Study Unit 4 Flashcards
Protectionism
any measure by govt to protect domestic producers
Tariffs
taxes imposed on imports
done to discourage consumption of imports, raise revenue, or both
if tariff rate too high, demand decreases, revenue declines
Import quotas
balance of payments
fixed limit
short run, help balance pmts position, decrease foreign pmts, prices of domestic products increase
balance of payments- sum of all trans bet domestic and foreign indiv, firms, and govt
Result of import quotas and tariffs
domestic consumers pay higher price, consumer less
domestic producers sell more as domestic consumer pay subsidy to them
trigger price
tariff barrier auto put on cheap imports below a reference price (price triggers tariff)
Repatriation
transfer foreign earned income back to domestic location
- exchange ctrl limit foreign currency trans & set exch rates to limit repatriation
- can impose taxes to imit
Export subsidy
pmts by govt to producers to increase exports
Economic effect of tariffs and quota
workers shift into less efficient protected industries
excess under tariff goes into govt coffers to spend on domestic concerns
-quotas drive up prices (thru the shortage caused) and excess goes to exporter
-tariff equally placed on importers, more efficient lower prices
i.q. doesn’t affect + and license assigned b/c of political favoritism
Arguments for protectionism
reduced imports protect domestic jobs
- costs of cheaper imports
- benefits less noticeable and in future (lower price, higher wages, more jobs in expert industries
Industries needed for national security
infant industries need protection
strategic trade policies
extension of infant industry, govt use trade barriers to reduce risk of product development by domestic fims
Demand for merch, assets, financial instruments rise
demand for currency rises
Fixed Exchange rate system
value of currency wrt another currency is fixed or allowed little fluctuation
advantage is predictability
disadvantage- govt manipulation
Freely Floating Exchange Rate
rate determined by mkt forces of S and D
advantage- auto corrects diseq in balance of pmts
disadvantage- vulernable to economics of other countries
Managed Float
govt only interferes if mkt forces move rates too far
advantage- mkt responsive yet got intervenes
Demand foreign currency
currency becomes cheaper, need more currency
Suppy foreign currency
more expensive, domestic goods more affordable and need more currency
5 factors affect currency exchange rates
Trade related
- relative inflation
- relative income level
- govt intervention
financial factors
- relative interest rates
- ease of capital flow
Relative inflation rate
inflation rises in foreign country, it’s products are more expensive and demand for currency falls, demand shift left
investors sell currency, more available, supply shift right
new equilibrium at lower price for domestic
foreign inflation causes domestic currency to appreciate
Relative income level
higher income means more comsuption opportunities in other countries, increase demand for those currenceis and shift demand right
-incomes rise, prices of FC rise, local currency depreciates
Relative interest rate
interest rises, demand rises shifting right
more investors buy currency. less available, supply shifts left
new equilibrium at higher price
DC depreciated against FC with higher interest rate
Ease of capital flow
most important factor
loosen restrictions, currency rises as investors want more returns
electronic trading helps
Spot rate vs forward rate
spot-# units of FC can receive today for single unit of DC
fwd- # units of FC rec’d for single unit of DC at some definite date in the future
Fwd premium vs fwd discount
premium-wrt DC when DC > FC in fwd market than in spot market (DC has more purchase pwr)
discount-wrt FC when DC
Firm w/ payable in FC wants
Firm w/ receivable in FC wants
FC to depreciate by settlement date; requires less DC
FC to appreciate; results in more units of DC
3 types of exposure to exchange rate risk
transaction-changes in rates between date of trans and settlement date
translation- exposure to changes between date of trans and when F/S in another currency are reported
economic- changes from economic conditions
Transaction exposure
estimate net CF for affected transactions
-if inflow and outflow are near =, exposure is minimal
measure effect of exposure in each currency
-range of rates for each currency estimated, reflects volatility; use hedging
Hedging wrt transaction exposure
some upside gone to protect against downside
principle-
debtor: lock in FC fwd to lock in purchase price (protects against FC appreciating)
creditor: lock in FC fwd by selling (protects against FC depreciating)
4 most common tools for transaction exposure
money market hedges
fwd contracts
futures contracts
currency options
Money Market Hedges
least complex
debtor
-buy MM instrument in FC timed to mature when payable due
creditor
-borrow FC, convert to DC then pay off foreign loan when receivable is collected
Forward Contract
large corp w/ close relationships with major banks enter into indiv trans (custom for parties involved)
bank guarantees currency will be available at definite rate in future; price charged by bank is the premium
Futures Contract
commodities traded on an exchange, available to more parties
available in generic amnts, less flexible than fwd
must perform contract
Currency option
not a binding contract, exercised only if purchasing party chooses to call or put
call option-holder has right to buy; available to hedges payable
put option- holder has right to sell; available for hedges receivable
translation exposure
risk foreign subsidiary B/S items change in value b/c of exchange rate fluctuations
degree of exposure based on
-proportion of total business conducted by foreign subs
-location of foreign subs
-applicable acctg method
