4: International Trade & Globalisation, Financial Markets & Institutions, Financial Context of Business Flashcards
What is the balance of payments? & 3 parts?
A statement of the value of transactions with other countries. (Double Entry)
Current account, Capital Account & Financial Account
What falls under the Current Account?
Trade in goods, services, investment income, money transfers.
What falls under the Capital Account?
Government loans to/from other countries.
What falls under the financial account?
Foreign direct investment, portfolio investment and flows of currency.
If imports > Exports what does this mean?
Current Account Deficit
What causes current account deficits? (Import side)
Increased import penetration:
Lower production costs abroad mean cheaper overseas goods.
High exchange rates makes imports cheaper than domestic goods.
Inflationary gaps increase demand for imports.
What causes current account deficits? (Export side)
Poor export performance:
Exports are not competitively prices so demand from foreign consumers will fall.
High exchange rates make exports more expensive.
Low economic growth in foreign countries reduces demand for exports.
What are the policies to eliminate current account deficits?
Devalue currency, protectionism & deflating domestic demand.
What is an exchange rate determined by?
Demand / Supply of the currency on a foreign exchange market.
What creates demand for a currency? & Impact of price fall?
Sale of exports and investments into the local economy by foreign investors.
A lower price of a currency will increase demand for the currency.
What creates supply for a currency? & Impact of price rise?
Supply is created by the purchase of imported goods, sale of exports and also by foreign investments made by local investors.
The supply for a currency will rise as it’s price rises.
How do interest rates influence exchange rates?
Lower interest rates lead to a reduction in demand from foreign investors. So, a reduction in interest rates will lead to a fall in exchange rates.
How does inflation impact exchange rates?
High inflation means products become more expensive (Less Competitive)
High inflation would be expected to lead to a fall in demand for exports.
A fall in demand for exports will lead to a fall in demand for currency and a fall for demand in exchange rates.
What is a free floating vs Fixed exchange rate?
Free floating: Exchange rate determined by market forces. This will be volatile and may cause reluctance to trade internationally.
Managed Float: Where a government will buy and sell currency to stabilise swings in exchange rate.
Fixed exchange rate: Government needs to buy and sell currency reserves. Creates more certainty and therefore encourages international trade. Far more intensive to manage.
What are the advantages of free trade?
Specialisation: in most productive activities (Climate/Natural Resources)
Product Range: Countries can obtain goods they cannot produce themselves.
Greater global efficiency: Driven through increased competition.
Economies of scale: larger markets for a firm’s output.
What are the disadvantages of free trade?
Dumping: Imported products sold below domestic production costs.
Infant industries: New domestic firms need time before they are able to compete with larger foreign rivals.
Structural unemployment: Important domestic firms driven out by foreign rivals.
Social responsibility: Low-cost producers neglecting social factors of production.
What are examples of protectionist measures?
Outright ban on imports.
Tariffs: Imported goods more expensive.
Subsidies to domestic producers.
Quotas: Restrictions on volumes of a product
These all conflict with principles of free trade
What is a free trade area?
No restrictions on supply of goods/services between member countries.
What is a customs union?
A free trade area + common external tariffs on imports from non-member countries.
What is a common/single market?
A customs union + free movement of factors of production and standardised market regulations.
What is an economic union?
Common/single market + common central bank, common interest rate & single currency. (Eurozone)
Aims of the WTO?
Reduce barriers to free trade
Eliminate discrimination in trade
Deter protectionist measures.
Aims of the World Bank?
Lends to developing countries to fund projects and policies that promote economic development.
Used to finance infrastructure projects.
Aims of IMF?
Support the stability of the international monetary system.
Provide loans to countries with balance of payments problems. (Strict conditions attached: Contractionary fiscal stance)
What are the drivers of globalisation?
Improvement of communications
Reduction in trade barriers
Emergence of Multi National Companies
What is the Pestel analysis? And what is it used for?
Political: Stability of government.
Economic: Economic growth, interest rates, inflation, exchange rates.
Social: Demographic changes
Technological: IT & Communication infrastructure.
Ecological: Attitudes to pollution and waste, climate change.
Legal: Employment legislation, health & safety legislation.
It is used to analyse potential opportunities or risks in the external environment.
What are expenditure reducing policies vs expenditure switching policies?
Reducing: deflating domestic economy through contractionary fiscal/monetary policy
Switching: Protectionist measures
What is the matching concept?
Organisations should try to match the time period of the finance they borrow. (Short term or long term) to the life of the assets they are financing.
What is a financial intermediary?
An institution (Bank) that channels funds from savers to borrowers.
What are the functions of financial intermediary?
Maturity transformation: Bridging the gap between savers desire for liquidity & borrowers desire for long term loan finance.
Aggregation of funds: Aggregating lots of small amounts of money into a large loan.
Pooling of losses (Risk spreading):Covering bad debt risks using interest earned from other loans.
Examples of financial markets?
Primary markets: Allows borrowers to raise new finance (Issuing shares)
Secondary markets: Allows investors to sell existing assets to other investors.
What are the sources of short-term finance? From intermediaries and financial markets.
Financial Intermediaries:
Overdraft, Revolving credit facility, Short term loans/leases.
Financial Markets:
Bills of exchange, commercial paper, bank bills, treasury bills.
What are the sources of long-term finance? From intermediaries and financial markets.
Financial Intermediaries:
Long term loans/leases.
Financial Markets:
Shares, Bonds, Eurobonds, Convertible bonds, Gilts.
How to calculate the bond yield?
Nominal rate / market price of bond.
Eg: £100 bond with 4% nom rate & £95 market price.
Current yield = 4/95 = 4.21%
What are the conflicting aims of commercial banks?
Profitability: Must make profit for shareholders using interest rates.
Liquidity: Sufficient cash to meet demands from depositors for cash withdrawals.
Security: To be stable and secure to encourage deposits.
What is credit creation?
Banks lend out most of the money it receives. (Fractional Reserve Banking)
This money is then deposited into another bank and supports a further loan.
This cycle repeats creating extra deposits > Initial deposit.
How do we calculate the credit multiplier & Increase in deposits?
Credit Multiplier = 1/Reserve ratio.
Increase in deposits = Initial deposit * Credit Multiplier
What are the functions of central banks?
Sets interest rates, regulates banking sector, banks to commercial banks & governments, manages foreign currency reserves.
What is the financial asset risk ranking order?
From Low to High risk >
Treasury Bills > Government bonds > Corporate bonds > Shares.
What is the impact of central banks on Market Yields?
Interest rates: Increase
Rate of return: Increase
Share Price: Decreases
How to calculate how much cash to be deposited for money supply to increase by X amount in addition to initial deposit? With given Reserve Ratio…
Let X = 300 & Reserve Rate = 20%
Step 1: Calculate Multiplier (1/20%) = 5
Step 2: Factor: 5 * C = 300 + C
Step 3: Divide both sides by 5: C = 60 + 0.2C
Step 4: Move C to one side: 0.8C = 60
Step 5: Solve for C: C= 60/0.8
C=75
What is simple vs compound interest?
Simple: Interest earned in equal amounts each period which is based on original investment.
Compound: Interest which as it is earned is added to the original investment, which itself earns interest.
How to calculate simple & compound interest?
Simple: S = X + ( NRX)
Compound: S = X * (1+R)^N
Where: X = Original sum, R = Interest Rate, N = Number of periods, S = Sum invested after n periods.
How to calculate Effective Annual Rate?
1 + R = (1+R)^N
What is discounting?
Expressing future cash flows in today’s terms (Time value of money)
How to discount?
X = S * 1/(1+R)^N
What is NPV & how to interpret the results?
The sum of all the present values of future cash flows minus any expenditure.
If NPV = Positive: Accept
If NPV = Negative: Reject
How to calculate Annuity & Perpetuity?
Annuity = Use Annuity factor tables.
Perpetuity = Cash Flow * (1/Cost of Capital)
What is IRR? & Compare it to NPV
The rate of interest where NPV = 0
IRR shows the % Return, NPV shows actual returns.
Basing off % alone can mean a smaller return to shareholders is chosen just because it had a higher IRR %.
Always better to go with NPV.
What are the impacts of higher interest rates on businesses?
Higher cost of capital > Future cash flows more heavily discounted > Lower Present values.
Decline in AD as a whole affecting revenue.
Higher exchange rates make exports more expensive to prospective importers from abroad.
What are the impacts of higher exchange rates on businesses?
Exports become more expensive to foreign countries.
Imports become cheaper.
Translation risks.
What are translation risks & how to manage?
Movements in exchange rates that affect value of foreign assets/liabilities in domestic currency.
Can manage by matching assets & liabilities in the same currency to offset any changes.
What can businesses do to manage impacts of exchange & interest rate changes?
Forward contracts: Fixed rates which mitigates risks but are usually not attractive rates.
Futures Contracts: Fixed Rates which mitigate risks but are standard size contracts only & not available more than 1 year ahead.
Options: > Call: Buy at specific rate, > Put: Sell at specific rates.
Can take advantage in attractive rate changes but are usually expensive to purchase.
