Key Terms Flashcards
political costs of international business include
Incl cost of paying bribes or lobbying for favorable or fair treatment
economic costs of IB
Relates primarily to the sophistication of the economic system, incl infrastructure and supporting businesses
legal costs of IB
Different product, workplace, and pollution standards; or poor protection for property rights
Occur when it is more costly to do business in countries with dramatically different product, workplace, and pollution standards, or where there is poor legal protection for property rights
political risk of IB
Likelihood that political forces will cause drastic changes in a country’s business enviro that adversely affects the profit and other goals of a business enterprise
economic risk of IB
likelihood that Econ mismanagement cause changes that adversely affect the profit and other goals of a firm
(length: Likelihood that economic mismanagement will cause drastic changes in a country’s business enviro that adversely affect the profit and other goals of a business enterprise)
legal risk of IB
Likelihood that a trading partner will opportunistically break a contract or expropriate property rights
why do governments matter
Stability
Laws and regulations
Development
Taxation
Corruption, fairness
democracy
based on individualism, elected govt
totalitarianism
Various forms:
Communist, theocratic, tribal, right-wing
pseudo-democracies
-Lie between pure democracies and complete totalitarianism systems
-Authoritarian elements have captured some or much of the machinery of state and use this in an attempt to restrict political and civil liberties
market economy
Private ownership
Supply and demand
Govt encourages free and fair competition
command economy
State ownership
Govt planning determines production and pricing
Incentives become problematic
mixed economy
Mix of private and govt ownership
Supply and demand but also regulation
common law
Based on cumulative wisdom and judges decisions - differs from country to country
Eg, defective products
statutory law
Enacted by legislative action
Eg, legal fees
civil law
Most common type of legal system
Based on codification and detailed listings
religious law
Based on faith and practice of a particular religion “theocracy”
bureaucratic law
Law is what the bureaucrats say it is
sanctions
Restrictions against commerce
embargos
Comprehensive sanction against ALL commerce with a given country
dual use
Export controls for (usually) high tech
extraterritoriality
Regulate business outside borders
nationalization
Transfer of ownership from private to public
Expropriation - compensated
Confiscation - no compensations
repatriation
controls on return of profits to home country
property safety laws
Set certain standards to which a product must adhere
product liability
-Involves holding a firm and its officers responsible when a product causes, injury, death, or damage
-When product safety laws are stricter in a firm’s home country than in a foreign country, or when liability laws are more lax, the firm has to decide whether to adhere to home country or host country standards
domestically oriented laws
Foreign ownership restrictions
Health and Safety
Environment
Labour
Criminal and Civil Liability
Property Rights
intellectual property
Patents, Copyrights and Trademarks
IP laws exist, but enforcement is lax
IP protection limits access
IP protection creates opportunities
-Research and Development
-Protect inventors
tariff
Taxes on goods crossing national borders
Quotas
Quantitative limits on imports (or exports)
trade is also limited by
shipping costs, currency conversion, communication etc
mercantilism
-Country’s wealth is measured by holdings of gold and silver
-Nations should strive to maximize exports and minimize imports
-Policy implications
–Export subsidies
–Import restrictions (quotas, tariffs)
what’s wrong with mercantilism
David hume
-Balance of trade surplus leads to inflation
Adam smith
-Zero sum game
-Acquisition of treasure vs acquisition of wealth
Mercantilism actually harms a country
-Import restrictions lead to inefficiencies
-Benefit of voluntary exchanges
absolute advantage
-Adam smith: A country should export those goods and services for which it is more productive than other countries are and import those for which the opposite is true
-Both countries will be better off
comparative advantage
-Trade what can be produced most efficiently relative to other countries
-Compares opportunity costs rather than inputs required
-There is a mutual benefit to exchange when individuals have different opportunity costs
-Gains from specialization and trade are based on comparative advantage
-Causes total production in the economy to rise without adding additional resources
-Each benefits by obtaining a good/service at a price lower than their opportunity cost for that good
What determines the products for which a country will have a comparative advantage
-Productivity
-Factor endowments
-A country will have a comparative advantage in producing products that intensively use the resources (factors of production) it has in relative abundance
implications of new trade theory
-Nations may benefit from trade even when they do not differ in resource endowments or tech
A country may dominate the export of a good bc of first mover advantage
-Identifies a source of comparative advantage
-extension of the theory is the implication that governments could consider strategic trade policies that nurture and protect firms and industries where first mover advantages and economies of scale are important
why do we have international trade
-businesses and individuals believe they will be better off
-businesses use trade to globalize their markets and to facilitate the globalization of production
gains and losses of int trade
-aggregate gains from specialization and trade are greater than the losses
-but, gains and losses unevenly distributed
–creates lobby initiative and complex policy choices
–challenge of willingness of winners to compensate losers via redistribution policies
-also issues of security, sovereignty, nationalism, enviro protection, inequality
national comparative advantage: porter’s diamond
why does a nation achieve international success in a particular industry
-4 attributes of a nation shape the environment in which local firms compete
1. factor endowments
2. demand conditions
3. related and supporting industries
4. firm strategy, structure, and rivalry
Factor endowments: basic factors
Natural resources, climate, location, demographics
Factor endowments: advanced factors
-Specialized factors which are created and therefore both harder to imitate and more valuable
-Advanced factors are a product of investment by individuals, companies, and governments
Factor endowments: selective factor disadvantage
the absence of a basic factor that would be advantageous to have in abundance
demand conditions
-Large sophisticated domestic consumer base compels innovations and quality improvements
-Picky buyers are valuable when they demand produce attributes that are also appealing to foreign consumers
why is competitiveness in related industries mutually reinforcing
Communication
Transportation
more/larger/competitive suppliers
workforce
competitive advantage of nations
1.Embrace adversity - seek out competition and demanding consumers
2.Quality not quantity - abundance of general use factors, large firms not important, but high quality factors, suppliers, buyers and rivals are
3.Agglomerate - rather than seeking cheap labour or land, locate in the middle of an industry cluster
national security
Belief that some industries should be self sufficient
-The pandemic has amplified this
Belief that some technologies should be protected
-Dual use controls
Some of foreign policy objectives
-Sanctions to encourage other countries to disarm in order to protect home from nuclear threats
foreign policy
-political aims
-human rights
-enviro protection
policy for domestic production
-Maintenance of existing jobs/industries
–Strong lobby groups
–Political costs, human costs
-Protecting consumers
–Restricting dangerous products
ad valorem tariff
Assessed as a percentage of market value
specific tariff
Monetary amount per unit
import tariff
Applies to goods entering a country
export tariff
Applies to goods leaving the country
transit tariff
applies to goods passing through a country
tariffs
-act as a trade barrier
-raise national revenue
quotas
quantity limit on imports
tariff rate quota
Low tariff on limited amount and then higher tariff after a certain level
voluntary export restraint
Promise to limit exports to a certain amount
other non-tariff barriers
Product Testing Standards
Restricted Access to Distribution Networks
Public Sector Procurement
Local Content Requirements
Regulatory Controls
Investment Controls
GATT
Generalized Agreement on Tariffs and Trade (1947 - 1994)
Eight rounds focused on developing a free and competitive international trading environment.
Most Favoured Nation (MFN) – preferential treatment given to one nation must be extended to all members.
WTO
Successor of GATT
-Created in 1995 with the aim to build a trading system:
Without discrimination
Freer
Predictable
More Competitive
Beneficial for Less Developed Countries
basic rules of WTO
*in notes
WTO recently:
164 members, ~98% of world trade
Limited progress since the late 90s.
-Doha round is stalled
The 2008/09 financial crisis
-Trade volume collapse (and subsequent recovery)
-Uptick in protectionism
Pandemic trade collapse, trade disputes
-Nationalism
Leadership (lack there of)
Agriculture
Intellectual Property
exchange rate
the price of one country’s currency in terms of another
-Currency A appreciates relative to currency B, if the price of A in terms of B increases.
-Currency A depreciates relative to currency B, if the price of A in terms of B decreases
foreign exchange market functions to
-the market to convert the currency of one country into another
-Provide instruments to hedge exposure to foreign exchange risk
foreign exchange risk
arises as a result of currency appreciations and depreciations – changes in the exchange rate.
direct exchange rate
price of foreign currency in terms of home currency.
Example: $1 US costs $1.10 Canadian
formula = 70usdx1.10cad/1usd=77cad
indirect exchange rate
price of home currency in terms of foreign currency.
Example: $1 Canadian costs $0.72 US
spot exchange rate
exchange rate on a given day.
forward exchange rate
exchange rate for some specified point in the future
how are the prices of most currencies driven
-market driven
-ie, the exchange rate at any given time is determined by the supply and demand for that currency
-However, the degree to which monetary authorities intervene in the market to manage the value of their currency varies considerably.
what determines the supply and demand of a currency
-Demand for the Canadian dollar is derived from foreigner’s desire to acquire Canadian goods, services and assets (anything purchased in Canadian $).
-Supply of Canadian dollars is driven by the desire of Canadians to acquire foreign goods, services and assets.
foreign exchange market
-Global network of banks, brokers, foreign exchange dealers.
-Businesses and individuals use the foreign exchange market to:
–Convert payables/receivable from one currency to another
–Investment opportunities
–Currency Speculation
-Governments also use the foreign exchange market
forex: consumption
businesses and individuals buy and sell currency as a result of transactions for goods or services.
forex: investment
search for the highest return
forex: arbitrage
attempts to exploit small differences in the price of a currency between markets.
forex: speculation
deliberate assumption of exchange rate risk in hopes of correctly predicting changes in the value of a currency.
what determines long run value of currency
-Supply and demand.
-The long run economic health of an economy and its assets (exports, firms, real estate, bonds, stocks…)
–“Fundamentals”
-The long run stability of an economy
-Possibly purchasing power parity (PPP)
law of one price
If the price of a good differs between two markets, arbitrage will continue until the price of the good is identical in both markets.
-This excludes transactions costs, transportation costs, taxes and so on, and applies to tradables only.
purchasing power parity (PPP)
-Exchange rates are determined by the relative prices of a similar basket of goods.
-This occurs because the process of buying goods in the cheap market and reselling them in the expensive market affects the demand for, and thus the price of, the foreign currency.
fundamentals
-Consumer spending
-Unemployment Rate
-Productivity Indices
-GDP…
-Inflation Rate
-Interest Rate
investor psychology and bandwagon effect
Expectations can be self fulfilling prophecies.
When one trader moves, others often follow.
Psychology and Bandwagon effects may be one of the largest determinants of exchange rates in the short run.
monetary policy
Monetary authorities step in to influence the value of an exchange rate by intervening in the market:
-Shifting either the supply or demand curves for their currency to change the price
Transaction exposure
translation exposure
economic exposure
managerial considerations for currency
Currency Convertibility
Foreign Exchange Risk:
-Transaction Exposure
-Translation Exposure
-Economic Exposure
forex risk exposure: currency depreciation
-Exporters tend to be better off as their products are less expensive in foreign currency
-Domestic firms competing with imports tend to be better off because competing imports are relatively more expensive in domestic currency
-Importers and consumers tend to be worse off as imported products are more expensive in domestic currency
-Foreign debt becomes more expensive but foreign assets become more valuable
-The larger, faster and more unexpected the depreciation, the greater the turmoil associated with it.
how do businesses manage currency risk
-understanding their exposure to currency changes and making strategic decisions which consider that exposure
-anticipating shifts in currency values
-hedging their exposure
–forward contracts
–currency options
–lead or lag strategies
–diversification
–matching debt and income currencies
forward contracts
A contract to buy or sell foreign currency at a
fixed price sometime in the future.
-A forward contract to purchase a currency is
beneficial if the spot rate at the date of
transaction is more expensive than that
offered by the contract (spot > forward)
-A forward contract to sell a currency is valuable if the opposite is true (spot < forward)
forward premium (forward discount)
is the proportion by which a country’s forward
exchange rate exceeds (falls below) its spot
rate
call option
the right to BUY a specified amount of foreign currency for a specific price any time up to a specified date.
Options give you the option to buy or sell, not the obligation to buy or sell.
put option
the right to SELL a specified amount of foreign currency for a specific price any time up to a specified date
Options give you the option to buy or sell, not the obligation to buy or sell.
diversification
Exposure to multiple currencies can act as a hedge
Flexibility in locations can also act as a hedge
matching debt and income currencies
Currency risk can be reduced if payables and receivables are in the same currency
Lead strategy
Lag strategy
how do businesses manage currency risk
-ID where/how they are exposed (translation, transaction, or economic exposure)
-quantify the exposure
–eg, if a particular exchange rate appreciates X% this year, how will we be affected; or how much would a particular exchange have to depreciate before a particular choice is no longer viable
-make strategic choices in hedging exposure
capital markets
-stock markets and bond markets are capital markets
-Consists of both primary and secondary markets
-Connecting investors and borrowers
-Cost of capital
stocks
stocks are equities - a form of ownership
can be used to raise capital
bonds
bonds are debt - a loan which must be repaid (to lenders by borrowers)
can be used to raise capital
global capital market
-different countries
-facilitates financing in a variety of currencies
-investors: opportunities and diversification
–More investment opportunities
–Portfolio diversification
-borrowers: cost and availability of capital
–search for lower cost of capital
growth of capital markets
tech improvements
-Processing of large volumes of stock and bond transaction information (e.g., real-time updates).
-Trade information on a number of exchanges can be accessed from anywhere in the world.
deregulation
-Traditionally financial services have been highly regulated.
-Restrictions have rapidly decreased (e.g., foreign ownership of domestic assets and domestic capital investment abroad)
global capital market risks
-Foreign Exchange Risk (in general)
-Nations more vulnerable to speculative capital flows
-Lack of quality information
–(Regardless of the quality of information) Investors react quickly to news events, which may encourage speculation
-Capital seeking short term gains
-Potential destabilization of economies
eurocurrency
A eurocurrency is a currency banked outside its country of origin.
-Example: A Japanese currency account held at the TD in Victoria. (this is a euro-yen)
why eurocurrency
-Few regulations
–Absence or near absence of reserve requirements make euro loans and euro deposits attractive
–Lowers cost of capital
global bond market
Bonds are an important means of financing for global firms
Two types of bonds – foreign bonds and Eurobonds
foreign bonds
-Bond issued by a resident of Country A but sold to residents of Country B, denominated in the currency of Country B and subject to Country B’s regulations.
-Example: British bank Lloyds sells Japanese yen denominated bonds in Japan (under Japanese regulations).
-have names like dim sum, maple, etc
eurobonds
Bond denominated in Currency A but sold outside of Country A
-Example: American Airlines borrows $500 million US to finance new aircraft purchases by selling Eurobonds denominated in US dollars to residents of Germany and France.
why are eurobonds appealing to international business
Regulatory costs
-Outside the regulatory domain of any single nation
–Eurobonds avoid most domestic regulations.
–Avoids tight controls often placed on foreign bond issues.
Disclosure costs
-If you wish to offer USD denominated bonds in the US, you must comply with SEC disclosure requirements
–SEC (Securities and Exchange Commission) as US regulator
-If you wish to offer USD denominated bonds in Japan, you do not have to comply with SEC disclosure.
global stock (equity) market
-Many stocks are listed on multiple exchanges and stock ownership is increasingly international.
-Why would a company list/IPO its stock on a foreign market?
–Liquidity of foreign markets – lowers the cost of capital
—Where to IPO? (higher share price)
–Satisfy the demand for local ownership.
–Visibility with local employees, customers, suppliers and bankers.
–Stock options in compensation.
–Facilitate future acquisitions.
business and the global capital market
Borrowing on the global capital market may
save money.
* Lower interest rates, fewer regulations, higher share prices…
International diversification changes your
exchange risks
* Lowers if you use global capital markets to borrow in the same currency in which you are operating.
* Increases if you are now borrowing in a currency you are not operating in
