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UGBA 178: Introduction to International Business


UGBA 178: Introduction to International Business Spring 2009 Midterm Review Nelda Gabbay Erik Kiewiet de Jonge Where we re headed today Overview of major trade ... – PowerPoint PPT presentation

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Title: UGBA 178: Introduction to International Business

UGBA 178 Introduction to International Business
  • Spring 2009 Midterm Review
  • Nelda Gabbay
  • Erik Kiewiet de Jonge

Where were headed today
  • Overview of major trade theories
  • Foreign Direct Investment (FDI)
  • Purchasing Power Parity (PPP)
  • The Fisher Effect and The International Fisher
  • Balance of Payments and Exchange Rates
  • FX Lingo
  • Questions

International Trade TheoryChapter 4
  • Focus on understanding the central concepts of
    the most widely recognized trade theories
  • Mercantilism
  • Absolute Advantage
  • Comparative Advantage
  • Heckscher-Ohlin Theory
  • New Trade Theory
  • Porters Diamond

International Trade TheoryChapter 4 Absolute
Advantage (Adam Smith)
200 units of resources
In tons
International Trade TheoryChapter 4 Comparative
Advantage (David Ricardo)
200 units of resources
In tons
International Trade TheoryChapter 4
Hecksher-Ohlin Theory
  • Comparative advantage rises from factor
  • Nations have varying factor endowments
  • Beware the Leontief Paradox theories sound great
    on paper, but do they actually work in practice?
  • Case in point The US exports many skill and
    innovation intensive products and imports many
    capital intensive products, despite having a
    large capital stock (and great technology to

International Trade TheoryChapter 4 New Trade
  • Suggests that the ability of firms to gain
    economies of scale can have important
    implications for international trade
  • First movers to capture significant economies of
    scale may gain scale-based competitive advantage
  • Ability to attain economies of scale may trump
    other advantages for countries
  • All this suggests that for some industries, the
    world market may only be able support a limited
    number of firms

International Trade TheoryChapter 4 Porters
Foreign Direct InvestmentChapter 7 What is it?
  • Occurs when a firm invests directly in new
    facilities to produce and/or market in a foreign
  • Must have controlling stake in foreign operations
  • E.g., Haier in Cali, Toyota in Kentucky, GM in
  • Once a firm undertakes FDI it becomes a
    multinational enterprise

Foreign Direct InvestmentChapter 7 Why the
increase in both the flow and stock of FDI in the
world economy over the last 30 years?
  • Firms still fear the threat of protectionism
  • The general shift toward democratic political
    institutions and free market economies has
    encouraged FDI
  • The globalization of the world economy is having
    a positive impact on the volume of FDI as firms
    undertake FDI to ensure they have a significant
    presence in many regions of the world

Foreign Direct InvestmentChapter 7 Whos got
the FDI?
  • Most FDI has historically been directed at the
    developed nations of the world, with the United
    States being a favorite target
  • FDI inflows have remained high during the early
    2000s for the United States, and also for the
    European Union
  • South, East, and Southeast Asia, and particularly
    China, are now seeing an increase of FDI inflows
  • Latin America is also emerging as an important
    region for FDI

Purchasing Power ParityChapter 9
  • PPP theory argues that given relatively efficient
    markets, the price of a basket of goods should
    be roughly equivalent in each country.
  • For example, in the US, this basket costs 100.
    How much, according to PPP, would this basket
    cost in Japan if 1 98?
  • Basket 100 ? 1 x 100 x 98 / ? 9,800
  • If the basket costs 10,780 a year later (still
    100 in the US), what must happen to exchange
  • depreciates relative to the , since Japanese
    prices rose by 10. The new exchange rate will
    be 1 107.8

Purchasing Power ParityChapter 9
  • Or, mathematically E/ P/P
  • In essence, PPP predicts that changes in relative
    prices will result in changes in exchange rates
  • e.g., If prices rise in the US by 10 while
    prices remain constant in the Eurozone, PPP
    predicts that the Euro will appreciate by 10
    relative to the dollar.
  • Inflation causes currencies to depreciate. High
    inflation in Mexico will cause the peso to
    depreciate vis-à-vis the dollar.
  • For fun, The Economists Big Mac Index provides a
    simplified and informative take on PPP

The Fisher EffectChapter 9 Interest Rates and
Exchange Rates
  • The Fisher Effect states that a countrys nominal
    interest rate (i) is the sum of the required real
    rate of interest (r) and the expected rate of
    inflation (I) over the lending period
  • i r I
  • Thus, you can see the relation between interest
    rates and inflation.
  • Lets take this international

The International Fisher EffectChapter 9
Interest Rates and Exchange Rates
  • The International Fisher Effect states that for
    any two countries the spot exchange rate should
    change in an equal amount but in the opposite
    direction to the difference in nominal interest
    rates between two countries. In other words
  • (S1 - S2) / S2 x 100 i - i
  • If the US has i 10 and Japan has i 6, we
    would expect?
  • The dollar to depreciate by 4 against the yen
    (dont worry about the equation for the midterm).

Balance of Payments and Exchange RatesChapter 9
  • Suppose a country runs a trade deficit for
    several years (imports more than exports) (e.g.,
  • Foreigners accumulate currency ()
  • Foreigners want to buy stuff in their own country
    and need their own currency to do so.
  • How to they get it? Covert! Use dollars to buy
    foreign currency.
  • Supply of dollars UP, foreign currency supply
  • Dollar depreciates, foreign currency appreciates.
  • NOTE Not a perfect explanation dont forget
    about interest rates! If the US has relatively
    high interest rates, foreigners may hold those
    dollars (probably in assets like US Treasuries,
    stocks, bonds, real estate, etc.) This wont
    depreciate the dollar and may have the opposite

Foreign Exchange LingoChapter 9
  • Spot Contract/Rate the here and now FX rate
  • Forward Contract Ill sell you at Day 30 for
  • Currency Swap simultaneous purchase and sale of
    a given amount of exchange for two different
    value dates
  • Todays spot is 1 120 and the 90-day forward
    is 1 110.
  • Step 1 Sell 1M to bank for 120M today.
  • Step 2 Enter forward contract to convert 120M
    to .
  • Step 3 Time passes, receive 1.09M (120M/110)
  • What happened? Yen was trading at a premium on
    the 90-day forward market, so firm gains by
    buying low, selling high.