Chapter TwoBalance of Payments: summary of all cash flows between domestic and foreign residents of a country over a period of time. Accounts for transactions between one country and all other countries. Has two components1. Current Account: summarizes the cash flows between one country and all othersa. Balance of Trade: Exports - Importsb. Factor Income: Interest and Dividends received by investors on foreign investmentsc. Transfer Payments: Aids, Grants and Gifts to and from other countries2. Capital Account: summarizes the flow of funds resulting from the sale of assets between one specified country and all other countriesb. Direct Foreign Investment (DFI): owning more than 10%, can be used to conduct business operationsc. Portfolio Investment: investment less than 10%, no transfer of controld. Other Capital Investment: very short term investment, such as money marketsInternational Trade Flows: Volume of trade has grown for most countries. European countries trade about 30%-40% of their GDP. US and Japan only trade about 10% of their GDP. The US has had a trade imbalance sine 1976 and this is mainly due to China and Japan.-Trade Agreements: decrease trade restrictions and increased trade -NAFTA: eliminated trade barriers between US, Mexico and Canada -GATT: free trade agreement between 117 countries -EU: use of a single currency between most European nations-Trade Disagreements: labor laws, outsourcing, tax breaks, tariffs and quotas. Exist to protect local firms, governments want to find to strategies that give their local firms an edge in exportingFactors Affecting International Trade Flows1. Impact of Inflation: If inflation increases, exports decrease and imports increase so the current account decrease. If prices increase, people will buy less2. Impact of National Income: If income increases, import increase and exports stay the same so the current account decreases3. Impact of Government Restrictions: subsidies for exporters exists so local firms can compete with lower cost global competitors. Will increase exports and increase the current account. Restrictions on imports will reduce imports and increase the current account4. Impact of Exchange Rates: If currency value increases, exports will decrease and imports will increase increase so the current account will increaseCorrecting a Balance of Trade Deficits: not necessarily a problem. Trade deficit can cause a transfer of jobs to some foreign countries. Any policy that will increase foreign demand for a country’s good will improve its balance-of-trade position. A floating exchange rate system may correct a trade imbalance.J-Curve: describes the short run tendency for a country’s balance of trade to deteriorate even while its currency is depreciationFactors Affecting Direct Foreign Investment1. Changes in Restrictions: new opportunities arise when barriers are removed2. Privatization: governments selling some of their operations to corporations and other investors; has increased DFI3. Potential Economic Growth: countries with higher growth potential are more attractive for DFI4. Tax Rates: Low tax rates on corporate earning attract DFI5. Exchange Rates: Firms like to invest in countries where the local currency is expected to strengthen against their ownFactors Affecting International Portfolio Investment1. Tax Rates on Interest or Dividends: Investors prefer low tax rates2. Interest Rates: Investors prefer high interest rates3. Exchange Rates: Investors prefer countries where the local currency is expected to strengthen against their ownAgencies That Facilitate International Flows- IMF: encourage internationalization of business through surveillance and financial & technical assistance- World Bank: makes loans to countries to enhance their economic development- World Trade Organization: provides a forum for trade negotiations- Bank for International Settlements: lender of the last resort- Multilateral Investment Guarantee Agency: helps develop international trade by offering insurance against political riskMultinational Finance Final Exam Study Guide- International Development Association: extends loans at low interest rates to countries that do not qualify for loans from the World Bank- International Financial Corporation: promote private enterprise within countries- - Countries pay dues based on GDP, US has the largest GDP so it pays the most and has the most say (controversial)Multinational Finance Final Exam Study GuideChapter ThreeWhy Creditors Enter International Markets1. To Capitalize on Higher Foreign Interest Rates2. Expect Foreign Currencies to Appreciate Against Their Own3. To Reap Benefits of DiversificationWhy Borrowers International Markets1. To Capitalize on Lower Foreign Interest Rates2. Expect Foreign Currencies to Depreciate Against Their OwnThe Benefit of International Diversification is Risk ReductionForeign Exchange Market: allows for the exchange of one currency for another. This market is served by larger commercial banks that hold inventories of each currency so they can accommodate requests by individuals or MNCs. The exchange rate specifies the rate at which one currency can be exchanged for another. How Exchange Rates are Dictated...- Gold Standard: each currency was converted into gold at a specified rate and the exchange rate between two currencies was determined by their relative convertibility rates per ounce of gold- Bretton Woods: called for fixed exchange rates between currencies- Smithsonian Agreement: fixed exchange rate with boundaries for how far the rates can fluctuate- Floating Exchange Rate System: exchange rates determined by Supply and DemandForward Exchange Transactions- Spot Market: where immediate exchanges occur at the spot rate; $3 trillion a day- Forward Market: enables MNCs to lock in an exchange rate at which it will buy or sell a certain quantity of a currency on a specified date. Customer in need of a foreign exchange are concerned with...- Quote Competitiveness- Special Banking Relationship- Speed of Execution- Advice about Current Market Conditions- Forecasting Advice- Inter-Bank Market: trading between banks- Bid/Ask Spread: (ask - bid) / bid. Factors affecting the bid/ask spread include order costs, inventory costs, competition, volume and currency risk. Banks buy at bid, consumers sell at bid. Banks sell at ask, consumers buy at askForeign Exchange Quotations - For Currencies Direct Quote: Represents the value of a foreign currency in