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any measure by govt to protect domestic producers



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


Import quotas

balance of payments

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


Result of import quotas and tariffs

domestic consumers pay higher price, consumer less

domestic producers sell more as domestic consumer pay subsidy to them


trigger price

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



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


Export subsidy

pmts by govt to producers to increase exports


Economic effect of tariffs and quota

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


Arguments for protectionism

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


strategic trade policies

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


Demand for merch, assets, financial instruments rise

demand for currency rises


Fixed Exchange rate system

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

advantage is predictability
disadvantage- govt manipulation


Freely Floating Exchange Rate

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


Managed Float

govt only interferes if mkt forces move rates too far
advantage- mkt responsive yet got intervenes


Demand foreign currency

currency becomes cheaper, need more currency


Suppy foreign currency

more expensive, domestic goods more affordable and need more currency


5 factors affect currency exchange rates

Trade related
-relative inflation
-relative income level
-govt intervention

financial factors
-relative interest rates
-ease of capital flow


Relative inflation rate

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


Relative income level

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


Relative interest rate

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


Ease of capital flow

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


Spot rate vs forward rate

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


Fwd premium vs fwd discount

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


Firm w/ payable in FC wants

Firm w/ receivable in FC wants

FC to depreciate by settlement date; requires less DC

FC to appreciate; results in more units of DC


3 types of exposure to exchange rate risk

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


Transaction exposure

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


Hedging wrt transaction exposure

some upside gone to protect against downside
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)


4 most common tools for transaction exposure

money market hedges
fwd contracts
futures contracts
currency options


Money Market Hedges

least complex
-buy MM instrument in FC timed to mature when payable due
-borrow FC, convert to DC then pay off foreign loan when receivable is collected


Forward Contract

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