Incoterms 2010 and International Business - 101
Incoterms 2010 and International Business - Wild - Quick Study - Chapter 10
Incoterms 2010 and International Business - 101
International Business: The Challenges of Globalization, 8th Edition, Wild & Wild
Incoterms 2010 and International Business - Wild - Quick Study - Chapter 10
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Quick Study
Quick Study 1
- Q: For a country with a currency that is weakening (valued low relative to other countries), what will happen to the price of its exports and the price of its imports?
A: Devaluation lowers the price of a country’s exports on world markets and increases the price of imports because the country’s currency is now worth less on world markets.
- Q: Unfavorable movements in exchange rates can be costly for business, so managers prefer that exchange rates be what?.
A: Stable exchange rates improve the accuracy of financial planning, including cash flow forecasts. Predictable exchange rates reduce the likelihood that companies will be caught off-guard by sudden and unexpected rate changes. This reduces the need for costly insurance (usually by currency hedging) against possible adverse movements in exchange rates.
- Q: The view that prices of financial instruments reflect all publicly available information at any given time is called what?
A: The efficient market view states that prices of financial instruments reflect all publicly available information at any given time.
Quick Study 2
- Q: The principle that an identical item must have an identical price in all countries when price is expressed in a common currency is called what?
A: The law of one price is a principle that an identical product must have an identical price in all countries when expressed in the same currency. This product must be identical in quality and content and be entirely produced within each country. If the price is not identical in each country, an arbitrage opportunity would arise—an opportunity to buy a product at a specific price in one country and sell it at a higher price in another country. The law of one price holds because if people were to attempt arbitrage, the greater demand for the product in the lower-priced market would increase its price there and the greater supply in the higher-priced market would lower its price there.
The limitations of the law of one price are several. First, the law of one price requires that the products must be identical in quality and content in each country, and must be entirely produced within each particular country. This is very hard to accomplish in today’s global economy except for most raw materials, fruits and vegetables, and the like. The Big Mac index comes close to an ideal but it has its own limitations. Second, the products must be “tradable” in the sense that it is practical to buy the product in one country and sell it in another to take advantage of an arbitrage opportunity. For example, the Big Mac index fails in this regard. Third, using a single product to determine what a nation’s exchange rate should be is far too simplistic a method. Probably every economy is far too complex to have its exchange rate determined by a single product.
- Q: A unique aspect of purchasing power parity in the context of exchange rates is that it is only useful when applied to what?
A: Purchasing power parity is the relative ability of two countries’ currencies to buy the same “basket” of goods in those two countries. It tells us how much of currency “A” that a person in country “A” needs in order to buy the same amount of products that a person in country “B” can buy with currency “B.” Purchasing power parity holds for internationally traded products that are not restricted by trade barriers and that entail few or no transportation costs.
- Q: What is the impact on purchasing power when growing demand for products outstrips a stagnant supply?
A: As growing demand for products outstrips stagnant supply, prices will rise and devour any increase in the amount of money the consumers have to spend.
- Q: What factors influence the power of purchasing power parity to accurately predict exchange rates?
A: There are limitations to the PPP concept. First, purchasing power parity is better at predicting long-term exchange rates than short-term rates. Unfortunately, short-term forecasts are often more beneficial to managers. Second, although PPP assumes a world of no transportation costs, this is clearly unrealistic. If adding transportation costs to the cost of a product makes the product equally or more expensive in the otherwise cheaper market, trade will not occur. Thus, because of the absence of an arbitrage opportunity after transaction costs, no leveling of prices between the two markets will occur. Third, although PPP assumes no trade barriers, we know this to be false in reality. Trade might not occur if a high tariff on an import increases the cost of the product significantly. Of course, the same is true if importing the product is made illegal. Fourth, PPP overlooks business confidence and human psychology. The confidence of businesspeople and consumers impacts the value of a nation’s currency. Confidence in a nation’s economic outlook encourages companies to invest and consumers to increase their spending. Currency traders can also influence the exchange rate of a nation’s currency. If traders believe a currency is overvalued, they can sell the currency on currency markets—thereby causing its value to fall and the exchange rate to adjust accordingly.
Quick Study 3
- Q: The gold standard is an example of what type of international monetary system?
A: In the earliest days of international trade, gold was the internationally accepted currency for payments of goods and services. The gold standard was an international monetary system in which nations linked the value of their paper currencies to specific values of gold. The value of a currency expressed in terms of gold is called its par value. Because each nation fixed its currency to gold, it also indirectly linked its own currency to those of other nations. Thus, the gold standard was called a fixed exchange rate system—one in which the exchange rate for converting one currency into another is fixed by international governmental agreement.
- Q: What are the main advantages of the gold standard?
A: There are three main advantages associated with an international monetary system based on the gold standard. First, because the gold standard maintained highly fixed exchange rates between currencies, it drastically reduced exchange-rate risk. Second, because the gold standard requires governments to convert paper currency into gold if demanded by holders of the currency, governments must always have adequate gold reserves on hand to pay them. Thus, a government cannot allow the volume of its paper currency to grow faster than its gold reserves. This created an effective tool in helping nations control inflation. Third, the gold standard also helped nations to correct trade imbalances. Suppose a nation is importing more than it is exporting. As gold flows out to pay for imports, the government must decrease the supply of paper currency in the domestic economy because it cannot have paper currency in excess of gold reserves. As the money supply falls, so do prices of goods and services in the country because demand is falling while supply is unchanged. The falling prices of the country’s goods make its exports cheaper on world markets. Exports rise until the nation’s international trade is once again in balance.
The fundamental principle of the gold standard was violated when nations involved in the First World War needed to finance their enormous war expenses by printing additional paper currency. This caused rapid inflation for these nations and caused them to abandon the gold standard altogether. Britain returned to the gold standard in the early 1930s at the same par value that existed before the war. However, the United States returned to the gold standard at a new, lower par value that reflected the inflation of previous years. The decision by the United States to devalue its currency and Britain’s decision not to do so lowered the price of U.S. exports on world markets and increased the price of British (and other nations’) goods imported into the United States. Countries retaliated against one another through “competitive devaluations” to improve their own trade balances. Faith in the gold standard vanished, as it no longer indicated a currency’s true value.
- Q: What is the name of the international monetary system that formed in 1944 following the demise of the gold standard?
A: The Bretton Woods agreement was an accord among nations to create a new international monetary system based on the value of the U.S. Dollar.
Quick Study 4
- Q: An exchange rate system in which currencies float against one another with governments intervening to stabilize currencies at target rates is called what?
A: A managed float system is one in which currencies float against one another, with governments intervening to stabilize their currencies at particular target exchange rates.
- Q: What do we call the arrangement whereby a nation lets its currency float within a margin around the value of another more stable currency?
A: A free float system is an arrangement whereby a nation lets its currency float within a margin around the value of another more stable currency.
- Q: A currency board is a monetary regime based on an explicit commitment to exchange domestic currency for what?
A: The currency board is a monetary regime based on an explicit commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate.
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Teaming Up |
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- Q: Suppose you and several classmates are a marketing team assembled by your Brazil-based firm to estimate demand in the U.S. market for its newly developed product. The market research firm you hired requires $150,000 to perform a thorough study. But your group is informed that the total research budget for the year is 3 million Brazilian real and that no more than 20 percent of the budget can be spent on any one project.
(3a.) If the current exchange rate is 5 real/$, will you have the market study conducted? Why or why not?
(3b.) If the exchange rate changes to 3 real/$, will you have the study conducted? Why or why not?
(3c.) At what exchange rate do you change your decision from rejecting the proposed research project to accepting the project?
A: (3a.) The answer is no. Converting real into dollars at an exchange rate of 5 real/$, we arrive at $600,000 (3,000,000/5 real/$ = $600,000). The research project costing $150,000 is 25 percent of the total research budget of $600,000 ($150,000/$600,000 = 0.25). This exceeds the cutoff figure of 20 percent for the cost of any single research project.
(3b.) The answer is yes. Converting real into dollars at an exchange rate of 3 real/$, we arrive at $1,000,000 (3,000,000 real/3 real/$ = $1,000,000). The research project costing $150,000 is 15 percent of the total research budget of $1,000,000 ($150,000/$1,000,000 = 0.15). This is below the cutoff figure of 20 percent for the cost of any single research project.
(3c.) The threshold exchange rate at which the project decision changes from “accept” to “reject” is 4 real/$. We can set up the problem as an equation which is .20x = $150,000. (The .20x is the 20 percent cutoff figure and the $150,000 is the cost of the project.) Solving the equation and dividing $150,000 by 0.20 gives us a figure of $750,000—the total research budget stated in dollars. Then, dividing the research budget stated in real (3 million real) by that stated in dollars ($750,000), we arrive at a real/$ exchange rate of 4 real/$.
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Ethical Challenges |
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- Q: You are the chair of an IMF task force. Your job is to reevaluate the policy of bailing out national governments that suffer losses in the private sector. Current policy is to enlist the governments of industrialized countries in bailing out emerging nations in the midst of financial crises. Taxpayers in industrial countries typically foot the bill for IMF activities, with total loans running into the many billions of dollars. Recent examples are the bailouts of Mexico, Indonesia, and Thailand. Some critics call this system a kind of “remnant socialism” that rescues financial institutions and investors from their own mistakes with money from taxpayers. For instance, the financial crisis in Thailand was largely a private-sector affair. Thai banks and insurance companies were heavily in debt and the central bank had recklessly pledged its foreign exchange reserves to shore up the currency. As chair of the task force, what is your position on this dilemma? Do you believe that the current system socializes losses (the government bails them out) and privatizes profits? Explain exactly who benefits from such bailouts. What is an alternative to an IMF bailout?
A: Students might look at the recent events in the U.S. financial system meltdown for ideas on this topic. They may research articles around the time of the Southeast Asian crisis to understand who benefits and loses when losses are socialized—the argument that private financial institutions earn healthy returns when times are good and taxpayers do not share in these gains (though stockholders in these companies do). The question is why should taxpayers bear losses when these institutions make bad investments? The companies may be more cautious if they know taxpayers would not bail them out. This may be a good question to pose as a debate between classmates playing the roles of proponents of private financial institutions on one side, and taxpayers on the other.
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Practicing International Management Case |
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Banking on Forgiveness
- This item can be assigned as a Discussion Question in MyManagementLab. Student responses will vary. Q: The World Bank and the IMF had once argued that the leniency of debt forgiveness would make it more difficult for the lenders themselves to borrow cheaply on the world’s capital markets. If you were a World Bank donor, would you support the HIPC Debt Initiative or argue against it? Explain your answer.
A: This question could set up a debate between groups arguing for and against debt relief. Students arguing for debt relief must explain the benefits (humanitarian, economic, etc.) that debt forgiveness is expected to have for the debtors and lenders. Students arguing against debt forgiveness must explain the harm to the institutional lenders and lending countries from the debt forgiveness and explain why debtor nations would be better off mired in crippling debt that denies their people basic health care and education.
- Q: In negotiating the HIPC Debt Initiative, the World Bank and the IMF worked closely together. At one point, however, the plan came to a standstill when the two organizations produced different figures for Uganda’s coffee exports, with the IMF giving a more optimistic forecast and so arguing against the need for debt relief. In your opinion, is there any benefit to these organizations working together? Explain. Which organization do you think should play a greater role in aiding economic development? Why?
A: Students should be encouraged to visit the Web sites of the International Monetary Fund and World Bank and gather other printed documents they publish in order to gain a fuller understanding of these organizations’ activities before answering this question.
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