international business midterm Flashcards
What expanded international trade? What dropped it?
- expanded when China entered the WTO
- dropped when financial crisis in 2008
What are the 4 country-based theories.
- mercantilism: we do not want to trade unless we must
- absolute advantage: focus on getting more and at a lower price, full specialization on what you do best and then you trade
- comparative advantage: which good a country should produce to maximize overall efficiency (opportunity cost)
- relative factor endowments (Heckscher-Ohlin theory and Leontief paradox)
- Heckscher-Ohlin theory: export goods we have the most of and import scarce goods
- Leontief paradox: Leontief tested Heckscher-Ohlin’s model, and the results were not consistent with the predictions of the model
What are the 4 firm-based theories.
- similarity theory: countries with similar per capita income have similar quality products
- product life cycle
- new trade theory: economies of scale (the more you do it, the more efficient you get, and costs go down), opening borders allows for more companies to compete and therefore creates a market
- national competitive advantage
What type of trade are country-based theories?
inter-industry trade (exchange of goods across different industries)
What type of trade are firm-based theories?
intra-industry trade (exchange of similar products within the same industry, cars for cars, phones for phones)
What is the difference between direct investments and portfolio investments? Give an example of both.
- direct investment: invest in a company and decide what to do with it, you have decision-making capabilities
- example of direct investment: opening a retail store
- portfolio investment: you do not get to decide what to do with a company that you invested in, no decision-making capabilities
- example of portfolio investment: lending money to someone in another country (you do not get to decide what they do with it)
What are the 2 main political factors?
- avoidance of trade barriers = if you do not make it into my country, and you ship it to my country, i will charge you the tariffs. if you make it to my country, i will not charge you the tariffs
- economic development incentives = invest in my country and i will give you money or give you tax credits
What is protectionism?
making decisions (at a country or regional level) that aim to protect things we consider important
What are stakeholders?
those that have the most to gain/lose are the most vocal in wanting to create change or to stop change
What are the 4 economic rationales?
- fighting unemployment: limit imports to increase employment
- protecting infant industries: new industry that you are trying to growth, try to protect it so you can compete with other players
- industrialization: established industry that you are trying to protect
- economic relationships with other countries: government compares its economic performance to other countries and enact policies to improve its relative position
What are the 4 noneconomic rationales?
- maintaining/extending spheres of influence: expanding political influence
- preserving national culture: limiting exports of items deemed to be part of their national culture
- maintaining essential industries: we are in power and there are industries that we have to protect (like health care)
- promoting acceptable practices abroad: use our economic influence to push the other region/country to change their behavior
What are 2 ways to control trade?
- quotas: directly influencing quantity
- tariffs: indirectly influencing quantity by directly influencing price
What are 3 ways you can directly influence quantity?
- quotas: there is a certain amount you can bring
- embargoes (type of quota): nothing can come into my country
- voluntary export restraint (type of quota): agreement between an exporting country and an importing country to limit the amount of a product that can be exported
What are 4 ways you can indirectly influence quantity by directly influencing price?
- specific duty: country assesses a tariff on a per unit basis
- ad valorem tariff: assessed as a percentage of the item’s value
- compound duty: when both a specific and an ad valorem tariff are assessed
- subsidies: given to help industries overcome market imperfections
What are tariffs?
- direct revenue stream for the government (if the government imposes them, they get the money)
- whoever brings it in the country must pay the tariff (and the money goes to the government)
What happens when a big country like the United States tariffs a small country like Iceland?
- prices stay the same in big country
- prices go down the entire amount of the tariff in small country
What happens when a small country like Iceland tariffs a big country like the United States?
- prices stay the same in big country
- prices go up the entire amount of the tariff in small country
What happens when a small, but not that small, country like Canada tariffs a big country like the United States?
- prices go up, but not the full amount of the tariff, in small country
- prices go down, but not the full amount of the tariff, in big country
What happens when a big country like the United States tariffs a small, but not that small, country like Canada?
- prices go down, but not the full amount of the tariff, in small country
- prices go up, but not the full amount of the tariff, in big country
What is the World Trade Organization?
- sign up to obey a set of rules about trade
- if there is a dispute, you go to the WTO
- a tiny country can take a large country to court (court = WTO) and win
What is the difference between a direct quote and an indirect quote?
- direct quote: how much of my currency do i need to buy one unit of foreign currency
- indirect quote: how much foreign currency you can buy with one unit of your currency
What is the difference between bid rate and ask rate?
- bid rate: price that a dealer is willing to pay to buy currency
- ask rate: price at which the dealer is willing to sell currency
What is spread?
difference between bid rate and ask rate
What is arbitrage? What are the 3 important things about it?
- free money (riskless profit)
- the three important things about arbitrage are: as fast as possible, put in as much money as possible and lock in the rates
What is the difference between appreciation and depreciation?
- appreciation: increase in value, positive % change
- depreciation: decrease in value, negative % change
What is the difference between forward exchange rate and spot exchange rate?
- forward exchange rate: negotiated today for delivery at a pre-specified future date
- spot exchange rate: rate at a given point in time (there is a rate now, but there was a different rate 3 seconds ago)
What is LIBOR?
base rate that institutions use to lend
What are eurocurrencies?
any currency that can be easily and freely exchanged for a foreign currency
Describe the evolution of capital mobility.
- Classical Gold Standard: fixed exchange rates, every country was fixed to gold
- Inter-War Years: 1914 to 1945, US dollar was the dominant reserve currency and only the US dollar remained convertible into gold, allowed a 1% threshold to buy or sell foreign or gold reserves, up to 10% devaluation was allowed (more than that required approval)
- Fixed Exchange Rates: early 70s, USA runs out of gold so leading countries were allowed to float their exchange rates
- Floating Era: countries no longer have the gold standard, exchange rates are less predictable
- Emerging Era: growing in emerging market economies and currencies
What is the difference between a fixed (pegged) exchange rate and a floating exchange rate?
- fixed/pegged: a country’s central bank sets and maintains the official exchange rate
- floating: government does not set the currency’s value or intervene in the marketplace, allowing supply and demand to determine the exchange value
Under fixed/pegged exchange rate, what is there?
- hard peg: government locks in an exchange rate, also called currency board, dollarization (using another country’s currency and abolishes its own) happens
- soft peg: exchange rate varies ±1% around a central rate
Under floating exchange rate, what is there?
- managed float: if you do not like what is going on, you can actively intervene
- free floating: cannot actively intervene if you do not like what is going on
Most countries have what type of exchange rate?
fixed
What is in the middle of fixed and floating exchange rates?
crawling/intermediate peg: actively manage currency to make it softly land at a new rate, government makes occasional small adjustments in its fixed rate of exchange
Give an example of fixed exchange rate.
- If people are excited for the US economy, demand will go up. Consequently, you must increase supply. In order to increase supply, you must print more money so that reserves go up.
- If people are concerned for your economy, demand will go down. Consequently, supply will go down to keep exchange rates fixed. Reserves will go down.
Give an example of floating exchange rate.
- If people are excited for Canada’s currency, demand will go up. However, supply will stay the same as Canada cannot intervene. The value of the currency will go up (appreciates).
- If people are worried for Canada’s currency, demand will go down. However, supply will stay the same as Canada cannot intervene. The value of the currency will go down (depreciates).
Describe the IMF (International Monetary Fund). When was it created?
- defend currencies, particularly emerging economies, against potential issues to keep it at a rate
- created during Bretton Woods
What are special drawing rights?
money that a country has that is maintained by the IMF
Describe the impossible trinity.
- Exchange rate stability (fixed or floating)
- Monetary independence (can you print your own money?, can you change exchange rates of your own?)
- Full financial integration (is it easy to move money in and out of the border?)
- You cannot keep all 3 (above) for long periods of time
Describe China’s situation in terms of the impossible trinity.
- have exchange rate stability
- have monetary independence
- does not have full financial integration
Describe Canada’s situation in terms of the impossible trinity.
- have full financial integration
- have monetary independence
- does not have exchange rate stability
Describe France’s situation in terms of the impossible trinity.
- have exchange rate stability
- have full financial integration
- does not have monetary independence
What is a pro and what is a con of fixed exchange rates?
- pro: no inflation
- con: need to manage reserves
What is seigniorage?
printing your own money
In balance of payments, what is deficit, export and import?
- deficit: more money going out than money coming in
- export: money earned from selling goods and services abroad
- import: money spent on purchasing goods and services from other countries.
What are the 2 primary sub accounts in balance of payments? Describe them. Which of these are big? Which of these are tiny?
- current account: goods (balance of trade) and services, net income
- capital/financial account: capital account can be defined as real estate for person use, financial account includes foreign direct investment and portfolio investment
- current and financial are big
- capital is tiny
In balance of payments, what does official reserves include?
- gold
- foreign currencies
What type of exchange rate does balance of payments follow? What does it mean?
- floating exchange rate
- inverse relationship between current account and financial account
In balance of payments, what does it mean to have a negative current account? What does it mean to have a positive current account?
- negative current account: import > export
- positive current account: export > import
In balance of payments, what is debit and credit?
- debit: cash out
- credit: cash in
What is the difference between capital flight and capital control?
- capital flight: money leaving out of a country (can have a snowball effect)
- capital control: limit on how much you can take in and out of country
In balance of payments, what does it mean to have a positive financial account? What does it mean to have a negative financial account?
- positive financial account: money in > money out
- negative financial account: money out > money in
In balance of payments, what does it mean to have a negative balance of trade? What does it mean to have a positive balance of trade?
- negative balance of trade: import > export
- positive balance of trade: export > import
What is a price index?
- used to track inflation
- basked of goods
What are the 4 concepts of international parity conditions in equilibrium? Describe them and provide their formulae.
- expected exchange rate changes
- expected inflation rate differential: expected inflation in the future
- relative interest rates: lending money and getting that money back later
- forward exchange rates: some point in the future
What theory connects expected exchange rate changes and expected inflation rate differential? Describe the theory.
- theory: relative PPP
- higher expected inflation = value currency will go down compared to other country
- lower expected inflation = value currency will go up compared to other country
- includes law of one price
What theory connects expected inflation rate differential and relative interest rates? Describe the theory.
- theory: fisher effect
- when you see a nominal/posted rate, part of it will be expected inflation and part of it will be real rate of return
- assumption = move money anywhere
- anytime there is a difference in a nominal/posted rate, it is due to expected inflation (real rates stay the same because of the assumption)
What theory connects relative interest rates and forward exchange rates? Describe the theory.
- theory: covered interest rate parity
- where a pair’s spot and forward currency prices are equal, representing no arbitrage opportunity
What theory connects forward exchange rates and expected exchange rate changes? Describe the theory.
- theory: unbiased forward rates
- sometimes we will be low, sometimes we will be high, but it will even out eventually
- if currency appreciates compared to mine = premium
- if currency depreciates compared to mine = discount
What theory connects expected exchange rate changes and relative interest rates? Describe the theory.
- theory: uncovered interest rate parity/international fisher effect
- lower nominal rate = lower expected inflation = higher value of currency = get premium
- higher nominal rate = higher expected inflation = lower value of currency = get discount
What is the law of one price? Provide its formula.
- a product’s price should be the same in all markets
What is absolute PPP? Provide its formula.
- if you know the price of something in one country, and you know the price of the same thing in another country, you can find the exchange rate
If we end up with two different amounts (arbitrage) in a covered interest arbitrage calculation using the box method, where should we borrow and where should we invest?
- invest on higher side
- borrow on lower side
