Study Unit 4

Question 1

Protectionism

Answer 1

any measure by govt to protect domestic producers

Question 2

Tariffs

Answer 2

taxes imposed on imports
done to discourage consumption of imports, raise revenue, or both
if tariff rate too high, demand decreases, revenue declines

Question 3

Import quotas

balance of payments

Answer 3

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

Question 4

Result of import quotas and tariffs

Answer 4

domestic consumers pay higher price, consumer less

domestic producers sell more as domestic consumer pay subsidy to them

Question 5

trigger price

Answer 5

tariff barrier auto put on cheap imports below a reference price (price triggers tariff)

Question 6

Repatriation

Answer 6

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

Question 7

Export subsidy

Answer 7

pmts by govt to producers to increase exports

Question 8

Economic effect of tariffs and quota

Answer 8

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

Question 9

Arguments for protectionism

Answer 9

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

Question 10

strategic trade policies

Answer 10

extension of infant industry, govt use trade barriers to reduce risk of product development by domestic fims

Question 11

Demand for merch, assets, financial instruments rise

Answer 11

demand for currency rises

Question 12

Fixed Exchange rate system

Answer 12

value of currency wrt another currency is fixed or allowed little fluctuation

advantage is predictability
disadvantage- govt manipulation

Question 13

Freely Floating Exchange Rate

Answer 13

rate determined by mkt forces of S and D
advantage- auto corrects diseq in balance of pmts
disadvantage- vulernable to economics of other countries

Question 14

Managed Float

Answer 14

govt only interferes if mkt forces move rates too far

advantage- mkt responsive yet got intervenes

Question 15

Demand foreign currency

Answer 15

currency becomes cheaper, need more currency

Question 16

Suppy foreign currency

Answer 16

more expensive, domestic goods more affordable and need more currency

Question 17

5 factors affect currency exchange rates

Answer 17

Trade related

• relative inflation
• relative income level
• govt intervention

financial factors

• relative interest rates
• ease of capital flow

Question 18

Relative inflation rate

Answer 18

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

Question 19

Relative income level

Answer 19

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

Question 20

Relative interest rate

Answer 20

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

Question 21

Ease of capital flow

Answer 21

most important factor
loosen restrictions, currency rises as investors want more returns
electronic trading helps

Question 22

Spot rate vs forward rate

Answer 22

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

Question 23

Fwd premium vs fwd discount

Answer 23

premium-wrt DC when DC > FC in fwd market than in spot market (DC has more purchase pwr)
discount-wrt FC when DC

Question 24

Firm w/ payable in FC wants

Firm w/ receivable in FC wants

Answer 24

FC to depreciate by settlement date; requires less DC

FC to appreciate; results in more units of DC

Question 25

3 types of exposure to exchange rate risk

Answer 25

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

Question 26

Transaction exposure

Answer 26

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

Question 27

Hedging wrt transaction exposure

Answer 27

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)

Question 28

4 most common tools for transaction exposure

Answer 28

money market hedges
fwd contracts
futures contracts
currency options

Question 29

Money Market Hedges

Answer 29

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

Question 30

Forward Contract

Answer 30

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

Question 31

Futures Contract

Answer 31

commodities traded on an exchange, available to more parties
available in generic amnts, less flexible than fwd
must perform contract

Question 32

Currency option

Answer 32

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

Question 33

translation exposure

Answer 33

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