International Business Midterm 1

Describe the features of a free trade area, a custom union, a common market, an economic union, and political union. Provide examples

1. All four forms of economic integration eliminate tariffs and quotas among member nations.2. At the next level, customs unions, common markets, and economic unions all have common external tariff and quota systems. 3. Common markets and economic unions provide for reducing or eliminating restrictions on people, money, and other factors.4. An economic union is the most highly evolved form of integration, calling for harmonization of economic policies and institutions.Examples include: free trade area - NAFTA; customs union - EU; common market - Central American Common Market (CACM); economic union - EU.

What are the main reasons international businesses use foreign exchange markets

1. the payments a company receives for its exports, the income from foreign investments, or the income it receives from licensing agreements with foreign firms may be in foreign countries. to use those funds in its home country, the company must convert them to its home country's currency 2. international businesses use foreign exchange markets when they must pay a foreign company for its products or services in its country's currency 3. use foreign exchange markets when they spare cash that they wish to invest for short terms in money markets. 4. currency speculation

Eurobonds

A bond placed in countries other than the one in whose currency the bond is denominated.

True

A borrower can hedge against unpredictable movements in exchange rates by entering into a forward contract to purchase the required amount of the currency being borrowed at a predetermined exchange rate when the loan comes due. Although this will raise the borrower's cost of capital, the added insurance limits the risk involved in such a transaction.

False

A common market entails even closer economic integration and cooperation than an economic union.

Future exchange rates

A currency future, also known as an FX future or a foreign exchange future, is a futures contract to exchange one currency for another at a specified date in the future at a price (exchange rate) that is fixed on the purchase date; see Foreign exchange derivative. Typically, one of the currencies is the US dollar.

Market maker

A dealer who stands ready to buy or sell a specific security or securities at all times

Discuss the arguments that favor a floating exchange rate system against a fixed exchange rate system

A fixed, or pegged, rate is a rate the government (central bank) sets and maintains as the official exchange rate. A set price will be determined against a major world currency (usually the U.S. dollar, but also other major currencies such as the euro, the yen, or a basket of currencies). In order to maintain the local exchange rate, the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which it is pegged. Floating Rates Unlike the fixed rate, a floating exchange rate is determined by the private market through supply and demand. A floating rate is often termed "self-correcting," as any differences in supply and demand will automatically be corrected in the market. Look at this simplified model: if demand for a currency is low, its value will decrease, thus making imported goods more expensive and stimulating demand for local goods and services. This, in turn, will generate more jobs, causing an auto-correction in the market. A floating exchange rate is constantly changing.

Equity loan

A loan secured on a mortgaged property.

Gold Standard

A monetary system in which paper money and coins are equal to the value of a certain amount of gold

Tariff

A tax on imported goods

Summarize Paul Krugman's arguments against adopting a trade policy that benefits domestic firms at the expense of other countries.

According to Paul Krugman, a country that adopts a strategic trade policy aimed at establishing domestic firms in a dominant position in a global industry will probably provoke retaliation.

Explain Ricardo's Theory

According to Ricardo's theory of comparative advantage, it makes sense for a country to specialize in the production of those goods that it produces most efficiently and to buy the goods that it produces less efficiently from other countries, even if this means buying goods from other countries that it could produce more efficiently itself.

What are the major drawbacks of licensing according to the internalization theory?

According to internationalization theory, licensing has three major drawbacks as a strategy for exploiting foreign market opportunities. (1) First, licensing may result in a firm's giving away valuable technological know-how to a potential foreign competitor.

Risk exposure

An aggregate measure of the potential impact of all risks at any given point in time in a project, program, or portfolio.

True

An oligopoly is an industry composed of a limited number of large firms. A critical competitive feature of such industries is interdependence of the major players: What one firm does can have an immediate impact on the major competitors, forcing a response in kind. By cutting prices, one firm in an oligopoly can take market share away from its competitors, forcing them to respond with similar price cuts to retain their market share. Thus, the interdependence between firms in an oligopoly leads to imitative behavior; rivals often quickly imitate what a firm does in an oligopoly. Imitative behavior can take many forms in an oligopoly. One firm raises prices, the others follow; one expands capacity, and the rivals imitate lest they be left at a disadvantage in the future.

True

As major players in the international trade and investment environment, businesses can influence government policy toward the international monetary system. For example, intense government lobbying by U.S. exporters helped convince the U.S. government that intervention in the foreign exchange market was necessary. With this in mind, business can and should use its influence to promote an international monetary system that facilitates the growth of international trade and investment.

What is the Bretton Woods agreement? How was it different from the gold standard?

Bretton Woods established a system of payments based on the dollar, which defined all currencies in relation to the dollar, itself convertible into gold, and above all, "as good as gold" for trade. U.S. currency was now effectively the world currency, the standard to which every other currency was pegged.

Transaction exposure

Change in the value of a financial position created by foreign currency changes between the establishment and the settlement of a contract

True

Consumers lose because they must pay more for certain imports

True

Countries, while not adopting a formal pegged rate, try to hold the value of their currency within some range against an important reference currency such as the U.S. dollar, or a "basket" of currencies. This is often referred to as a dirty float.

Labor Productivity

David Ricardo's theory of comparative advantage offers an explanation in terms of international differences in

True

Despite the move toward a free market stance in recent years, many countries still have a rather pragmatic stance toward FDI. In such cases, a firm considering FDI must often negotiate the specific terms of the investment with the country's government. Such negotiations center on two broad issues. If the host government is trying to attract FDI, the central issue is likely to be the kind of incentives the host government is prepared to offer to the MNE and what the firm will commit in exchange. If the host government is uncertain about the benefits of FDI and might choose to restrict access, the central issue is likely to be the concessions that the firm must make to be allowed to go forward with a proposed investment

Explain how the principle of diminishing returns weakens the Ricardian model.

Diminishing returns show that it is not feasible for a country to specialize to the degree suggested by the simple Ricardian model outlined earlier. Diminishing returns to specialization suggest that the gains from specialization are likely to be exhausted before specialization is complete.

True

Domestic producers gain, because the tariff affords them some protection against foreign competitors by increasing the cost of imported foreign goods

True

Economies of scale are unit cost reductions associated with a large scale of output. Economies of scale have a number of sources, including the ability to spread fixed costs over a large volume, and the ability of large-volume producers to utilize specialized employees and equipment that are more productive than less specialized employees and equipment

Discuss the two schools of thought on exchange rate forecasting.

Efficient Market and Ineffecient Market Efficient Market school, = Many believe the exchange market is efficient at setting forward rates. An efficient market is one in which prices reflect all available public information. Inefficient Market - Does not reflect all information

Explain how equity loans and debt loans differ in terms of attractiveness to businesses.

Equity loans happen when an organisation decides to sell its stock to investors. Equity loans helps in the growth of the company and pay for important items. It also permits the stockholder to own a small or large part of the company, depending on their investment in the stock. Investors purchase stock to yield dividend and in anticipation of benefitting through gains in the price of the stock, which in theory reflects future dividend yields. A company need not pay back this loan in case they are at a loss. But the company should pay more if they are earning high profits. Debt loans are loans that a corporation has to pay back over time, usually to repay a predetermined portion of the loan amount. Thus, in the debt loans the risk is more for company as payments are to be made regardless of the profits. Debt loans might be useful for already well-established companies as they know they can generate enough revenue to pay back the loan.

What are the central issues facing the WTO at the present time?

Four issues at the top of the agenda for the WTO are the increase in antidumping policies, the high level of protectionism in agriculture, the lack of strong protection for intellectual property rights in many nations, and continued high tariff rates on nonagricultural goods and services in many nations.

False

Free trade refers to a situation where a government attemptsto influence through quotas or duties what its citizens can buy from another country, or what they can produce and sell to another country.

Describe the different exchange rate policies that are in practice today.

Free-Floating Systems Managed Float Systems Fixed Exchange Rates Fixed Exchange Rates Through Intervention

Explain the difference between fundamental analysis and technical analysis.

Fundamental analysis is a method of evaluating securities by attempting to measure the intrinsic value of a stock. Technical analysis differs from fundamental analysis in that the stock's price and volume are the only inputs. Both methods are used for researching and forecasting future trends in stock prices

True

Historically, substantial regulatory barriers separatednational equity markets from each other.

True

Host governments use a wide range of controls to restrict FDI in one way or another. The two most common are ownership restraints and performance requirements.

What are the ways in which host governments restrict inward FDI?

Host governments use a wide range of controls to restrict FDI in one way or another. The two most common are ownership restraints and performance requirements. Ownership restraints can take several forms. In some countries, foreign companies are excluded from specific fields. In other industries, foreign ownership may be permitted although a significant proportion of the equity of the subsidiary must be owned by local investors. Performance requirements can also take several forms. Performance requirements are controls over the behavior of the MNE's local subsidiary. The most common performance requirements are related to local content, exports, technology transfer, and local participation in top management.

What does the internalization theory seek to explain?

Internalization theory explains the existence of the firm because it is the most efficient way of coordinating a set of activities rather than market exchange. The firm grows when it can absorb markets and it will do so until the costs to the firm of further growth exceed the benefits.

True

It is argued that by appropriate actions, a government can help raise national income if it can somehow ensure that the firm or firms that gain first-mover advantages in an industry are domestic rather than foreign enterprises. Thus, according to the strategic trade policy argument, a government should use subsidies to support promising firms that are active in newly emerging industries

True

Licensing is not a good option in three situations. First, licensing is hazardous in high-tech industries where protecting firm-specific expertise is very important. Second, licensing is not attractive in global oligopolies where tight control is necessary so that firms have the ability to launch coordinated attacks against global competitors. Finally, in industries where intense cost pressures require that MNEs maintain tight control over foreign operations,licensing is not the best option

True

Licensing tends to be more common, and more profitable, in fragmented, low-technology industries in which globally dispersed manufacturing is not an option. A good example is the fast food industry

Describe some home-country policies that encourage outward FDI.

Many investor nations now have government-backed insurance programs to cover major types of foreign investment risk. The types of risks insurable through these programs include the risks of expropriation, war losses, and the inability to transfer profits back home. In addition, several advanced countries also have special funds or banks that make government loans to firms wishing to invest in developing countries. As a further incentive to encourage domestic firms to undertake FDI, many countries have eliminated double taxation of foreign income. Last, and perhaps most significant, a number of investor countries (including the United States) have used their political influence to persuade host countries to relax their restrictions on inbound FDI.

True

Mercantilism supports the idea that countries should export more than they import.

Consider the role of investor psychology and bandwagon effects on how well purchasing power parity and the international Fisher effect explain short-term movements in exchange rates.

Neither PPP nor the International Fisher Effect have proven to be good at explaining short- term movements in exchange rates. One reason for their poor explanatory power may be the impact of investor psychology on short-run exchange movements. Studies show that expectations about exchange rates tend to become self-fulfilling prophecies. A bandwagon effect occurs when investors in increasing numbers start following the lead of someone who may be pushing the value of a currency up or down due to psychological reasons. As a bandwagon effect builds up, the expectations of investors become a self- fulfilling prophecy and the market moves in the way the investors expected.

What does the new trade theory suggest?

New trade theory (NTT) suggests that a critical factor in determining international patterns of trade are the very substantial economies of scale and network effects that can occur in key industries. ... In some industries, two countries may have no discernible differences in opportunity cost at a particular point in time.

True

New trade theory stresses that in some cases countries specialize in the production and export of particularproducts not because of underlying differences in factor endowments, but because in certain industries the world market can support only a limited number of firms.

What are common criticisms against the IMF?

On giving loans to countries, the IMF make the loan conditional on the implementation of certain economic policies. These policies tend to involve: Reducing government borrowing - Higher taxes and lower spending.

True

PPP theory states that given relatively efficient markets, the price of a "basket of goods" should be roughly equivalent in each country.

As of 2016, the European ________________ has 751 members and is directly elected by the populations of the member states. It is primarily a consultative rather than legislative body.

Parliament

According to the ____________ of FDI, exploiting host countries to the exclusive benefit of their capitalist-imperialist home countries. They argue that MNEs extract profits from the host country and take them to their home country, giving nothing of value to the host country in exchange

Radical

Debt loan

Requires a corporation to repay loan at regular intervals.

What is an example of retaliation?

Some examples of retaliation would be a termination or failure to hire, a demotion, a decrease in pay, a decrease in the number of hours that you've worked. The cause will be obvious things such as a reprimand, a warning or lowering of your evaluation scores.

Currency ___________ typically involves the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates.

Speculation

What are the drawbacks of the Eurocurrency market

The Eurocurrency market has two drawbacks. In an unregulated system, such as the Eurocurrency market, the probability of a bank failure that would cause depositors to lose their money is greater. Thus, the lower interest rate received on home-country deposits reflects the costs of insuring against bank failure.

Discuss the establishment of GATT. What was GATT's objective?

The General Agreement on Tariffs and Trade (GATT) was created after World War II to aid global economic recovery through reconstructing and liberalizing global trade. GATT's main objective was to reduce barriers to international trade through the reduction of tariffs, quotas and subsidies.

Explain the Heckscher Ohlin trade theory

The Heckscher-Ohlin theory emphasizes the interplay between the proportions in which the factors of production (such as land, labor, and capital) are available in different countries and the proportions in which they are needed for producing particular goods. This explanation rests on the assumption that countries have varying endowments of the various factors of production.

True

The IMF's policies designed to cool overheated economies by reining in inflation and reducing government spending have been highly criticized. One criticism is that the IMF's "one-size-fits-all" approach to macroeconomic policy is inappropriatefor many countries. The IMF has also been accused of intensifying moral hazard through its rescue packages. Finally, it has been suggested that the IMF has become too powerful for an institution that lacks any real mechanism for accountability.

False

The International Fisher Effect is a good predictor of short-run changes in spot exchange rates.

Explain the North American Free Trade Agreement and then debate its ratification

The North American Free Trade Agreement (NAFTA) was implemented in order to promote trade between the U.S., Canada, and Mexico. The agreement, which eliminated most tariffs on trade between the three countries, went into effect on January 1, 1994. Numerous tariffs-particularly those related to agriculture, textiles, and automobiles-were gradually phased out between January 1, 1994 and January 1, 2008. Debate continues surrounding NAFTA's impact on its signatory countries. While the United States, Canada, and Mexico have all experienced economic growth, higher wages, and increased trade since NAFTA's implementation, experts disagree on how much the agreement actually contributed to these gains, if at all, on U.S. manufacturing jobs, immigration, and the price of consumer goods. The results are hard to isolate, and other significant developments have occurred on the continent and globally in the past quarter-century.

What was the major advantage of the system (Gold)?

The advantages of the gold standard are that (1) it limits the power of governments or banks to cause price inflation by excessive issue of paper currency, although there is evidence that even before World War I monetary authorities did not contract the supply of money when the country incurred a gold outflow, and (2) it creates certainty in international trade by providing a fixed pattern of exchange rates.

How does the global capital market benefit borrowers?

The borrowers (governments, businesses, and people who spend more than their income) borrow the savers' investments through the capital markets. When savers make investments, they convert risk-free assets such as cash or savings into risky assets with the hopes of receiving a future benefit.

Explain John Dunning's Eclectic Paradigm.

The eclectic paradigm, also known as the OLI Model or OLI Framework (OLI stands for Ownership, Location, and Internalization), is a theory in economics. It is a further development of the internalization theory and published by John H. Dunning in 1979.

How will EU countries benefit from the establishment of a single currency? What, if any, are the costs of a single currency?

The euro eliminates exchange rate risks and conversion costs The euro facilitates the free movement of EU citizens, goods, services and capital. The euro encourages competition, thereby increasing efficiency. The euro promotes stability and growth. Stronger presence in the global economy.

True

The foreign exchange market serves two main functions. The first is to convert the currency of one country into the currency of another. The second is to provide some insurance againstforeign exchange risk, or the adverse consequences of unpredictable changes in exchange rates.

True

The important thing to understand about an import tariff is who suffers and who gains. The government gains, because the tariff increases government revenues

False

The inefficient market school argues that forward exchange rates do the best possible job of forecasting future spot exchange rates, and, therefore, investing in forecasting services would be a waste of money.

Discuss the infant industry argument for intervention in markets. What is GATT's position on the argument?

The infant industry argument is an economic rationale for trade protectionism. The core of the argument is that nascent industries often do not have the economies of scale that their older competitors from other countries may have, and thus need to be protected until they can attain similar economies of scale.

What are the financial advantages that make the Eurocurrency market attractive to both depositors and borrowers?

The main factor that makes the Eurocurrency market attractive to both depositors and borrowers is that it: lacks government regulation. Banks offer higher interest rates on Eurocurrency deposits than on deposits made in the home currency because Eurocurrency deposits: lack government regulations.

dentify the multinational institutions that were established at the Bretton Woods agreement. What were their roles in the international monetary system?

The purpose of the IMF was to monitor exchange rates and identify nations that needed global monetary support.

Explain how the rivalry within an industry affects international competence.

The rivalry within an industry affects international competence by increasing the intensity of competition. For example, high intensity of rivalry means competitors are aggressively trying to compete in the market such as lowering the price of the products.

Explain how the theories of trade differ in terms of their support to governmental intervention.

The theories of Smith, Ricardo, and Heckscher-Ohlin form part of the case for unrestricted free trade. The argument for unrestricted free trade is that both import controls and export incentives (such as subsidies) are self-defeating and result in wasted resources. Both the new trade theory and Porter's theory of national competitive advantage can be interpreted as justifying some limited government intervention to support the development of certain export-oriented industries.

What are the four attributes that are discussed in Porter's diamond?

There are four elements highlighted in the diamond: factor conditions, demand conditions, firm strategy, structure, and rivalry, and related and supporting industries.

What are the main functions of the foreign exchange market?

Transfer Function Credit Function Hedging Function

Two Components of FDI

Typically, there are two main types of FDI: horizontal and vertical FDI. Horizontal: a business expands its domestic operations to a foreign country. In this case, the business conducts the same activities but in a foreign country. For example, McDonald's opening restaurants in Japan would be considered horizontal FDI.

What were the major disadvantages of the product life-cycle theory introduced by Vernon?

Viewed from an Asian or European perspective, Vernon's argument that most new products are developed and introduced in the United States seems ethnocentric and increasingly dated. This is a major disadvantage of the product life-cycle theory.

Do you think a new trade theorist would stress the role of luck and entrepreneurship? Explain

Yes. New trade theory is at variance with the HOT, since new trade believes in first-mover advantages, not necessarily because of factor endowments; new trade theorists stress the role of luck, entrepreneurship, and innovation in giving a firm first-mover advantages

Subsidy

a sum of money granted by the government or a public body to assist an industry or business so that the price of a commodity or service may remain low or competitive.

Administrative trade policies

administrative policies, typically adopted by government bureaucracies, that can be used to restrict imports or boost exports

What is the Leontief Paradox?

economics is that a country with a higher capital per worker has a lower capital/labor ratio in exports than in imports

The Heckscher-Ohlin theory predicts that countries will

export those goods that make intensive use of factors that are locally abundant.

The pragmatic nationalist view is that FDI

has both benefits and costs. According to this view, FDI should be allowed so long as the benefits outweigh the costs.

Trade creation occurs when

higher-cost external producers are replaced by lower-cost external producers within the free trade area.

import quotas

limitations set by a government on the amount of a product allowed to enter or leave a country

Trade diversion occurs when

lower-cost external suppliers are replaced by higher-cost suppliers within the free trade area. A regional free trade agreement will benefit the world only if the amount of trade it creates exceeds the amountit diverts

Eurocurrency

money deposited in a financial center outside of the country whose currency is involved

The EU is considered an imperfect economic union because

not all members of the EU have adopted the euro, the currency of the EU; differences in tax rates and regulations across countries still remain; and some markets, such as the market for energy, are still not fully deregulated.

A country's balance-of-payments accounts keep track ofthe

payments and receipts from other countries for a particular time period.

Dumping

selling products in a foreign country at lower prices than those charged in the producing country

Currency swaps

simultaneous purchase and sale of a given amount of foreign exchange for two different value dates

Forward exchange rates

the exchange rate governing a forward exchange

Economic exposure

the extent to which a firm's future international earning power is affected by changes in exchange rates

The WTO was encouraged to extend its reach to encompass regulations governing foreign direct investment, something the GATT had never done. Two of the first industries targeted for reform were

the global telecommunicationand financial services and industries

Spot exchange rates

the rate at which a foreign exchange dealer converts one currency into another currency on a particular day

Systemic risk

the risk that the failure of one financial institution can bring down other institutions as well

Voluntary export restraints

voluntarily imposed limits on the number or volume of products exported to a particular country

A ___________ is a quota on trade imposed by the exporting country, typically at the request of the importing country's government. One of the most famous historical examples is the limitation on auto exports to the United States enforced by Japanese automobile producers in 1981.

voluntary export restraint (VER)

A country is said to be in balance-of-trade equilibrium

when the income its residents earn from exports is equal to the money its residents pay to other countries for imports (the current account of its balance of payments is in balance).