakness in the Japanese yen. How would you interpret this statement?

One of South Korea's primary competitors in exporting is Japan, which produces and exports many of the same types of products to the same countries. When the Japanese yen is weak, some importers switch to Japanese products in place of South Korean products. For this reason, it is often suggested that South Korea's primary export problem is weakness in the Japanese yen.

What is the Modified Gold Standard?

Parity values changed, i.e. the US experienced the lowest inflation during the war and gained preeminence in international finance Pound was overvalued and there was a run on gold, 1931 UK declared pound inconvertible....and the US in 1933

What are two aspects of Government Policy toward FOREX Market?

Policy toward the level and variability of the (nominal spot) exchange rate. In simple terms, the choice between a floating exchange rate and a fixed exchange rate (managed or dirty float depending on ones notion of government). · Restrictions (if any) on the use of the foreign exchange market. These restrictions are generally called exchange controls.

What falls under the category of Investment sales and Purchases?

Portfolio Investment Direct Investment

What is a Freeley Floating Exchange Rate System?

Rates are determined by market forces without governmental intervention.

What is the Fisher effect?

Real interest rate = Nominal interest rate - inflation rate

What are Pegged Exchange Rate System?

The currency's value is pegged to a foreign currency or to some unit of account, and thus moves in line with that currency or unit against other currencies. Mexican peso's peg to the U.S. dollar (1994)

Explain how governments might give their local firms a competitive advantage in the international trade arena.

Some governments offer subsidies to their domestic firms so that those firms can produce products at a lower cost than their global competitors. They may also have very limited environment and child labor restrictions, which allows local firms to produce at a low cost.

What is the theory of comparative advantage?

Specialization by countries can increase production efficiency.

What are some agency conflicts of Subsidiary Managers of the MNC?

Subsidiary managers may be tempted to make decisions that maximize the values of their respective subsidiaries. 1.Empire Building 2.Behavioral aspects 3.Escalating commitment

What is a Fixed Exchange Rate System?

System: Rates are held constant or allowed to fluctuate within very narrow bands only. Examples: Bretton Woods era (1944-1971), Smithsonian Agreement (1971)

When a corporation's shareholders differ from its managers, a conflict of goals can exist, what is this called?

The Agency Problem

When did the Eurocurrency market start? What stimulated it?

The Eurocurrency market (market for Eurodollars) developed during the 1960s and 1970s, stimulated by regulatory changes in the U.S. and the growing importance of OPEC.

Of what is the current account generally composed?

The current account balance is composed of (1) the balance of trade, (2) the net amount of payments of interest to foreign investors and from foreign investment, (3) payments from international tourism, and (4) private gifts and grants.

Assume a simple world in which the U.S. exports soft drinks and beer to France and imports wine from France. If the U.S. imposes large tariffs on the French wine, explain the likely impact on the values of the U.S. beverage firms, U.S. wine producers, the French beverage firms, and the French wine producers.

The U.S. wine producers benefit from the U.S. tariffs, while the French wine producers are adversely affected. The French government would likely retaliate by imposing tariffs on the U.S. beverage firms, which would adversely affect their value. The French beverage firms would benefit.

Of what is the capital account generally composed?

The capital account is composed of all capital investments made between countries, including both direct foreign investment and purchases of securities with maturities exceeding one year.

Are equity markets more liquid in the developed world or emerging markets?

The developed world tend to be much more liquid than emerging markets

What is the balance of trade?

The difference between total exports and imports

What is a Yankee Stock Offering?

The direct sale of new equity capital to U.S. public investors by foreign firms.

U.S.-based MNCs commonly invest in foreign securities. a. Assume that the dollar is presently weak and is expected to strengthen over time. How will these expectations affect the tendency of U.S. investors to invest in foreign securities?

The expectations of a strong dollar would discourage U.S. investors from investing abroad. If the dollar is relatively weak now, U.S. investors need more dollars to make purchase foreign currency (when investing). If the dollar strengthens over their investment horizon, they will exchange the foreign currency (as the investment is liquidated) into dollars at a less favorable exchange rate than the exchange rate at which they converted dollars into the foreign currency. That is, the exchange rate effect would reduce the yield that they earn on their investment.

What does the liquidity of a currency affect?

The liquidity of a currency affects the sensitivity of the exchange rate to specific transactions.

In general terms, what is the attraction of foreign investments to U.S. investors?

The main attraction is potentially higher returns. The international stocks can outperform U.S. stocks, and international bonds can outperform U.S. bonds. However, there is no guarantee that the returns on international investments will be so favorable. Some investors may also pursue international investments to diversify their investment portfolio, which can possibly reduce risk.

What is the Imperfect Markets Theory?

The markets for the various resources used in production are "imperfect."

A relatively small U.S. balance of trade deficit is commonly attributed to a strong demand for U.S. exports. What do you think is the underlying reason for the strong demand for U.S. exports?

The strong demand for U.S. exports is commonly attributed to strong foreign economies or to a weak dollar.

What is transfer payments?

The third main component of the current account is transfer payments, which represent aid, grants, and gifts from one country to another.

Would the U.S. balance of trade deficit in China be eliminated if the yuan was revalued upward by 20%? Or by 40%? Or by 80%?

This is an open question without a perfect answer. Yet, it should at least make students realize that a small increase in the value of the yuan is not going to make Chinese products more expensive than U.S. products in labor-intensive industries, given that Chinese wages may be less than one-tenth of U.S. wages in these industries.

Is a negative current account harmful to a country? Discuss.

This question is intended to encourage opinions and does not have a perfect solution. A negative current account is thought to reflect lost jobs in a country, which is unfavorable. Yet, the foreign importing reflects strong competition from foreign producers, which may keep prices (inflation) low.

There has been considerable momentum to reduce or remove trade barriers in an effort to achieve "free trade." Yet, one disgruntled executive of an exporting firm stated, "Free trade is not conceivable; we are always at the mercy of the exchange rate. Any country can use this mechanism to impose trade barriers." What does this statement mean?

This statement implies that even if there were no explicit barriers, a government could attempt to manipulate exchange rates to a level that would effectively reduce foreign competition. For example, a U.S. firm may be discouraged from attempting to export to Japan if the value of the dollar is very high against the yen. The prices of the U.S. goods from the Japanese perspective are too high because of the strong dollar. The reverse situation could also be possible in which a Japanese exporting firm is priced out of the U.S. market because of a strong yen (weak dollar). [Answer is based on opinion.]

If the yuan was revalued to the extent that it substantially reduced the U.S. demand for Chinese products, would this shift the U.S. demand toward the U.S. or toward other countries where wage rates are relatively low? In other words, would the correction of the U.S. balance of trade deficit have a major impact on U.S. productivity and jobs?

To the extent that there are decent substitute products in other low wage countries, it seems likely that U.S. consumers would just shift their demand toward the products in these countries. If so, a correction in the U.S. balance of trade deficit with China would shift jobs to other low-wage countries rather than to the U.S.

What is non sterilized intervention?

When a central bank intervenes in the foreign exchange market without adjusting for the change in money supply

Why might different tax laws on corporate income across countries allow firms from some countries to have an competitive advantage in the international trade arena?

When a government imposes lower corporate tax rates, firms may be able to charge lower prices for their products and still make a profit.

What is the short formula for the current account balance?

Y = C + S + T C= Consumption S= savings T = Taxes

What is the long formula for the current account?

Y= (C+I+G) +(X-M) C = Consumption I = Investment G = Government X = exports M = Imports

What is the current account?

account represents a summary of the flow of funds between one specified country and all other countries due to purchases of goods and services or to the cash flows generated by income-producing financial assets.

What is Licensing?

allows a firm to provide its technology in exchange for fees or some other benefits.

What is Direct foreign investment?

any method of conducting business that requires a direct investment in foreign operations

What is depreciation?

decline in a currency's value