Introduction to International Business

1
Introduction to International Business

• July 28 2008
• Discussion Section
• Foreign Direct Investment Political Economy of
  FDI
• Foreign Exchange International Monetary System

2
Agenda

• Chapters 3456 in a nutshell
• Tips for future assignment
• Review Chapters 7
• Discussion Questions
• Review Chapter 9 10
• Discussion Questions
• QA regarding the Midterm

3
Chapters 3456 in a nutshell

• Chapter 3
• What is culture What are the determinants of
  culture How does culture affect business
• Chapter 4
• What are ethical dilemmas How do ethical
  dilemmas arise What are some of the standards
  used to evaluate ethics Which ones are straw
  men arguments
• Chapter 5
• What are the theories that explain the observed
  pattern of international trade
• Chapter 6
• What are some of the instruments that governments
  use to restrict trade What are some political
  and economic justifications for trade
  intervention Are these justifications
  justified How has the world trading system
  developed

4
Review of Case Write-ups

• (1) Include your name and student ID
• (2) Please staple (rather than paperclip)
• (3) Please email only if you cannot attend
  section (or put DUPLICATE in email header)
• (4) Use header/footer to indicate name and page X
  of Y on every page
• (5) Label your answers
• (6) Answer EVERY question
• (7) Grade statistics
• Morning Mean 15.12 Stdev 3.76
• Afternoon Mean 11.92 Stdev 2.74

5
Common problems

• (1) One-sided responses
• E.g. the Nike is evil responses. If there is
  only one side to the issue it is not an ethical
  dilemma. It is okay to conclude with one or the
  other side but you need to consider both sides
  first.
• (2) Generalities-No support for your claims
• Saying Nike should blah blah blah without saying
  why
• Assertions almost never carry as much weight as
  supported argumentation
• (3) Failure to cite theories/ethical constructs
  in the text
• The textbook is not intended to be used solely as
  a paperweight
• (4) Personal opinion is not proper argument
  unless supported by reasoning (See (2))
• Goal of assignments is to assess whether you
  learned the material in class
• (5) Lack of structure/organization
• Run-on diatribes are hard to read
• (6) Please dispense with irrelevant facts
• Include only those facts to
  support your claim. Avoid making mistakes of
  facts.

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Consider question 1 Composite of inferior
answers

• Should Nike be held responsible for the
  conditions at foreign factories that it does not
  own
• I think Nike should be held responsible. People
  need to be able to make enough money to live
  work in a safe place and a company should take
  care of its employees. Nike has a lot of
  financial power and it can terminate contracts
  when it wants to and so it can force
  subcontractors to comply with local laws. Plus
  Nike is financially successful so it has a
  philanthropic responsibility. Nike knows what is
  going on at foreign factories so it cannot
  escape its responsibility. Nike is a
  world-famous company and therefore each country
  has its own standards. Since Nike is
  world-famous it should follow the standards of
  the country it is operating in.

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Whats a better approach

• Nike should not be held responsible for working
  conditions in foreign factories it does not own.
• Reason 1 with support and key terms in bold
  (e.g. Friedman Doctrine )
• Reason 2 with support and key terms in bold
  (e.g. naive immoralist).
• Nike should be held responsible for working
  conditions in foreign factories it does not own.
• Reason 1 with support and key terms in bold
  (e.g. Kantian Doctrine)
• Reason 2 with support and key terms in bold
  (e.g. Justice Theory).
• Conclusion
• State your conclusion clearly and succinctly and
  apply appropriate reasoning cited above to
  support it.

8
How would this look written out

• Based on the traditional straw men arguments it
  is easy to argue that Nike should not be held
  responsible. The cultural relativism argument
  posits that ethics and working conditions are a
  product of culture. Subcontractors are thus
  entitled to establish working conditions of their
  own and Nike a foreign entity cannot be
  responsible for different standards in another
  country.
• Another such argument the Friedman doctrine
  posits that a firms only social responsibility
  is to increase profits and stay within the law.
  If Nikes subcontractors stay within the law
  Nike should only look for the most cost-effective
  subcontractor.
• However these arguments fail upon further
  inquiry. As Nike vets and approves
  subcontractors based on their overall ability to
  provide a service the working conditions of the
  factories should be a component in their
  assessment of the subcontractor. As a
  multinational corporation it possess the power
  to control resources and move its production
  facilities from country to country affecting
  thousands of jobs and lives. According to the
  utilitarian framework it therefore has a moral
  obligation to be socially responsible to the
  society it operates in because of the sheer
  number of workers it affects even when balanced
  against a potential increase in prices spread
  across consumers of its products. Moreover Nike
  could follow valid principles of justice
  impartially using the veil of ignorance a
  concept brought up by John Rawls. According to
  this theory Nike should distribute economic
  goods (its vast resources and profits) more
  equitably with the workers of its foreign
  subcontractors by demanding better working
  conditions even if it means greater costs to the
  company.
• 
  Vaishnavi Jayakumar (with slight
  modifications)

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Chapter 7 Learning Goals

• Be familiar with current trends regarding FDI in
  the world economy.
• Understand the different theories of foreign
  direct investment.
• Appreciate how political ideology shapes a
  governments attitudes towards FDI.
• Understand the benefits and costs of FDI to home
  and host countries.
• Be able to discuss the range of policy
  instruments that governments use to influence
  FDI.
• Articulate the implications for management
  practice of theory and government policies
  associated with FDI.

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Chapter 7 Foreign Direct Investment

• What is FDI
• FDI in the world economy
• Trends Direction of FDI Source of FDI Shift to
  Services
• Form of FDI
• Greenfield vs. Acquisitions and Mergers
• Why undertake FDI
• Theories that explain WHY FDI occurs
• Limitations of exporting and licensing
• Internationalization theory
• Theories that explain the patterns in FDI
• Strategic behavior in in oligopoly competition
  (KnickerkbockersMultipoint Competition Theory)
• Vernons Product Life Cycle Theory
• The Eclectic Paradigm (combines the two sets of
  theories above)
• Dunning location-specific advantages
  externalities

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Chapter 7 Review continued

• Political Ideology and FDI
• Radical View
• Free Market View
• Pragmatic Nationalism
• Government Response
• Encourage/restrict outward FDI
• Encourage/restrict inward FDI

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Chapter 7 Critical Thinking Questions

• In 2003 inward FDI accounted for some 78 of
  gross fixed capital formation in Ireland but
  only 0.6 in Japan. What do you think explains
  this differences in FDI flows into the two
  countries

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Chapter 7 Critical Thinking Questions

• Compare and contrast these explanations of FDI
  internalization theory Vernons product life
  cycle theory and Knickerbockers theory of FDI.
  Which theory do you think offers the best
  explanation of the historical pattern of FDI
  Why

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Chapter 7 Critical Thinking Questions

• You are the international manager of a US
  business that has just invented a revolutionary
  new personal computer that can perform the same
  functions as existing PCs but costs only half as
  much to manufacture. Several patents protect the
  unique design of this computer. Your CEO has
  asked you to formulate a recommendation for how
  to expand into Western Europe. Your options are
  (a) to export from the US (b) to license a
  European firm to manufacture and market the
  computer in Europe and (c) to set up a wholly
  owned subsidiary in Europe. Evaluate the pros
  and cons of each alternative and suggest a course
  of action to your CEO.

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Chapter 7 Critical Thinking Questions

• Inward FDI is bad for (i) a developing economy
  and (ii) a developed economy and should be
  subjected to strict controls. Discuss.

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Chapter 7 Critical Discussion Questions

• Firms should not be investing abroad when there
  is a need for investment to create jobs at home.
  Discuss.

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Chapter 7 Critical Thinking Questions

• Do you think the successful conclusion of a
  multilateral agreement to liberalize regulations
  governing FDI will benefit the world economy
  Why

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Chapter 9 Learning Goals

• Be conversant with the functions of the foreign
  exchange market.
• Understand what is meant by spot exchange rates.
• Appreciate the role that foreign exchange rates
  play in insuring against foreign exchange risk.
• Understand the different theories explaining how
  currency exchange rates are determined and their
  relative merits.
• Be familiar with the merits of different
  approaches towards exchange rate forecasting.
• Understand the differences between transaction
  translation and economic exposure and what
  managers do to manage each type of exposure.

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Chapter 9 The Foreign Exchange Market

• What is the FOREX market for
• Currency conversion insuring against foreign
  exchange risk (using spot exchange forward
  exchange or currency swaps)
• Arbitrage in FOREX markets
• Theories about how FOREX rates are determined
• Price and exchange rates law of one price
  purchasing power parity money supply and price
  inflation
• Interest rates and exchange rates Fisher Effect
  International Fisher Effect
• Investor psychology and bandwagon effects
• Forecasting in FOREX markets
• Efficient v. Inefficient Schools Approaches
• FOREX Exposures and Multinational Firms
• Transaction Translation Economic

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Example of a currency swap

• For example consider the US-based company (Acme
  Tool Die) that has raised money by issuing a
  Swiss Franc-denominated Eurobond with fixed
  semi-annual coupon payments of 6 on 100 million
  Swiss Francs. Upfront the company receives 100
  million Swiss Francs from the proceeds of the
  Eurobond issue (ignoring any transaction fees
  etc.). They are using the Swiss Francs to fund
  their US operations.
• Why issue bonds in Swiss Francs The only
  rationale for doing this is because there are
  investors with Swiss Franc funds who are looking
  to diversify their portfolios with US credits
  such as Acmes. They are willing to buy Acmes
  Eurobonds at a lower yield than Acme can issue
  bonds in the US. A Eurobond is any bond issued
  outside of the country in whose currency the bond
  is denominated.
• Because this issue is funding US-based
  operations we know two things straightaway. Acme
  is going to have to convert the 100 million Swiss
  Francs into US dollars. And Acme would prefer to
  pay its liability for the coupon payments in US
  dollars every six months.
• Acme can convert this Swiss Franc-denominated
  debt into a US dollar-like debt by entering into
  a currency swap with the First London Bank.
• Acme agrees to exchange the 100 million Swiss
  Francs at inception into US dollars receive the
  Swiss Franc coupon payments on the same dates as
  the coupon payments are due to Acmes Eurobond
  investors pay US dollar coupon payments tied to
  a pre-set index and re-exchange the US dollar
  notional into Swiss Francs at maturity.
• Acmes US operations generate US dollar cash
  flows that pay the US-dollar index payments.
• First London Bank make Swiss-Franc denominated
  payments.
• In essence Acme and First London Bank have
  swapped currencies

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Chapter 9 Critical Thinking Questions

• The interest rate on South Korean government
  securities with one-year maturity is 4 and the
  expected inflation rate is 2. The interest rate
  on U.S. government securities with one-year
  maturity is 7 and the expected rate of
  inflation is 5. The current spot exchange rate
  for Korean won is 1 W1200. Forecast the spot
  exchange rate one year from today. Explain the
  logic of your answer

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Answer

• The international Fisher effect suggests that the
  exchange rate will change in an equal amount but
  in an opposite direction to the difference in
  nominal interest rates. Hence since the nominal
  interest rate is 3 higher in the US than in
  South Korea the dollar should depreciate by 3
  relative to the South Korean Won. Using the
  formula from the book (S1 - S2)/S2 x 100 i -
  iWon and substituting 7 for i 4 for iWon and
  1200 for S1 yields a value for S2 of 1W1165.

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Chapter 9 Critical Thinking Questions

• Two countries Great Britain and the United
  States produce just one good beef. Suppose the
  price of beef in the United States is 2.80 per
  pound and in Britain it is 3.70 per pound.
• According to PPP theory what should the
  dollar/pound spot exchange rate be
• Suppose the price of beef is expected to rise to
  3.10 in the United States and to 4.65 in
  Britain. What should the one-year forward
  dollar/pound exchange rate be
• Given your answers to parts a and b and given
  that the current interest rate in the United
  States is 10 what would you expect the current
  interest rate to be in Britain

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Answer

• (a) According to PPP the / rate should be
  2.80/3.70 or .76/.
• (b) According to PPP the / one year forward
  exchange rate should be 3.10/4.65 or .67/.
• (c) Since the dollar is appreciating relative to
  the pound and given the relationship of the
  international Fisher effect the British must
  have higher interest rates than the US. Using the
  formula (S1 - S2)/S2 x 100 i - i we can solve
  the equation for i with S1.76 S2.67 i
  10 yielding a value of 23.4 for the British
  interest rates.

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Chapter 9 Critical Thinking Questions

• You manufacture wine goblets. In mid-June you
  receive an order for 10000 goblets from Japan.
  Payment of 400000 is due in December. You
  expect the yen to rise from the present rate of
  1 130 to 1 100 by December. You can
  borrow yen at 6 a year. What should you do

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Answer

• (1) The simplest solution would be to just wait
  until December take the 400000 and convert it
  at the spot rate at that time which you assume
  will be 1100.
• In this case you would have 4000 in
  mid-December.
• (2) Forward Contract
• If the current 180-day forward rate is lower than
  100/ then a forward contract might be
  preferable since it both locks in the rate at a
  better level and reduces risk.
• If the rate is above 100/ then whether you
  choose to lock in the forward rate or wait and
  see what the spot does will depend upon your risk
  aversion.
• (3) Borrow Money
• There is a third possibility also. You could
  borrow money from a bank that you will pay back
  with the 400000 you will receive (400000/1.03
  388350 borrowed) convert this today to US
  (388350/130 2987) and then invest these
  dollars in a US account. For this to be
  preferable to the simplest solution you would
  have to be able to make a lot of interest (4000
  - 2987 1013) which would turn out to be an
  annual rate of 51 ((1013/4000) 2). If
  however you could lock in these interest rates
  then this method would also reduce any exchange
  rate risk. What you should do depends upon the
  interest rates available the forward rates
  available how large a risk you are willing to
  take and how certain you feel that the spot rate
  in December will be 100 1.

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Chapter 9 Critical Thinking Questions

• You are the CFO of a US firm whose wholly owned
  subsidiary in Mexico manufactures component parts
  for your US assembly operations. The subsidiary
  has been financed by bank borrowings in the
  United States. One of your analysts told you that
  the Mexican peso is expected to depreciate by 30
  percent against the dollar on the foreign
  exchange markets over the next year. What
  actions if any should you take

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Answer

• Your financing and operating capital are in
  dollars yet many of your costs (labor) must be
  in peso. Your hard assets are all in peso and
  their value will decline. On the other hand if
  the peso depreciates then your dollars will go
  further. So perhaps doing nothing is the best
  approach. If you are pretty sure that the peso
  will depreciate then you may want to avoid any
  major peso-denominated costs that you can until
  after devaluation. That may mean holding back on
  shipments if possible and you may want any
  dollar-denominated purchases made before the
  devaluation. You may want to move any
  peso-denominated major accounts into dollars
  before the devaluation.

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Chapter 10 Learning Goals

• Be familiar with the historical development of
  the modern global monetary system.
• Describe the role played by the World Bank and
  the IMF in the international monetary system.
• Be familiar with the differences between a fixed
  and a floating exchange rate system.
• Know what exchange rate systems are used in the
  world today and why countries adopt different
  exchange rate regimes.
• Understand the debate surrounding the role of the
  IMF in the management of financial crises.
• Appreciate the implications of the global
  monetary system for currency management and
  business strategy.

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Chapter 10 The International Monetary System

• Different exchange rate regimes
• Fixed
• Floating pegged dirty float
• Fixed versus Floating Exchange Rates
• Why choose floating exchange rates
• Monetary policy autonomy
• Trade balance adjustments
• Why choose fixed exchange rates
• Monetary discipline
• Speculation
• Uncertainty
• Trade Balance Adjustment
• Who is right

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Chapter 10 Critical Thinking Questions

• Debate the relative merits of fixed and floating
  exchange rate regimes. From the perspective of
  an international business what are the most
  important criteria in a choice between the
  systems Which system is the more desirable for
  an international business

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Chapter 10 Critical Thinking Questions

• Imagine that Canada the United States and
  Mexico decide to adopt a fixed exchange rate
  system. What would be the likely consequences of
  such a system for (a) international businesses
  and (b) the flow of trade and investment among
  the three countries

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Chapter 10 Critical Thinking Questions

• Do you think the standard IMF policy
  prescriptions of tight monetary policy and
  reduced government spending are always
  appropriate for developing nations experiencing a
  currency crisis How might the IMF change its
  approach What would the implications be for
  international business

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About the Midterm

• Unless you have made special arrangements please
  show up at your own class time  If you are in
  the morning class come to the morning exam and
  if you are in the afternoon class come to the
  afternoon exam.  Each class receives a different
  version of the exam.  If you come to the wrong
  exam (the one youre not enrolled in) WE WILL
  MAKE NO POSITIVE ADJUSTMENT TO YOUR SCORE EVEN IF
  THERE IS A DIFFERENCE IN AVERAGES BETWEEN THE TWO
  CLASSES. 
• The exams will be held in the same class room
  C230 from 1030 a.m. to 100 p.m. for the morning
  class and from 330 p.m. to 600 p.m. for the
  afternoon class
• Please bring your own (green) scantron sheet if
  you have one.  If not we will provide one for
  you but supplies are limited.
• There is no need for a blue book.  Please answer
  all short answers in the exam itself.
• Please bring a number 2 pencil -- the scantron
  sheets will be graded electronically.  If you use
  a pen you will be marked 0 for all answers. 
  Needless to say bring an eraser.
• You are allowed one sheet of notes and a language
  dictionary for the exam. 
• Sanny will be holding office hours from 130 p.m.
  to 300 p.m. at Cafe Strada (located on Bancroft
  X College Ave)

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Articles to Focus On

• Main Street HK
• South Koreas E-Mart Is No Wal-Mart
• Not Exactly Counterfeit
• New Economics Arms Race
• New Rulers of Finance