Multinational Finance Final Exam Study Guide Chapter Two Balance 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 components 1 Current Account summarizes the cash flows between one country and all others a Balance of Trade Exports Imports b Factor Income Interest and Dividends received by investors on foreign investments c Transfer Payments Aids Grants and Gifts to and from other countries 2 Capital Account summarizes the flow of funds resulting from the sale of assets between one specified country and all other countries b Direct Foreign Investment DFI owning more than 10 can be used to conduct business operations c Portfolio Investment investment less than 10 no transfer of control d Other Capital Investment very short term investment such as money markets International 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 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 exporting Factors Affecting International Trade Flows 1 Impact of Inflation If inflation increases exports decrease and imports increase so the current account 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 decrease If prices increase people will buy less 2 Impact of National Income If income increases import increase and exports stay the same so the current account decreases 3 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 account 4 Impact of Exchange Rates If currency value increases exports will decrease and imports will increase increase so the current account will increase Correcting 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 depreciation Factors Affecting Direct Foreign Investment 1 Changes in Restrictions new opportunities arise when barriers are removed 2 Privatization governments selling some of their operations to corporations and other investors has 3 Potential Economic Growth countries with higher growth potential are more attractive for DFI 4 Tax Rates Low tax rates on corporate earning attract DFI 5 Exchange Rates Firms like to invest in countries where the local currency is expected to strengthen against Factors Affecting International Portfolio Investment 1 Tax Rates on Interest or Dividends Investors prefer low tax rates 2 Interest Rates Investors prefer high interest rates 3 Exchange Rates Investors prefer countries where the local currency is expected to strengthen against their increased DFI their own own Agencies 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 risk Multinational Finance Final Exam Study Guide International Development Association extends loans at low interest rates to countries that do not qualify for 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 loans from the World Bank controversial Multinational Finance Final Exam Study Guide Chapter Three Why Creditors Enter International Markets 1 To Capitalize on Higher Foreign Interest Rates 2 Expect Foreign Currencies to Appreciate Against Their Own 3 To Reap Benefits of Diversification Why Borrowers International Markets 1 To Capitalize on Lower Foreign Interest Rates 2 Expect Foreign Currencies to Depreciate Against Their Own The Benefit of International Diversification is Risk Reduction Foreign 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 Demand Forward 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 ask To convert to direct quote divide 1 by the exchange rate Direct Quote Represents the value of a foreign currency in dollars Indirect Quote Represent the number of units of a foreign currency per dollar