Exam 1 Flashcards
Multinational Enterprise
Economic function with operations and/or assets in at least one other country than its home country
Benefits to Multiunationalization
- Access to new markets
- Access to cheaper or more skilled labor
- Lower taxes or other operational costs
- Technological development
- Increase export production
- Diversification
Costs to Multinationalization
o Legal framework of host countries. o Political Risks. o Mobility of Capital. o Resource exploitation. o Threat to domestic competitors. o Profit repatriation.
Multinational Enterprise Modes of Operation
o Licensing o Franchising o Joint venture o New foreign subsidiary o Management contracts
Multinational Enterprise Modes of Operation - Licensing
occurs when the home country firm authorizes the host country firm to use some or all its intellectual property (patents, trademarks, copyrights, brand names) in exchange for fees or some royalty payment. However, the licensee retains control over its operations.
Multinational Enterprise Modes of Operation - Franchising
occurs when the home country firm authorizes the host country firm to utilize its full set of operations including its brand names, logos etc. in return for royalty payments and has more control over the latter’s operations.
Multinational Enterprise Modes of Operation - Joint venture
occurs when both home and host country firms form a corporate entity or partnership that is jointly owned and operated.
Multinational Enterprise Modes of Operation - New foreign subsidiary
occurs when the home country firm penetrates the host market by establishing a new operation in the host country.
Multinational Enterprise Modes of Operation - Management contracts
occurs when the home country firm agrees to operate facilities or provide other management services to a host country firm for a fee
International monetary system
a set of procedures, mechanisms, processes, and which are established to determine the rate at which one currency is exchanged in respect of another currency.
Evolution of the IMS
1876-1913 - Gold Standard
1914-1945 - Wolrd Wars 1 and 2
1944-1971 - Bretten Wood System
Gold Standard
Underlying value of a country’s currency was based on the weight of gold
o Exchange rate was based on the weight of gold between 2 countries.
o The value of each country’s currency was backed by its gold reserves
How to settle a transaction in gold
- Step 1 – determine the amount gold (in ounces) something is worth in home country
- Step 2 – determine the amount of gold (in ounces) something is worth in foreign country
- Step 3 – determine exchange rate of the gold between the 2 countries
Bretton Woods System
- Established USD based international monetary system
- Countries agreed to keep currencies fixed +/- 1%
- International transactions settled in USD
- US responsible for converting US dollars to gold
- Created IMF and World Bank
IMF – International Monetary Fund
o Created to monitor exchange rates and lend reserve currencies to nations with balance of payments deficits.
o Three main objectives
- Monitors the global economy and the economies of member countries:
- Lends to countries with balance of payments difficulties:
- Provides Capacity Development:
International Bank for Reconstruction and Development/World Bank
o Created to “financial assistance for the reconstruction after World War II and the economic development of less developed countries.”
o Three main objectives
- Helping create sustainable economic growth.
- Target development areas such as providing access to health care, education, water and sanitation, and energy.
- Building a country’s resilience to shocks and threats.
Cryptoasset
A financial asset created by cryptography and recorded in digital form on a distributed ledger (blockchain) but does not represent any financial claim, or a liability of, any identifiable entity or individual
Blockchain
Digital Ledgers of economics transactions that are measured in cryptocurrencies
2 Major issues with Cryptoassets
- Price risk
- Money laundering/terrorist fudding – due to anonymity
Blockchain in the MNF
o Instant Payments o Foreign Currency trading o Asset Management/Trading o Cross-border/Securities settlements o Remittances
Foreign Exchange Market
financial market in which foreign currencies and foreign assets are traded or exchanged
Foreign exchange Market Structures Operated by Central Banks
- Foreign Exchange Standing Facility
- Allocation
- Auction
- Fixing
Foreign Exchange Standing Facility
market participants can trade foreign currencies with the central bank at a predetermined rate.
Allocation
foreign currencies for trading are apportioned for specific market participants or for specific purposes.
Auction
foreign currencies are traded based on a competitive bidding process.
Fixing
foreign currencies are traded at the daily exchange rate of a fixing session (a time of day when the price of currencies for commercial transactions are set, or fixed).
Foreign exchange Market Structures Operated by Interbank Market
- Over the Counter (OTC)
- Brokerage
- Market making
Over the Counter (OTC)
a decentralized market in which market participants (banks) trade with each other
Brokerage
facilitates the trading of currencies on behalf of clients
Market making
market participants quote their own bid and offer prices in currency trading transactions
Foreign Exchange Trading Activities
o Purchase/sale of foreign currencies for commercial trade transactions by customers
o Purchase/sale of foreign currencies for investment by customers
o Purchase/sale of foreign currencies for hedging
o Purchase/sale of foreign currencies for speculative purposes
Purchase/sale of foreign currencies for commercial trade transactions by customers
- May need to pay for goods overseas and need foreign currency
- May have customers pay invoices in foreign currency and need to convert to local currency
Purchase/sale of foreign currencies for investment by customers
- Opportunity to acquire an appreciating asse;t
- Opportunity to acquire an asset in a foreign asset
Purchase/sale of foreign currencies for hedging
- Largest risk for MNC is foreign exchange risk
- To manage this risk- hedge the risk
Purchase/sale of foreign currencies for speculative purposes
- Allow MNC to profit from a trade
Foreign Exchange Rate Direct Quote
domestic currency quoted as a unit of the foreign currency
USD first = direct quote
Foreign Exchange Rate Indirect Quote
foreign currency quoted as a unit of the domestic currency
Currency Appreciation
an increase in the value of a country’s currency relative to another
Currency Depreciation
a reduction in the value of a country’s currency relative to another
Foreign Exchange Rates – Cross Rates Process
Step 1: Determine if arbitrage opportunity exists
Step 2: If so, determine the profit
Hard Peg
Exchange Rate remains fixed in perpetuity
Floating
Exchange Rate floats in perpetuity. Moves in waves with a degree of uncertainity. This is what the US uses
Soft Peg
Somewhere in between. Moves around a fixed value with an allowable margin. The fixed rate changes or is reevaluated at a defined frequency.
Theories of ER Determination
o Purchasing Power Parity Approaches
o Balance of Payments (Flows) Approaches
o Monetary Approaches
o Asset Market Approach
Purchasing Power Parity
o The Law of One Price
o Absolute PPP
o Relative PPP
The Law of One Price - Need to verify
o The ratios of the prices of goods between two different countries will tell you what the ER is
o The Big Mac Index -> (US Big Mac price)/(UK Big Mac Price)=Exchange Rate
Absolute PPP - Need to verify
FX rate is the ratio of price levels (inflation) between countries
- Compare price levels (Inflation) between 2 countries – the ratio of inflation between 2 countries
Relative PPP - Need to verify
change in FX rates is a function of changes in price levels (inflation) between countries
- Look at change of price levels (Inflation) between 2 countries
Balance of Payment Approaches
BOP = Current Account (imports + exports) + Financial accounts (accounts payables and receivables)
Fixed Exchange Rate: BOP>0
- More exports than imports
- These goods and services will pay with their local currency -> the local currency value will go up
- To maintain the fixed ER, the authority in that country will need to bring down the value of that local currency -> need to increase supply of local currency
- The “local” currency is the currency of the exporting country
Fixed Exchange Rate: BOP<0
- More imports than exports
- The home country people will be demanding the foreign currency
- There will be an oversupply of the local currency (due to not being used)
- Need to bring the value of the domestic currency back up -> buy up the domestic currency -> price begins to go back up
Floating Exchange Rate: BOP>0
`- Exports greater than imports
- Foreign buyers are demanding the local currency -> local currency deman goes up -> value of local goes up -> foreign buyers will reduce demand for exported goods because they get too expense -> BOP gets closer to 0 -> ER levels out
Floating Exchange Rate: BOP<0
`- Imports greater than exports
- Excess supply in domestic currency -> exports become cheaper -> exports go up -> value of domestic currency goes up -> ER levels out
Monetary Approach
Exchange rate is determined by the demand and supply of money
Asset Market Approach
Exchange rate is determined by the supply and demand for financial assets
Market Intervention Approaches
o Direct Intervention
o Indirect Intervention
o Capital Controls
Direct Intervention
active buying and selling of domestic currency to influence its supply and therefore price against foreign currency
Indirect Intervention
Using monetary policy tools (interest rates => money supply) to effect changes in exchange rates
Capital Controls
direct prohibition or limiting access to foreign currency.
