Midterm Study Guide Flashcards
1
Q
What does International Business Involve?
A
- Involves managing trade, investments, and other activities across national boundaries
2
Q
What is the difference between IB and Global Business?
A
- Broader than IB and covers all business activities around the world.
- Includes both traditional cross-border activities and domestic activities of firms facing
global competition.
3
Q
What is a Institution Based View?
A
- Suggests that the success or failure of a firm is influenced by the “rules of the game,”
which include formal (laws, regulations) and informal (norms, ethics) institutions. - Focuses on how firms navigate these rules in different countries
4
Q
What is a Resource Based View?
A
- Emphasizes that internal resources and capabilities are key to a firm’s success.
- Some firms may thrive even in challenging environments due to their unique strengths.
5
Q
What is Globalization?
A
- Defined as the increasing integration of markets and societies worldwide.
- Seen as a powerful force that connects economies, businesses, and people.
6
Q
What are the two views on Globalization?
A
Proponents and Critics
7
Q
What do Proponents argue?
A
e that globalization fosters economic growth, cultural exchange, and
improved technology.
8
Q
What do Critics argue?
A
it causes job losses in rich countries, exploits workers in poorer regions,
and can increase inequality
9
Q
What is semi-globalization?
A
- Concept that market integration is substantial but not complete.
- Barriers still exist, making international strategies complex and nuanced.
10
Q
What are Black Swan Events?
A
- Rare, unpredictable events (e.g., 9/11, COVID-19) that significantly impact global
business.
11
Q
How do business prepare for Black Swan Events?
A
- Companies use scenario planning to anticipate and mitigate the effects of such
events
12
Q
What is the goal of globalization of production?
A
- Goal: Lower costs and improve product quality for competitive advantage.
13
Q
What is GDP?
A
Gross Domestic Product: The sum of value added by resident firms, households,
and governments operating in an economy
14
Q
What is GNP
A
Gross National Product aka GNI (Gross National Income): GDP plus income from nonresident sources abroad; GNI is a
term used by the World Bank and other international organizations to supersede the term
GNP
15
Q
What is PPP?
A
Purchasing Power Parity: A conversion that determines the equivalent amount of
goods and services that different currencies can purchase
16
Q
What does the WTO do?
A
World Trade Organization: - Polices international trade and resolves disputes.
- Ensures compliance with trade agreements.
17
Q
What does the IMF do?
A
International Monetary Fund:
-Maintains order in the global monetary system.
- Provides financial support to countries in economic distress.
18
Q
What does the World Bank do?
A
- Promotes economic development and poverty reduction.
- Provides funding for infrastructure projects in developing nations
19
Q
What does the UN do?
A
United Nations:
- Focuses on maintaining peace and security.
- Encourages cooperation and promotes human rights.
20
Q
What is the general goal of Globalization?
A
- Encourages interconnected economies and societies.
- Supporters believe it leads to greater prosperity, more jobs, and lower prices.
21
Q
What is Deglobalization?
A
- A reaction against the negative effects of globalization (e.g., loss of national sovereignty,
economic imbalances). - NGOs and activists often push back against globalization’s impact on the environment,
human rights, and local cultures.
22
Q
Definition of Institutions
A
- Institutions are the “rules of the game” in society that guide the behavior of individuals and
firms.
23
Q
What is the purpose of Institutions?
A
- Their primary role is to reduce uncertainty in economic transactions, which helps minimize
transaction costs
24
Q
What are transaction costs?
A
- Transaction costs refer to the expenses associated with making an economic exchange,
such as legal fees, negotiation costs, or risks of deceit.
25
What is the Institutional Framework?
Made up of 3 pillars:
- Regulatory Pillar: Coercive power of governments to enforce laws.
- Normative Pillar: Values, norms, and beliefs shared by society that influence behavior.
- Cognitive Pillar: Deep-rooted beliefs taken for granted, shaping how people perceive the
world and behave.
26
What is a democracy?
- Citizens elect representatives to govern on their behalf.
- Allows freedom of expression and organization, which encourages entrepreneurship.
27
What is Totalitarianism?
- One person or party exercises absolute control over all aspects of life.
28
Types of Totalitarianism:
*Communist Totalitarianism: Dominated by a communist party.
*Right-Wing Totalitarianism: Intense opposition to communism; restricts freedom to
prevent communist influence.
*Theocratic Totalitarianism: Religious leaders hold political power.
*Tribal Totalitarianism: One ethnic group monopolizes power, oppressing other groups.
29
What is Authoritarianism?
- Centralized power, limited political pluralism, and suppression of dissent.
30
What are their impacts on business?
- Different political systems create varying levels of **political risk**.
- Businesses must assess how political changes could disrupt operations and take
precautions
31
What are some precautions businesses can take?
- Developing unique resources.
- Establishing strong political connections.
- Preparing for geopolitical risks.
32
What is a Legal System?
- A legal system outlines how laws are created, interpreted, and enforced in a country.
33
Types of Legal Systems:
-Civil Law
-Common Law
-Theocratic Law
34
What is Civil Law?
- Based on comprehensive statutes and codes that dictate the law.
- Found in countries like France, Germany, and Japan.
35
What is Common Law?
- Evolved through judicial decisions and precedents.
- Judges have more flexibility in interpreting laws.
- Practiced in countries like the United States, United Kingdom, and Canada.
36
What is Theocratic Laws?
- Based on religious principles and teachings.
- Islamic law is a prominent example and is practiced in countries like Saudi Arabia and
Iran.
37
What is important about property rights?
- Property Rights protect the legal ownership and control over resources.
- Intellectual Property Rights (IPR) protect creations of the mind, such as inventions
(patents), literary works (copyright), and brand symbols (trademarks)
38
What can cause property rights to be undermined?
Corruption in the legal system can undermine these rights, discouraging investment and
economic growth.
39
What is an economic system?
- The economic system governs how resources are allocated and how production and
consumption are organized.
40
What are different types of economic systems?
-Market Economy
-Command Economy
-Mixed Economy
41
What is a market economy?
- Driven by supply and demand with minimal government intervention.
- Private ownership of resources, and the market determines production and prices
42
What is a command economy?
- The government controls all aspects of economic activity, including production and
pricing.
- Little incentive for firms to innovate or be efficient.
43
What is a mixed economy?
- Combines elements of both market and command economies.
- Government may intervene to support certain industries or social objectives
44
How does a economy shift to being a market-based system?
*Deregulation: Removing restrictions on private enterprises.
*Privatization: Transferring ownership from the state to private hands.
- Establishing a legal system to protect property rights.
45
What are drivers of economic development?
*Culture: Historically, people argued that rich countries succeed because of smarter or
harder-working populations, but this view is outdated.
*Geography: Natural resources and favorable locations matter, but they are not sufficient
on their own.
*Institutions: The most accepted view today is that institutions—both formal and
informal—are the primary determinants of economic success.
46
What are the incentives of private ownership?
- Maximizes profit for owners and investors.
- Decision-making is based on market forces and competition.
47
What are the incentives of state ownership?
- Prioritizes social goals such as job security and minimizing social unrest.
- Decisions are made by bureaucrats, leading to inefficiencies.
48
What is state capitalism?
- A hybrid model where the state plays a significant role in the economy while maintaining a
market system.
- Many state-owned enterprises (SOEs) today are publicly listed with a mix of private and
public ownership.
49
Implications of International Business?
- Firms must understand the political, legal, and economic systems of each country they
operate in.
- The attractiveness of a country depends on balancing the **benefits** (e.g., market size,
purchasing power) with **costs** (e.g., political, economic, legal costs) and **risks** (e.g.,
political instability, economic mismanagement).
50
What are informal institutions?
○ Informal institutions are systems of unwritten rules and shared beliefs that
guide individual and firm behavior.
○ They differ from formal institutions, which include laws and regulations, by
being embedded in culture, ethics, and social norms.
○ These institutions are often based on socially transmitted information,
such as traditions and shared history.
51
What are the main four manifestations of Culture?
1. Language
2. Religion
3. Social Structure
4. Education
52
What is a high context culture?
○ In high-context cultures (e.g., Japan), communication relies heavily on
unspoken context, such as body language or the tone of voice.
53
What is a low context culture?
○ In low-context cultures (e.g., United States), messages are communicated
more explicitly, and the spoken word carries most of the meaning.
54
What is the Cluster Approach?
○ Groups countries into cultural clusters with similar values and practices
(e.g., Anglo cluster includes the U.S. and U.K.).
○ This helps firms identify regions where business practices are more likely to
align with their own cultural norms.
55
What are the six components to the Dimension Approach?
■ Power Distance: Acceptance of unequal power distribution.
■ Individualism vs. Collectivism: Degree to which individuals see
themselves as independent or part of a group.
■ Masculinity vs. Femininity: Emphasis on achievement and
competition vs. care and quality of life.
■ Uncertainty Avoidance: Comfort with ambiguity and risk.
■ Long-term Orientation: Focus on future rewards vs. short-term
results.
■ Indulgence vs. Restraint: Extent to which people try to control their
desires and impulses.
56
What are Ethics?
○ Ethics refers to the principles and standards governing the conduct of
individuals and firms.
○ Ethical behavior involves balancing profit-making with moral considerations,
such as respect for human rights, environmental protection, and social
responsibility.
57
What are common ethical issues?
○ Employment practices (e.g., fair wages and working conditions).
○ Human rights (e.g., freedom of speech and association).
○ Environmental pollution (e.g., reducing harmful emissions).
○ Corruption (e.g., bribery and unethical dealings)
58
What are strategies that companies use to manage ethical challenges?
1. Reactive: Denying responsibility and doing less than required.
2. Defensive: Doing only the minimum to comply with regulations.
3. Accommodative: Accepting responsibility and meeting ethical
expectations.
4. Proactive: Anticipating ethical responsibilities and exceeding
expectations.
59
What is the gist of Ethical Relativism:
-Ethics vary by culture, and businesses should adapt to
local standards.
60
What is the gist of Ethical Imperialism?
-There is a universal set of ethics that should be applied regardless of context.
61
What is a strategic response to ethical challenges?
○ Firms may adopt strategies that align with local ethical norms or develop universal standards that guide behavior in all markets
62
What are the differences between Western and Eastern Values?
○ Western Values (e.g., Protestant work ethic) are often associated with
capitalism and economic success.
○ Eastern Values (e.g., Confucianism and Islam) emphasize collective
well-being and long-term stability.
63
What is Cultural Intelligence?
○ Cultural Intelligence is the ability to understand and adapt to new cultures
64
Cultural Intelligence involves three components:
1. Awareness: Recognizing your own cultural biases and appreciating
other cultures.
2. Knowledge: Understanding the symbols, rituals, and values of
different cultures.
3. Skills: Applying knowledge and awareness to interact effectively in
diverse settings.
65
What are the six rules firms should follow when venturing into foreign markets?
1. Be Prepared:
2. Slow Down:
3. Establish Trust:
4. Respect Language Differences:
5. Understand and Respect Cultural Differences:
6. Avoid Judging Superiority
66
What are firm resources?
○ Resources are the tangible and intangible assets that a firm uses to
implement its strategies.
○ They are the building blocks of a firm’s success and include physical assets, human resources, financial assets, and intangible assets like brand
reputation
67
What are firm capabilties?
○ Capabilities refer to a firm's ability to effectively use its resources.
○ They are often seen as a firm’s capacity to perform activities using resources
in a dynamic and competitive environment.
68
What are tangible resources?
○ Observable and quantifiable assets such as financial resources, physical equipment, and technological infrastructure.
○ Examples: Cash reserves, machinery, and proprietary technology.
69
What are intangible resources?
○ Difficult to quantify and often based on perceptions, knowledge, and reputation.
○ Examples: Brand equity, company culture, customer loyalty, and intellectual property (e.g., patents).
70
What are dynamic capabilities?
○ The ability of a firm to adapt its resources and capabilities in response to
changing market conditions.
71
What is included in dynamic capabilities?
○ Dynamic capabilities include:
■ Sensing: Ability to identify new opportunities.
■ Seizing: Ability to capture value from these opportunities.
■ Reconfiguring: Ability to restructure assets and capabilities to
maintain flexibility and competitiveness.
72
What is the Value Chain?
○ A sequence of activities (upstream to downstream) that a firm undertakes to
deliver a product or service, adding value at each stage.
○ If these activities are spread across different regions, it becomes a global value chain.
73
What is the purpose of Value Chains?
○ Helps firms decide which activities to perform in-house and which to
outsource.
○ The value chain can highlight whether a company’s internal resources are being used optimally to create value.
74
What are Make-or-Buy Decisions?
○ Companies often face the decision of whether to produce a good or service
in-house or to outsource it.
○ Outsourcing: Turning over an activity to an external supplier to focus on core
competencies.
○ Offshoring: Outsourcing to a foreign supplier to take advantage of cost
benefits.
○ Onshoring: Outsourcing to a domestic firm.
75
What are the four components to VRIO?
-Value: Does the resource create value?
-Rarity: Is the resource rare and not possessed by many competitors
-Imitability: Is it difficult for competitors to imitate?
-and Organization: Is the firm organized to exploit this resource?
76
What is the implications of Value?
-If a resource is not valuable, it leads to a competitive disadvantage.
■ Example: If a company’s technology is outdated, it may harm its
competitiveness.
77
What is the implications of Rarity?
■ If a resource is valuable but common, it only results in competitive
parity.
■ Example: Basic customer service skills are valuable but not rare.
78
What are the implications of imitability?
■ If a resource is valuable and rare but easy to imitate, it only provides a
temporary competitive advantage.
■ Resources that are hard to imitate often involve tacit knowledge,
unique processes, or a complex culture that rivals cannot easily
replicate.
79
What are the implications of organization?
■ If a resource meets the first three criteria but the firm is not organized
to take advantage of it, it will not lead to sustained success.
■ Example: A company may have a strong R&D department, but if it
lacks the marketing capability to commercialize new products, the
resource is underutilized.
80
When does the strategic sweet spot occur?
-occurs when a firm finds a unique position where it
can create value in a way that rivals cannot easily replicate.
○ Managers must continuously search for such spots to sustain competitive
advantage
81
What is commoditization?
○ Over time, unique products may lose their uniqueness and become
commodities, making them less profitable.
○ Companies must decide which activities to keep in-house (e.g., core
competencies) and which to outsource (e.g., routine services).
82
What is Captive Sourcing?
○ Setting up a subsidiary in a foreign location to perform activities in-house
while leveraging the advantages of the local market.
○ Example: A company sets up its own factory in another country instead of
using a third-party supplier.
83
What is OEM?
Original Equipment Manufacturer:
○ Produces goods based on the designs of other firms.
84
What is ODM?
Original Design Manufacturer:
○ Designs and manufactures products but may not sell under its own brand.
85
What is OBM?
Original Brand Manufacturer:
○ Designs, manufactures, and sells products under its own brand.
○ Example: A small electronics company that starts as an OEM may evolve into an OBM by developing its own brand identity.
86
What is a Trade Surplus?
When a country exports more than they import
87
What is a Trade Deficit?
When a country imports more than they export
88
What are the two components that make up the Balance of Trade?
Trade Deficit, and Trade Surplus
89
What is Mercantilism?
○ Originated in the 16th-17th centuries and viewed trade as a zero-sum game.
○ Nations should maximize exports and minimize imports to accumulate wealth, primarily in the form of gold and silver
90
What is the Theory of Absolute Advantage?
○ A country has an absolute advantage if it can produce a good more efficiently
than another country.
○ Encourages specialization and free trade for mutual benefits.
91
What is an example of Absolute Advantage?
○ Example: If the U.S. is more efficient at producing airplanes and China at
producing wheat, both should specialize and trade to maximize their production.
92
What is the Theory of Comparative Advantage?
○ Even if a country has an absolute advantage in producing multiple goods, it should specialize in the good where it has the lowest opportunity cost.
93
What is an example of Comparative Advantage?
○ Example: If the U.S. is more efficient at producing both cars and wheat, but its efficiency is greater in cars, it should specialize in car production and trade
wheat from other nations.
94
What is the Product Life Cycle Theory?
○ Describes how the location of production changes as a product matures.
○ Stages of the Product Life Cycle:
1. New Product: Developed and produced in the innovation nation (e.g.,
the U.S.).
2. Maturing Product: Production spreads to other developed nations as
demand grows.
3. Standardized Product: Production shifts to developing nations to
take advantage of lower costs
95
What is the Strategic Trade Theory?
○ Suggests that government intervention can help firms gain a first-mover advantage in industries with high entry barriers (e.g., aerospace).
○ By providing subsidies and support, governments can help local firms
dominate globally.
96
What is an example of Strategic Trade Theory?
○ Example: The success of Airbus in competing with Boeing was significantly
aided by European government subsidies.
97
What is the Porter's Diamond Theory?
○ Explains why certain industries in specific nations are globally competitive.
○ Four determinants of national competitive advantage:
1. Factor Conditions: Availability of skilled labor, resources, and
infrastructure.
2. Demand Conditions: Sophisticated and demanding local customers push firms to innovate.
3. Related and Supporting Industries: Competitive supplier industries
enhance industry performance.
4. Firm Strategy, Structure, and Rivalry: Domestic competition drives
innovation and efficiency.
98
What are Tariff Barriers? And how do they benefit governments?
○ Import Tariff: A tax on imported goods, either as a fixed charge (specific
tariff) or a percentage of value (ad valorem tariff).
○ Tariffs increase government revenue, protect domestic industries, and can be
used as political tools in trade negotiations.
99
What are Non-Tariff Barriers? (NTBs)
○ Include subsidies, import quotas, export restraints, local content requirements, and administrative policies.
100
What are subsidies?
○ Subsidies: Financial support to domestic firms, making their products more competitive globally.
101
What are import quotas?
○ Import Quotas: Limit the number of goods that can be imported.
102
What are VERs?
○ Voluntary Export Restraints (VERs): Agreements where exporting countries
limit their exports.
103
What are Antidumping Policies?
○ Antidumping Policies: Aim to prevent foreign firms from selling goods below cost to undermine local industries
104
What is a protectionists view?
■ Argues for protecting domestic industries and jobs, especially in the
face of unfair foreign competition (e.g., China’s alleged dumping of
solar panels).
105
What are the implications of navigating trade barriers?
○ Firms must be aware of and adapt to trade regulations, such as tariffs,
quotas, and local content rules.
○ Trade barriers can affect where firms locate production and whether they need to establish local facilities to meet regulations.
106
What are the implications of protectionism?
○ Protectionist policies can provide short-term benefits to industries but may lead to retaliation and long-term disadvantages.
107
What is FDI?
1. Foreign Direct Investment (FDI) involves a firm investing directly in facilities to produce or market a product in a foreign country.
2. The United Nations defines FDI as having an equity stake of 10% or more in a foreign-based enterprise, which grants management control rights.
108
What are the differences between FDI and FPI?
1. Foreign Portfolio Investment (FPI) refers to investing in foreign stocks and bonds without taking active management control.
2. FDI involves a more significant stake and control, making the firm a
Multinational Enterprise (MNE).
109
What are the two types of FDI?
1. Horizontal FDI: Duplicates a firm’s home country activities in a host country
(e.g., a U.S. car manufacturer setting up production in Germany to make the same models sold in the U.S.).
2. Vertical FDI: Moves different stages of the value chain to host countries.
■ Upstream Vertical FDI: Engages in earlier stages of production (e.g.,
extracting raw materials).
■ Downstream Vertical FDI: Focuses on later stages (e.g., sales and
distribution)
110
Why do firms engage in FDI?
Ownership, Location, and Internalization. A three prong framework created by John Dunning
111
OLI Frame work involves what?
Ownership Advantages, Location Advantages, and Internalization Advantages.
112
What are Ownership Advantages?
■ Firm-specific capabilities such as proprietary technology, trademarks,
and managerial skills.
■ These assets must be valuable, rare, hard-to-imitate, and organizationally embedded (VRIO) to provide competitive advantage abroad.
113
What are Location Advantages?
■ Host countries may offer natural resources, skilled labor, or access
to markets that are favorable for foreign firms.
■ Agglomeration: The clustering of firms in a location creates benefits
like knowledge spillovers and specialized labor pools.
114
What are Internalization Advantages?
■ Internalization occurs when a firm replaces the external market
(e.g., exporting or licensing) by establishing its own operations in
multiple countries.
■ This helps combat market failures such as high transaction costs and
prevents the loss of proprietary knowledge.
115
What are the benefits of FDI to a host country?
○ Capital Inflow: FDI brings foreign capital, improving the host country’s
balance of payments.
○ Technology Transfer: Local firms gain from technology spillovers and adopt new practices through imitation and learning.
○ Job Creation: FDI creates both direct and indirect jobs, boosting the local
economy.
116
What are the costs of FDI to a host country?
○ Loss of Economic Sovereignty: Foreign firms may dominate critical sectors, influencing local economic decisions.
○ Profit Repatriation: MNEs often send profits back to the home country,
reducing local economic benefits.
○ Impact on Domestic Firms: Foreign competition can drive local businesses
out of the market.
117
What are the benefits of FDI to the home country?
○ Repatriated Earnings: Home countries benefit from the profits earned
abroad.
○ Export Opportunities: FDI often requires components and services from the
home country, boosting exports.
○ Learning Opportunities: Home country firms can gain insights and
innovations from their foreign operations.
118
What are the costs of FDI to the home country?
○ Job Loss: Moving production abroad can result in job losses in the home country.
○ Capital Outflow: FDI represents a capital investment that could have been used domestically.
○ Tax Avoidance: Some firms use FDI to reduce their tax burden through
complex international structures.
119
What are some views on FDI?
The main three are:
-Radical View, Free Market View, and the Pragmatic Nationalism
120
What is the Radical view on FDI?
○ FDI is seen as a tool of exploitation and imperialism.
○ Associated with countries that restrict or ban foreign investments, viewing it
as detrimental to national interests.
121
What is the Free market view on FDI?
○ Supports unrestricted FDI because it maximizes efficiency and economic
welfare.
○ Countries with a free market perspective create FDI-friendly policies.
122
What is the Pragmatic Nationalistic view on FDI?
○ Accepts FDI if its benefits (e.g., job creation, technology transfer) outweigh the costs (e.g., loss of control over domestic industries).
○ Encourages FDI selectively based on industry or region.
123
What are the forms that FDI can take?
● Greenfield Investment:
○ Establishing new operations from scratch in a foreign country.
○ Offers full control but is time-consuming and costly.
● Mergers and Acquisitions (M&A):
○ Acquiring or merging with an existing foreign firm.
○ M&As are faster and less risky compared to greenfield investments, as they leverage existing infrastructure and market presence.
124
What is the Obsolescing Bargain Model?
○ The initial agreement between an MNE and a host government may become obsolete over time.
○ After the MNE has made significant investments, the host government may
demand more (e.g., higher taxes or stricter regulations).
125
What is Bargaining Power?
○ MNEs and governments have different levels of bargaining power based on
their strengths (e.g., technology for MNEs vs. market access for
governments).
126
What are the three C's of negotiations?
■ Common Interests: Aligning the interests of both parties.
■ Conflicting Interests: Managing and minimizing disputes.
■ Compromises: Finding a balance to achieve a mutually beneficial
outcome.
127
How do Host Governments regulate FDI?
○ Encouraging Inward FDI: Incentives such as tax breaks and infrastructure
support to attract foreign investors.
○ Restricting Inward FDI: Ownership restraints and performance requirements
to protect national interests.
128
How do Home Governments regulate FDI?
○ Encouraging Outward FDI: Insurance programs and elimination of double
taxation to support firms investing abroad.
○ Restricting Outward FDI: Controls on investments in politically sensitive
countries or tax haven jurisdictions.
129
What are implications for managers and firms?
● Managers need to assess whether FDI is justified compared to other foreign entry modes (e.g., licensing, exporting).
● Firms must align their location advantages with strategic goals and be aware of institutional constraints (e.g., regulations, cultural differences).
130
What is Foreign Exchange Rate?
1. The foreign exchange rate is the price of one currency in terms of another.
2. It represents the amount of one currency required to purchase a unit of
another currency (e.g., USD/JPY or EUR/USD).
131
How does inflation effect exchange rate?
■ High inflation reduces the purchasing power of a currency, leading to
depreciation.
■ A country with lower inflation rates tends to see its currency
appreciate over time.
132
How does interest rate effect exchange rate?
■ Countries with higher interest rates attract more capital, leading to
appreciation of their currency.
■ Conversely, lower interest rates reduce the demand for a currency,
causing depreciation.
133
How does the Balance of Payments effect exchange rate?
■ A country's international transaction statement, reflecting its trade
balance (exports minus imports).
■ Current Account Surplus: Currency appreciates.
■ Current Account Deficit: Currency depreciates.
134
What was the Gold Standard?
○ Currencies were pegged to a specific amount of gold.
○ Provided high stability and predictability but required central banks to
maintain gold reserves.
○ Collapsed during World War I due to countries’ inability to maintain gold
reserves
135
What was the Bretton Woods System?
○ Created after World War II to stabilize international trade.
○ All currencies were pegged to the U.S. dollar, and the dollar was convertible
into gold at $35 per ounce.
○ Provided stability but collapsed in 1971 when the U.S. stopped converting
dollars into gold due to high inflation.
136
What was the Post-Bretton Woods System?
○ No single currency is pegged to gold or any other standard.
○ Currencies float based on market supply and demand, leading to flexibility
but also volatility.
○ The U.S. dollar remains a dominant global currency.
137
What are different types of currency risks?
○ Transaction Exposure:
■ The risk that currency fluctuations will impact the value of individual
transactions.
■ Can lead to real monetary loss.
○ Translation Exposure:
■ The impact of exchange rate changes on a firm’s financial statements.
■ Affects only the reported figures, not actual cash flow.
○ Economic Exposure:
■ The extent to which a firm’s future earnings are affected by changes in
exchange rates.
■ Long-term effect on pricing, sales, and costs
138
What are strategies that financial companies can use?
○ Spot Transactions: Immediate exchange of currencies.
○ Forward Transactions: Buy/sell currencies for future delivery to protect
against rate fluctuations.
○ Currency Swaps: Exchanging currency payments at specified times.
139
What are strategies that non-financial companies can use?
○ Invoicing in Home Currency: Reduces risk by billing in the firm’s own
currency.
○ Currency Hedging: Uses financial instruments to offset potential losses from
currency movements.
○ Strategic Hedging: Diversifying operations across multiple countries to balance out risks.
140
What are derivatives?
-Derivatives are financial contracts whose value is derived from an underlying
asset, such as currencies, stocks, or commodities.
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What are the different types of derivatives?
1. Forward Contracts:
■ Agreements to exchange an asset at a set price at a future date.
■ Commonly used for managing foreign exchange risk.
2. Futures Contracts:
■ Standardized forward contracts traded on an exchange.
■ Involves daily settlement to manage risk.
3. Options:
■ Call Option: Right to buy an asset at a set price within a specified
period.
■ Put Option: Right to sell an asset at a set price within a specified
period.
4. Swaps:
■ Agreement to exchange cash flows between two parties.
■ Examples include interest rate swaps (exchange fixed interest
payments for floating ones) and currency swaps (exchange
payments in different currencies).
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How can firms forecast exchange rates?
○ Fundamental Analysis: Predicts rates based on economic factors like
interest rates and inflation.
○ Technical Analysis: Uses past trends and patterns to predict future
movements.
