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110 Cards in this Set
- Front
- Back
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Theory of Comparative Advantage |
Specialization increases production efficiency |
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Imperfect Markets Theory |
Factors of production are immobile providing incentive to seek out foreign opportunities |
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Product Cycle Theory |
As a firm matures, it recognizes opportunities outside its domestic market |
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How firms engage in international business |
International trade, licensing, franchising, joint ventures, acquisitions of existing opportunities, establishing new foreign subsidiaries |
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Licensing |
Obligates a firm to provide its technology in exchange for fees, allows firms to use their tech in foreign markets w/o a major investment & transportation costs- difficult to ensure quality control |
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Franchising |
Obligates firm to provide special sales or service strategy, support, and an initial investment in exchange for periodic fees. Allows penetration into foreign markets w/o a major investment in foreign countries |
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Join ventures |
A venture that is jointly owned and operated. Allows 2 firms to provide their respective cooperative advantages in a project. |
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Acquisition of Existing Operations |
Allows firms to have full control over foreign business and quickly gain large share of market. Risk of large losses. Low liquidity. |
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Establishing New Foreign Subsidiaries |
A method of establishing operations in a foreign market that requires a large investment; can tailor specific to company, smaller investment than buying existing firm |
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Risks Surrounding MNC Cash Flows |
Exposure to International economic conditions, political risk, & exchange rate risk |
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Current Account |
Includes payment for goods and services, factor income payments, transfer payments |
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Balance of Trade |
The difference between total exports and imports |
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Capital & Financial Accounts |
Direct Foreign Investment, Portfolio investment, other capital investment, errors & omissions |
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Factors Affecting Internation Trade Flows |
Cost of Labor, Inflation, National Income, Government Policies, Exchange Rates |
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Impact of Government Policies on Trade Flows |
Restrictions on imports, (tariffs & quotas), subsidies for exporters (dumping), restrictions on piracy, environmental restrictions, labor laws, business laws, tax breaks, country security laws |
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Limitations of a Weak Home Currency Solution |
Competition, Impact of other currencies, prearranged international trade transactions (leads to j-curve), intracompany trade |
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Factors affecting Direct Foreign Investment (DFI) |
Changes in restrictions, privatization, potential economic growth, tax rates, exchange rates, |
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Factors affecting international portfolio investment |
tax rate on interest or dividends, interest rates, exchange rates |
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IMF (International Monetary Fund) |
promotes coop between countries, promotes stability in exchange rates, provides temp funds to members, promote free mobility of capital funds, promote free trade |
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Compensatory Financing Facility |
attempts to reduce the impact of export instability on countries, |
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Special Drawing Rights |
How financing is measured in the IMF |
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A banks bid quote will always be ____________ than it's ask quote. |
less. |
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Bid Ask Spread |
Ask rate - Bid rate / ask rate. covers bank's cost of conducting foreign exchange transaction. |
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Direct Quotation |
Represents the value of a foreign currency in dollars |
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Indirect Quotation |
Represents the number of units of a foreign currency per dollar.
Indirect Quote = 1/Direct Quote |
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When the Euro appreciates against the dollar, the indirect exchange rate of the Euro is ________. |
Declining |
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When the Euro depreciates against the dollar, the indirect exchange rate of the Euro is _______. |
Rising |
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Cross Exchange Rate |
The amount of one foreign currency per unit of another foreign currency |
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Forward Contracts |
Contract to exchange currencies at a future date at a predetermined rate. |
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Forward Rate |
exchange rate specified by the forward contract |
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Forward Market |
OTC market where forward contracts are traded |
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Futures Contracts |
Similar to forward contracts, but sold on an exchange; standardized |
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Currency Call Option |
The right to buy a currency at a specified strike price within a specified period of time |
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Currency Put Option |
Provides the right to sell currency at a specified strike price within a specified period of time |
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To hedge receivables: |
Sell futures or forward contracts; or buy puts |
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To hedge payables: |
Buy futures or forward contracts; or buy calls |
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European Money Market |
Eurocurrency market; Dollar deposits in foreign countries |
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Asian Money Market |
Dollar denominated deposits in hong kong & singapore. |
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Eurocredit Loans |
loans of 1 year or more extended by banks to MNCs or government agencies in europe |
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Syndicate of banks |
when a single bank is unwilling or unable to lend the amount needed by an MNC or government agency; lead bank is responsible for negotiating terms |
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Foreign Bonds |
Issued by a borrower foreign to the country where the bond is placed |
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Eurobonds |
bonds sold in countries other than the country of the currency denominating the bond |
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Yankee Stock |
Foreign corporations issuing stock in the U.S. |
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American Depository Receipts |
certificates representing bundles of stock. ADR shares can be traded the same as stocks. |
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Factors that Affect Exchange Rates |
supply & demand, interest rates, inflation, income levels, government controls, expectations |
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Increase in U.S. inflation: |
increase in U.S. demand for foreign goods, increase in U.S. demand for foreign currency, increase in the exchange rate for the foreign currency |
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Increase in U.S. interest rates: |
Increase in demand for U.S. deposits, increased demand for dollars, increased exchange rate for the dollar. |
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Increase in U.S. income levels: |
increase in U.S. demand for foreign goods, increase in U.S. demand for foreign currency, increase in exchange rate of foreign currency. |
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Government Controls |
foreign exchange barriers, foreign trade barriers, intervening in foreign exchange markets, affecting macro variables such as inflation, interest, & income |
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Expectations |
If investors expect currency in one country to rise, they will all invest in that country, increasing the demand for that currency, causing it to rise. |
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Speculation |
Investing in undervalued currencies before they appreciate. Borrowing funds in overvalued currencies and converting back to their own before they depreciate. |
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Carry-Trade |
investors attempt to capitalize on the differential in interest rates between 2 countries |
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Forward Premium (discount) |
Percent by which the forward rate exceeds the spot rate |
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Futures vs Forward Contract |
Futures: standardized # of units per contract, offer greater liquidity than forward contracts, typically based on us dollar, but may be offered crossrates, traded on chicago mercantile exchange |
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Closing out a futures position |
sellers (buyers) of currency futures can close out their positions by buying (selling) identical futures contracts prior to settlement. most currency futures are closed out before the settlement date. |
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Currency Call Options: |
If the spot rate rises above the strike price, the owner of the call will exercise |
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Premium |
The buyer of a currency call option pays a premium to purchase the option. |
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In the money |
If the spot rate is in a favorable position to exercise the currency option |
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At the money |
Strike price = Spot rate |
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Out of the money |
spot rate is not in a favorable position relative to the strike price |
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Factors affecting currency call option premiums |
Spot price relative to the strike price, length of time before expiration, potential variability of currency |
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firms can use call options to: |
hedge payables, hedge project bidding to lock in a dollar cost of expenses, hedge target bidding of a possible acquisition, speculate on expectations of future movements in a currency |
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Straddle |
1 call + 1 put. equal probabilities of appreciation and depreciation |
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Strip |
2 puts + 1 call. probability for depreciation higher than that of appreciation. |
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Strap |
2 calls + 1 put. probability for appreciation higher than that of depreciation. |
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european-style currency options |
must be exercised on the expiration date if exercised at all. |
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Fixed Exchange Rate System |
Rates are held constant or allowed to fluctuate within narrow boundaries. Central banks can devalue or revalue currency against foreign currencies. |
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Freely Floating Exchange Rate System |
Rates are determined by market forces without government intervention. country is insulated from foreign inflation and unemployment. Can adversely affect a country with high inflation and high unemployment. |
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Managed Float Exchange Rate System |
Allowed to float- periodically managed to prevent the currency from going too far in one direction. |
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Reasons for government intervention |
smooth exchange rate movements, establish implicit exchange rate boundaries, respond to temporary disturbances |
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Direct Intervention |
flooding the market with dollars or buy dollars, reliance on reserves |
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Nonsterilized Intervention |
When the government intervenes in the foreign exchange market without adjusting for the change in the money supply |
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Sterilized Intervention |
When the government intervenes in the foreign exchange market and simultaneously engages in offsetting transactions in the treasury securities market |
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Speculating on the intervention |
Some speculators try to guess when the fed will intervene and profit off their intervention |
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Indirect Intervention |
Influence factors that determine currency values: interest rates, restrictions on exchange, intervention warnings, |
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International Arbitrage |
Capitalizing on a discrepancy in quoted prices by making a riskless profit. Arbitrage causes prices to realign. |
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3 Forms of Arbitrage |
locational arbitrage, triangular arbitrage, covered interest arbitrage |
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Locational Arbitrage |
The process of buying a currency in a location where it is priced cheaper and selling it in a location where the price is higher. Gains from arbitrage & realignment. |
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Triangular Arbitrage |
Currency transactions in the spot market to capitalize on discrepancies in the cross exchange rates between 2 countries. bid-ask spread. realignment. |
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Covered Interest Arbitrage |
Capitalizing on the interest rate differential between 2 countries while covering your exchange rate risk with a forward contract. Covered = hedged. Timing of alignment. |
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Interest Rate Parity |
In equilibrium, the forward rate differs from the spot rate by a sufficient amount to offset the interest rate differential between 2 currencies |
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Considerations when assessing interest rate parity |
Transaction costs, political risk, differential tax laws |
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Purchasing Power Parity (PPP) |
Absolute Form: prices of same basket of products in 2 different countries should be equal when measured in common currency (law of one price.)
Relative Form: the prices won't necessarily be the same, but the rate of change in prices should be similar when measured in common currency |
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International Fisher Effect predicting exchange rate movements |
the nominal interest rates of 2 countries differ because of the difference in expected inflation between the 2 countries |
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Rely on PPP to estimate exchange rate movement |
how would the exchange rate be influenced by the expected inflation rates |
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IFE suggests that currencies with high interest rates will have ____ expected inflation and the inflation will cause the currencies to depreciate. |
high. high interest rates = high inflation (contradictory)W |
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Why firms forecast exchange rates |
hedging decisions, short term investment decisions, capital budgeting decisions, earnings assessment, long term financing decisions |
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technical forecasting |
involves the use of historical exchange rate data to predict future values. Limitations: focuses on near future, inconsistency, rarely provides range of possible values |
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Fundamental Forecasting |
based on fundamental relationships between economic variables and exchange rates; use of sensitivity analysis; use of PPP. Limitations: unknown timing of impact of some factors, forecasts of some factors may be difficult to obtain, some factors are not easily quantified, regression coefficients may not remain constant. |
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Market based Forecasting |
use of spot rate to forecast the future spot rate. use of forward rate to forecast the future forward rate. |
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Mixed Forecasting |
weighted average of the various types of forecasting |
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Absolute Forecast Error |
(forecasted value - realized value) / realized value |
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Forecast Bias |
forecast error that are consistently positive or negative over time |
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Weak Form Efficiency |
Historical exchange rate information is already reflected in today's exchange rate and is not useful for forecasting |
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Semi-strong Form Efficiency |
All relevant current and public information is already reflected in today's exchange rate |
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Strong Form Efficiency |
All relevant public and private information is already reflected in today's exchange rate |
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Transaction Exposure |
Sensitivity of the firm's contractual cash transactions in foreign currencies to exchange rate movements |
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Measurement of Currency Volatility |
Standard Deviation measures the degree of movement for each currency |
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Correlation Coefficient |
indicate the degree to which two currencies move in relation to each other |
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Value at Risk (VaR) |
Maximum 1-day loss |
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Economic Exposure |
The sensitivity of a firm's all cash flows to exchange rate movements- operating exposure |
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Translation Exposure |
The exposure of the MNC's consolidated financial statements to exchange rate fluctuations; locations, accounting methods |
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Money Market Hedge to hedge payables |
Borrow in home currency. Deposit in foreign currency. |
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Forward or Futures Hedge |
allows the MNC to lock in the exchange rate at which it can sell a specific currency |
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Money Market Hedge |
Involves borrowing the currency that will be received and using the receivables to pay off the loan |
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Put option hedge |
provides the right to sell a specific amount of a particular currency at a specified strike price by a specified expiration date |
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Motives for Direct Foreign Investment: revenue related |
attract new sources of demand, enter profitable markets, exploit monopolistic advantages, react to trade restrictions, diversify internationally, |
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Motives for Direct Foreign Investment: cost related |
fully benefit from economies of scale, use foreign factors of production, use foreign raw materials, use foreign technology, react to exchange rate movements |
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Host government view of DFI |
Only approve of DFI that benefits locals. New jobs or technology. No competition to local business. |
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Barriers to DFI |
Protective barriers, red tape barriers, industry barriers, environmental barriers, regulatory barriers, ethical differences, political instability |
