Chapter 1: Globalization

Globalization refers to the shift toward a more integrated and interdependent

world economy, including two facets:

1) Globalization of markets
2) Globalization of production.

Globalization of markets refers to the merging of historically distinct and

separate national markets into one huge global marketplace.

 falling trade barriers make it easier to sell globally

 consumers’ tastes and preferences are converging

Globalization of production refers to the sourcing of goods and services from

locations around the globe to take advantage of national differences in the cost
and quality of factors of production like land, labor, and capital.

 Companies can
 lower their overall cost structure
 improve the quality or functionality of their
 product offering

Global Institutions are needed to help manage, regulate, and police the global
marketplace.

 General Agreement on Tariffs and Trade (GATT)

 World Trade Organization (WTO)
 International Monetary Fund (IMF)
 World Bank
 United Nations (UN)

The World Trade Organization (WTO) (like its predecessor GATT) polices the
world trading system, makes sure that nation-states adhere to the rules laid down
in trade treaties.
  promotes lower barriers to trade and investment
 As of 2009, 153 member nations collectively accounted for 97% of world
trade

The International Monetary Fund (IMF) (1944) maintains order in the

international monetary system.

The World Bank (1944) promotes economic development, focusing on making

low interest loans governments in poor nations

The United Nations (1945) maintains international peace and security, develops
friendly relations among nations, cooperates in solving international problems
and in promoting respect for human rights, is a center for harmonizing the actions
of nations.

Drivers of Globalization (Two macro factors globalization)

1) Declining trade and investment barriers

2) Technological change
 microprocessors and telecommunications
 the Internet and World Wide Web
 transportation technology

Multinational Enterprise (MNE) A MNE is any business that has productive

activities in two or more countries

TNC (translational corporation) managed and owned by two different countries.

Global company integrates its operations that are located from different
countries. (Owned and managed by two different countries)

Multi-domestic company allows each of its foreign company to act fairly

independently. Packaging and producing products according to country (Coca-
Cola)
 Chapter 2: National differences in
political economy
The political economy of a nation refers to how the political, economic, and legal
systems of a country are interdependent

 they interact and influence each other

 they affect the level of economic well-being in the nation

Political system refers to the system of government in a nation.

According to the degree to which the Thus the degree to which the
country emphasizes collectivism as country is totalitarian or democratic.
opposed to individualism.

Collectivism stresses the primacy of collective goals over individual goals.

(Totalitarianism)

 collectivism is equated with socialists (Karl Marx 1818-1883)

 manage to benefit society as a whole, rather than individual capitalists
 socialism split into
a) Communism – socialism can only be achieved through violent revolution
and totalitarian dictatorship in retreat worldwide by mid-1990s.
b) Social democrats – socialism is achieved through democratic means
retreating as many countries move toward free market economies state-
owned enterprises have been privatized.

Individualism refers to philosophy that an individual should have freedom in his

own economic and political pursuits.

 Private ownership
 implies democratic political systems and free market economies
Democracy refers to a political system in which government is by the people,
exercised either directly or through elected representatives.

 usually associated with individualism

 pure democracy is based on the belief that citizens should be directly involved
in decision making

Totalitarianism is a form of government in which one person or political party

exercises absolute control over all spheres of human life and prohibits opposing
political parties.

There are three types of economic systems

1. Market economies - all productive activities are privately owned and

production is determined by the interaction of supply and demand government
encourages free and fair competition between private producers.

2. Command economies - government plan the goods and services that a country
produces, the quantity that is produced, and the prices as which they are sold

 all businesses are state-owned, and governments allocate resources for “the
good of society”

3. Mixed economies - certain sectors of the economy are left to private ownership
and free market mechanisms while other sectors have significant state ownership
and government planning.

 governments tend to own firms that are considered important to national

security

The legal system of a country refers to the rules that regulate behavior along with
the processes by which the laws are enforced and through which redress for
grievances is obtained.

 It protects property rights and the machinery to enforce that system.

There are three types of legal systems

1. Common law - based on tradition, precedent, and custom. (English)

 Under a common law system, contracts tend to be very detailed with all
contingencies spelled out

2. Civic law - based on detailed set of laws organized into codes. (Roman)

 Under a civil law system, contracts tend to be much shorter and less
specific because many issues are already covered in the civil code.

3. Theocratic law - law is based on religious teachings.

4. Contract law - is the body of law that governs contract enforcement. (Extra)

 A contract is a document that specifies the conditions under which an

exchange is to occur and details the rights and obligations of the parties
involved.

Intellectual property - property that is the product of intellectual activity Can be

protected using

 Patents – exclusive rights for a defined period to the manufacture, use, or

sale of that invention.
 Copyrights – the exclusive legal rights of authors, composers, playwrights,
artists, and publishers to publish and disperse their work as they see fit.
 Trademarks – design and names by which merchants or manufacturers
designate and differentiate their products.

Two ways to measure levels of economic development are

1. Gross national income (GNI) per 2. Purchasing power parity (PPP)

person. involves adjusting GNI by purchasing
power.

The shift toward a market-based system involves

  Deregulation – removing legal restrictions to the free play of markets, the
establishment of private enterprises, and the manner in which private
enterprises operate.
 Privatization - transfers the ownership of state property into the hands of
private investors
 Legal System It protects property rights and the machinery to enforce that
system.

Managers must consider foreign market risks:

1. Political risk - the likelihood that political forces will cause drastic changes in a
country's business environment that adversely affects the profit and other goals
of a business enterprise.

2. Economic risk - the likelihood that economic mismanagement will cause drastic
changes in a country's business environment that adversely affects the profit and
other goals of a business enterprise.

3. Legal risk - the likelihood that a trading partner will opportunistically break a
contract or expropriate property rights.

First mover advantages are the advantages that accrue to early entrants into a
market and establish loyalty and experience in a country.
 Chapter 3 & 4: Political economy and
Economic development; Differences in
Culture
Culture is a system of values and norms that are shared among a group of people
and that when taken together constitute a design for living.

Different components of culture

 Values are Abstract ideas/assumptions about what a group believes to be

good, right and desirable.
 Norms are social rules and guidelines that prescribe appropriate behavior in
particular situations.

Society is a group of people who share a common culture.

Determinants of culture

 Social structure  Education

 Religion  Economic philosophy
 Language  Political philosophy

Social structure two dimensions

1) Group 2) individual

Social stratifications are hierarchical social categories. (Lower, middle, higher)

Social mobility is the extent to which individuals can move out of the social strata
into which they are born.

Hofstede’s cultural 4 dimensions of culture

1) Power distance 3) Uncertainty avoidance

2) Individualism versus collectivism 4) Masculinity versus femininity
Power distance: Cultures are ranked high or low on this dimensions based on the
particular society’s ability to deal with inequalities.

Individualism versus collectivism focuses on the relationship between the

individual and his/her fellows within a culture.

 Individualistic- individual achievement and freedom highly valued

 Collectivist societies- tend to be more relationship oriented.

Uncertainty avoidance measures the extent to which a culture socializes its

members into accepting ambiguous situations and tolerating uncertainty.

Masculinity versus femininity looks at the relationship between gender and work
roles.
 Chapter 5: Ethics in International
Business
Ethics are accepted principles of right or wrong that govern the conduct of a
person, the members of a profession, or the actions of an organization.

Business ethics are the accepted principles of right or wrong governing the
conduct of business people.

Social responsibility refers to the idea that business people should take the social
consequences of economic actions into account when making business decisions,
and that there should be a presumption in favor of decisions that have both good
economic and good social consequences.

Organizational culture refers to the values and norms that are shared among
employees of an organization.
 Chapter 6: International trade theory
Free trade is a situation where a government does not attempt to influence
through quotas or duties what its citizens can buy from another country or what
they can produce and sell to another country.

Trade theory shows why it is beneficial for a country to engage in international

trade even for products it is able to produce for itself.

International trade allows a country to specialize in the manufacture and export

of products that it can produce efficiently, import products that can be produced
more efficiently in other countries.

Mercantilism suggests that it is in a country’s best interest to maintain

 A trade surplus is to export more than it imports

 Advocates government intervention to achieve a surplus in the balance of
trade (Government involvement in promoting exports and limiting imports)
 Accumulated wealth in terms of gold and silver

Mercantilism views trade as a zero-sum game - one in which a gain by one

country results in a loss by another.

Absolute advantage - Adam Smith argued that a country has an absolute

advantage in the production of a product when it is more efficient than any other
country in producing it.

 When one country can produce a unit of good with less cost than another
country, the first country has an absolute (cost) advantage in producing
that good
 Both countries will gain from the trade –
 Results in specialization
 Increases productivity
  countries should specialize in the production of goods for which they have
an absolute advantage and then trade these goods for the goods produced
by other countries
 Adam Smith: Wealth of Nations (1776) argued:
1. Capability of one country to produce more of a product with the
same amount of input than another country can vary
2. A country should produce only goods where it is most efficient, and
trade for those goods where it is not efficient
 Suppose, A can produce x cheaper than B, and B can produce y cheaper
than A • Means, A has an absolute advantage in the production of x and B
in the production of y. A will export x to B, and B will export y to A.
 Assume that two countries, Ghana and South Korea, both have 200 units of
resources that could either be used to produce rice or cocoa
 In Ghana, it takes 10 units of resources to produce one ton of cocoa and 20
units of resources to produce one ton of rice
 Ghana could produce 20 tons of cocoa and no rice, 10 tons of rice and no
cocoa, or some combination of rice and cocoa between the two extremes
 In South Korea it takes 40 units of resources to produce one ton of cocoa
and 10 resources to produce one ton of rice
 South Korea could produce 5 tons of cocoa and no rice, 20 tons of rice and
no cocoa, or some combination in between

How Does The Theory Of Absolute Advantage Work?

 Without trade
 Ghana would produce 10 tons of cocoa and 5 tons of rice
 South Korea would produce 10 tons of rice and 2.5 tons of
cocoa
 With specialization and trade
 Ghana would produce 20 tons of cocoa
 South Korea would produce 20 tons of rice
 Ghana could trade 6 tons of cocoa to South Korea for 6 tons of
rice
 After trade
 Ghana would have 14 tons of cocoa left, and 6 tons of rice
 South Korea would have 14 tons of rice left and 6 tons of cocoa
 If each country specializes in the production of the good in
which it has an absolute advantage and trades for the other,
both countries gain
 Limitations

 Explains the causes of trade only when both the countries enjoy
absolute advantage in the production of at least one product
 Assumes that transportation costs are either nonexistent or
insignificant, which may not always hold good
 Assumes that prices are comparable across countries, implying stability
of exchange rate
 Perfect mobility of labor between sectors – labor may be mobile but to
an extent

Comparative Advantage - David Ricardo asked what might happen when one
country has an absolute advantage in the production of all goods. Nations can still
gain from trade even without an absolute advantage.

 Difference in opportunity cost

 A country has a Comparative Advantage in producing a good if the
opportunity cost of producing that good in terms of other goods is lower in
that country compared to other countries
 Even if countries do not have an absolute advantage, they can gain from
trade by allocating resources based on their comparative advantage and
trade with each other
 Gains from trade depends on the terms of trade
a. The ratio of export prices to import prices is referred to as
terms of trade
b. i.e., it represents how many units of one product is
exchanged for one unit of the other product between the two
countries
 Ricardo’s theory of comparative advantage suggests that countries should
specialize in the production of those goods they produce most efficiently
and buy goods that they produce less efficiently from other countries,
even if this means buying goods from other countries that they could
produce more efficiently at home.
  David Ricardo: Principles of Political Economy (1817)
 Trade is a positive-sum game
 Assume Ghana is more efficient in the production of both cocoa and rice
 In Ghana, it takes 10 resources to produce one ton of cocoa, and 13 1/3
resources to produce one ton of rice
 So, Ghana could produce 20 tons of cocoa and no rice, 15 tons of rice and
no cocoa, or some combination of the two
 In South Korea, it takes 40 resources to produce one ton of cocoa and 20
resources to produce one ton of rice
 So, South Korea could produce 5 tons of cocoa and no rice, 10 tons of rice
and no cocoa, or some combination of the two

How Does The Theory Of Comparative Advantage Work?

 With trade
 Ghana could export 4 tons of cocoa to South Korea in
exchange for 4 tons of rice
 Ghana will still have 11 tons of cocoa, and 4 additional tons
of rice
 South Korea still has 6 tons of rice and 4 tons of cocoa
 if each country specializes in the production of the good in
which it has a comparative advantage and trades for the
other, both countries gain
 Comparative advantage theory provides a strong rationale
for encouraging free trade
Is Unrestricted Free Trade Always Beneficial? (3 simple extensions and 1
Limitation)

Unrestricted free trade is beneficial, but the gains may not be as great as
the simple model of comparative advantage would suggest
 Immobile resources: Resources do not always move easily from one
economic activity to another
 Diminishing returns:
(1) Diminishing returns to specialization suggests that after some point,
the more units of a good the country produces, the greater the
additional resources required to produce an additional item
(2) Different goods use resources in different proportions
 Free trade (open economies):
(1) Free trade might increase a country’s stock of resources (as labor and
capital arrives from abroad). Opening a country to trade could
increase a country's stock of resources as increased supplies become
available from abroad
(2) Increase the efficiency of utilization and so free up resources for
other uses
Could A Rich Country Be Worse Off With Free Trade? (Limitations-samuelson
critique)

Paul Samuelson - the dynamic gains from trade may not always be beneficial.

Free trade may ultimately result in lower wages in the rich country.

Heckscher-Ohlin Theory

 Eli Heckscher and Bertil Ohlin - comparative advantage arises from

differences in national factor endowments
 the extent to which a country is endowed with resources like land,
labor, and capital
 predict that countries will export goods that make intensive use of
those factors that are locally abundant, and import goods that make
intensive use of factors that are locally scarce
 Remember, focus on relative advantage, not absolute advantage
 International differences in labor productivity
 Ricardian view – Differences in countries resources – H-O model
 Also called Factor-proportions Theory
 Provides a different explanation of comparative advantage
  Comparative advantage arises from difference in national factor
endowments
 Difference in factor endowments explains the differences in factor costs
 The more abundant a factor, the lower its cost
 This theory assumes that technologies are the same across countries

Does The Heckscher-Ohlin Theory Hold? (The Leontief Paradox)

 Wassily Leontief theorized that since the U.S. was relatively abundant
in capital compared to other nations, the U.S. would be an exporter of
capital intensive goods and an importer of labor-intensive goods.
 He found that U.S. exports were less capital intensive than U.S. imports
 Since this result was at variance with the predictions of trade theory, it
became known as the Leontief Paradox
 US has a special advantage in producing new and innovative products
Such products may be less capital intensive and heavily use skilled labor
and innovative entrepreneurship Ex: Computer software
 That is, the H-O model has predictive power once the impact of
differences of technology on productivity is controlled for

Product Life Cycle Theory

 The product life-cycle theory - (Raymond Vernon) – as products mature

both the location of sales and the optimal production location will
change affecting the flow and direction of trade
 Initially, the product would be produced and sold in the U.S.
 As demand grew in other developed countries, U.S. firms would begin
to export
 demand for the new product would grow in other advanced countries
over time making it worthwhile for foreign producers to begin
producing for their home markets
 As the market in the U.S. and other advanced nations matured, the
product would become more standardized, and price the main
competitive weapon
 Producers based in advanced countries where labor costs were lower
than the United States might now be able to export to the U.S
 If cost pressures were intense, developing countries would acquire a
production advantage over advanced countries
 Production became concentrated in lower-cost foreign locations, and
the US became an importer of the product
 Focus on the product, not its factor proportions
 less emphasis on comparative cost
 Increased emphasis on technology’s impact on product cost

i) the innovation ii) the effects of scale of

economies
National Competitive Advantage (Porter, 1990) (“Porter’s Diamond”)

 Michael Porter tried to explain why a nation achieves international success

in a particular industry and identified four attributes that promote or
impede the creation of competitive advantage
 A nation attains competitive advantage if its firms are competitive
 The theory attempts to analyze the reasons for a nations success in a
particular industry
 And, firms become competitive through innovations
 Innovation – either technical improvements to the product or to the
production process
1. Factor endowments - a nation’s position in factors of production necessary
to compete in a given industry
i) can lead to competitive advantage
ii) can be either basic (natural resources, climate, location) or advanced
(skilled labor, infrastructure, technological know-how, Communications
research, and education)
iii) While basic factors can provide an initial advantage they must be
supported by advanced factors to maintain success.
iv) Advanced factors: Are the result of investment by people, companies,
government and are more likely to lead to competitive advantage
v) If a country has no basic factors, it must invest in advanced factors
2. Demand conditions - the nature of home demand for the industry’s product
or service
a) influences the development of capabilities
b) sophisticated and demanding customers pressure firms to be competitive
c) Demand impacts quality and innovation
d) Makes firms to sell superior products as the market demands high quality
3. Relating and supporting industries - the presence or absence of supplier
industries and related industries that are internationally competitive
(1) can spill over and contribute to other industries
(2) successful industries tend to be grouped in clusters in countries
4. Firm strategy, structure, and rivalry - the conditions governing how
companies are created, organized, and managed, and the nature of domestic
rivalry
i) different management ideologies affect the development of national
competitive advantage
ii) vigorous domestic rivalry creates pressures to innovate, to improve
quality, to reduce costs, and to invest in upgrading advanced features
iii) Strategy - Investment plans, use of labor force, vision – all depends on
the country’s capital market and labor market
iv) Structure - Management styles But, there is no single managerial,
ownership or operational strategy universally appropriate
v) Rivalry Intense competition spurs innovation Example: Japanese
automobile and electronics industries
 Countries should be exporting products from those industries where all
four components of the diamond are favorable, while importing in those
areas where the components are not favorable
 Government policy can affect demand through product standards
influence rivalry through regulation and antitrust laws impact the
availability of highly educated workers and, advanced transportation
infrastructure.
What Are The Implications Of Trade Theory For Managers?
1. Location implications - a firm should disperse its various productive
activities to those countries where they can be performed most efficiently
2. First-mover implications - a first-mover advantage can help a firm dominate
global trade in that product
3. Policy implications - firms should work to encourage governmental policies
that support free trade and firms should lobby the government to adopt
policies that have a favorable impact on each component of the diamond
Balance Of Payments - A country’s balance of payments accounts keep track
of the payments to and receipts from other countries for a particular time
period
  so, the sum of the current account balance, the capital account and the
financial account should always add up to zero
 There are three main accounts
1. The current account records transactions that pertain to
goods, services, and income, receipts and payments.
Current account deficit - a country imports more than it
exports. Current account surplus – a country exports
more than it imports.
2. The capital account records one time changes in the
stock of assets
3. The financial account records transactions that involve
the purchase or sale of assets (net change in U.S. assets
owned abroad, foreign owned assets in the United
States).

New Trade Theory

 suggests that the ability of firms to gain economies of scale (unit cost
reductions associated with a large scale of output) can have important
implications for international trade
 In industries with high fixed costs:
 Specialization increases output, and the ability to enhance
economies of scale increases
 Learning effects are high. These are cost savings that come from
“learning by doing”
 without trade, nations might not be able to produce those products where
economies of scale are important
 with trade, markets are large enough to support the production necessary
to achieve economies of scale
 so, trade is mutually beneficial because it allows for the specialization of
production, the realization of scale economies, and the production of a
greater variety of products at lower prices
  First mover advantages - the economic and strategic advantages that
accrue to early entrants into an industry. First-mover Advantage: The firm
which enter first may gain an advantage
 Competitors may emerge because of “ First mover advantage”
 Economies of scale may preclude new entrants
 Role of the government becomes significant
 Some argue that it generates government intervention and strategic trade
policy
 first movers can gain a scale based cost advantage that later entrants find
difficult to match

 Economies of Scale: Reduction of average cost as a result of increasing the

output
 Increasing Returns: a unit increase in inputs results in more than one unit
increase in output
 Economies of scale is an important source of increasing returns to
specialization
 New Trade Theory supports the Comparative Advantage theory by identifying
economies of scale as an important source of comparative advantage
 Firms achieve economies of scale through First-mover Advantage
 Theory of Imperfect Competition Characteristics
1) A few major producers
2) Differentiated products
3) Firm is a ‘price setter’ not ‘price taker’
4) Firms can sell more only by reducing their prices (downward slopping demand
curve)
 Chapter 7: Political economy of
International Business
 Free trade occurs when governments do not attempt to restrict what
citizens can buy from another country or what they can sell to another
country

 Governments use various methods to intervene in markets ( Instruments

to trade policy):

1) Tariffs - taxes levied on imports that effectively raise the cost of imported
products relative to domestic products
a) Specific tariffs - levied as a fixed charge for each unit of a good imported
b) Ad valorem tariffs - levied as a proportion of the value of the imported
good
2) Subsidies - government payments to domestic producers
a) Subsidies help domestic producers
b) compete against low-cost foreign imports
c) gain export markets
d) Consumers typically absorb the costs of subsidies
3) Import Quotas - restrict the quantity of some good that may be imported into
a country
4) Voluntary Export Restraints - quotas on trade imposed by the exporting
country, typically at the request of the importing country’s government
5) Local Content Requirements - demand that some specific fraction of a good
be produced domestically
a) benefit domestic producers
 b) consumers face higher prices
6) Administrative Policies - bureaucratic rules designed to make it difficult for
imports to enter a country
7) Antidumping Policies – aka countervailing duties - punish foreign firms that
engage in dumping and protect domestic producers from “unfair” foreign
competition
Dumping - selling goods in a foreign market below their costs of production, or
selling goods in a foreign market below their “fair” market value

Why Do Governments Intervene In Markets?

1) Political arguments - concerned with protecting the interests of certain groups

within a nation (normally producers), often at the expense of other groups
(normally consumers)
2) Economic arguments - concerned with boosting the overall wealth of a nation
– benefits both producers and consumers

What Are The Political Arguments For Government Intervention?

1) Protecting jobs
2) for national security
3) Retaliation for unfair foreign competition - when governments take, or
threaten to take, specific actions, other countries may remove trade barriers
4) Protecting consumers from “dangerous” products, environment and human
rights

What Are The Economic Arguments For Government Intervention?

1) The infant industry argument - an industry should be protected until it can

develop and be viable and competitive internationally
2) Strategic trade policy - first mover advantages can be important to success
governments can help firms from their countries attain these advantages ,
governments can help firms overcome barriers to entry into industries where
foreign firms have an initial advantage
 Chapter 8: FDI
Foreign direct investment (FDI) occurs when a firm invests directly in new
facilities to produce and/or market in a foreign country

1) There are two forms of FDI:

1. A Greenfield investment - the 2. Acquisition or merging with an

establishment of a wholly new existing firm in the foreign country
operation in a foreign country

Outflows of FDI are the flows of FDI Inflows of FDI are the flows of FDI
out of a country into a country

Exporting - producing goods at home Licensing - granting a foreign entity

and then shipping them to the the right to produce and sell the
receiving country for sale) firm’s product in return for a royalty
fee on every unit that the foreign
entity sells

Benefits of inward FDI for a host country are:

1. The resource transfer effect 3. The balance of payments effect

2. The employment effect 4. Effects on competition and

economic growth

Three main costs of inward FDI:

1. Adverse effects on competition 3. The perceived loss of national

within the host nation sovereignty and autonomy

2. Adverse effects on the balance of

payments
Benefits of FDI to the home country include:

1. The effect on the capital account of payments from the inward flow of
the home country’s balance of foreign earnings

2. The employment effects that arise 3. The gains from learning valuable
from outward FDI skills from foreign markets that can
subsequently be transferred back to
the home country
 Chapter 9: Regional Integration
Regional economic integration refers to agreements between countries in a
geographic region to reduce tariff and non-tariff barriers to the free flow of goods,
services, and factors of production between each other

Levels of Economic Integration

There are five levels of economic integration:

1. Free trade area - all barriers to the trade of goods and services among member
countries are removed, but members determine their own trade policies with
regard to nonmembers

2. Customs union - eliminates trade barriers between member countries and

adopts a common external trade policy

3. Common market - no barriers to trade between member countries, a common

external trade policy, and the free movement of the factors of production

4. Economic union - involves the free flow of products and factors of production
between members, the adoption of a common external trade policy, and in
addition, a common currency, harmonization of the member countries’ tax rates,
and a common monetary and fiscal policy

5. Political union - independent states are combined into a single union

Trade creation occurs when low cost producers within the free trade area replace
high cost domestic producers

Trade diversion occurs when higher cost suppliers within the free trade area
replace lower cost external suppliers
 Chapter 10: The Foreign Exchange
Market
 Foreign exchange market

1. is used to convert the currency of one country into the currency of

another

2. provides some insurance against foreign exchange risk - the adverse

consequences of unpredictable changes in exchange rates

 The exchange rate is the rate at which one currency is converted into
another

 Currency speculation - the short-term movement of funds from one

currency to another in the hopes of profiting from shifts in exchange rates

 The spot exchange - a foreign exchange dealer converts one currency into
another currency on a particular day immediately. A spot rate is a price for
a transaction that is happening immediately. ( especially within 2 days)
 The spot exchange rate is the rate at which a foreign exchange dealer
converts one currency into another currency on a particular day

 Forward exchanges - two parties agree to exchange currency and execute

the deal at some specific date in the future

 Forward exchanges rate- the rate at which two parties agree to exchange
currency and execute the deal at some specific date in the future

a) rates for currency exchange are typically quoted for 30, 90, or 180 days into
the future

 A currency swap is the simultaneous purchase and sale of a given amount

of foreign exchange for two different value dates
 Arbitrage refers to the simultaneous buying and selling of the same
security in different markets to take advantage of a price difference for
making riskless profit. Arbitrage is the purchase and sale of an asset in
order to profit from a difference in the asset's price between markets.
Arbitrage is the process of buying a currency low and selling it high.

 The law of one price - in competitive markets free of transportation costs

and barriers to trade, identical products sold in different countries must
sell for the same price when their price is expressed in terms of the same
currency.

I. The arbitrage opportunity would be achieved whereby a trader

would purchase the asset in the market it is available at a
lower price and then sell it in the market where it is available
at a higher price. Over time, market equilibrium forces would
align the prices of the asset.
II. The law of one price is an economic concept that states that
the price of an identical asset or commodity will have the same
price globally, regardless of location, when certain factors are
considered.
III. The law of one price is achieved by eliminating price
differences through arbitrage opportunities between markets.
IV. When the law of one price holds, arbitrage profits such as
these will persist until the price converges across markets.
V. When the law of one price holds, arbitrage profits such as
these will persist until the price converges across markets.
VI. For example, if a particular security is available for $10 in
Market A but is selling for the equivalent of $20 in Market B,
investors could purchase the security in Market A and
immediately sell it for $20 in Market B, netting a profit of $10
without any true risk or shifting of the markets.
VII. As securities from Market “A” are sold on Market “B”, prices
on both markets should change in accordance with the
changes in supply and demand, all else equal. Increased
 demand for these securities in Market A, where it is relatively
cheaper, should lead to an increase in its price there.
VIII. Conversely, increased supply in Market B, where the security is
being sold for a profit by the arbitrageur, should lead to a
decrease in its price there. Over time, this would lead to a
balancing of the price of the security in the two markets,
returning it to the state suggested by the law of one price.
IX. Violations of the Law of One Price:
In the real world, the assumptions built into the law of one
price frequently do not hold:

 Transportation Costs,
 Transaction Costs (The transaction costs to buyers and
sellers are the payments that banks and brokers receive
for their roles),
 Legal Restrictions,
 Market Structure

 Purchasing power is the amount of goods or services that a unit of currency

can buy at a given point in time. The financial ability to buy products and
services. Inflation tends to erode the purchasing power of a currency over
time. Central banks try to keep prices stable through maintaining the
purchasing power of the currency by setting interest rates and other
mechanisms.
 Purchasing power parity theory (PPP) argues that given relatively efficient
markets the price of a “basket of goods” should be roughly equivalent in
each country.
I. The law of one price is the foundation of purchasing power
parity.
II. Purchasing power parity states that the value of two
currencies is equal when a basket of identical goods is priced
the same in both countries.
III. It ensures that buyers have the same purchasing power across
global markets.
 IV. Purchasing power parity (PPP) is a popular metric used by
macroeconomic analysts that compares different countries'
currencies through a "basket of goods" approach.
V. Purchasing power parity (PPP) allows for economists to
compare economic productivity and standards of living
between countries.
VI. Efficient market is one where the market price is an unbiased
estimate of the true value of the investment; prices reflect all
available information and adjust instantly to any new
information. Efficient markets are markets in which few
impediments to international trade and investment exist).
VII. An inefficient market is one in which prices do not reflect all
available information.
VIII. Drawbacks of Purchasing Power Parity:
Transport Costs, Tax Differences, Government Intervention,
and Market Competition.
IX. Inflation is the rate at which the general level of prices for
goods and services is rising and, consequently, the purchasing
power or value of a currency is falling. A positive relationship
between the inflation rate and the level of money supply
exists. When the growth in the money supply is greater than
the growth in output, inflation will occur.
X. Deflation is the general decline of the price level of goods and
services. (Opposite to inflation).
XI. PPP predicts that changes in relative prices will result in
changes in exchange rates. When inflation is relatively high, a
currency should depreciate. So, if we can predict inflation
rates, we can predict how a currency’s value might change.
The growth of a country’s money supply determines its likely
future inflation rate. When the growth in the money supply is
greater than the growth in output, inflation will occur.
 The Fisher Effect is an economic theory that describes the relationship
between inflation and both real and nominal interest rates.
 a. The Fisher Effect states that a country’s nominal interest rate
(i) is the sum of the required real rate of interest (r) and the
expected rate of inflation over the period for which the funds
are to be lent (I). In other words, i = r + I.
b. The Fisher Effect states that the real interest rate equals the
nominal interest rate minus the expected inflation rate. In
other words, r = i - I.
c. So, if the real interest rate is the same everywhere, any
difference in interest rates between countries reflects differing
expectations about inflation rates. In other words, i = I (1)-I (2).
I (1) = Inflation in country 1, I (2) = Inflation in country 2.
 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.
I. The International Fisher Effect (IFE) is an economic theory
stating that the expected disparity between the exchange
rates of two currencies is approximately equal to the
difference between their countries' nominal interest rates.
II. In other words: (S1 - S2) / S2 x 100 = i $ - i ¥. Where i $ and i ¥
are the respective nominal interest rates in two countries (in
this case the US and Japan), S1 is the spot exchange rate at
the beginning of the period and S2 is the spot exchange rate
at the end of the period.
 The bandwagon effect is when people start doing something because
everybody else seems to be doing it.
 CURRENCY CONVERTIBILITY

I. A currency is freely convertible when a government of a

country allows both residents and non-residents to purchase
unlimited amounts of foreign currency with the domestic
currency
II. A currency is externally convertible when non-residents can
convert their holdings of domestic currency into a foreign
currency, but when the ability of residents to convert
currency is limited in some way
III. A currency is nonconvertible when both residents and non-
residents are prohibited from converting their holdings of
domestic currency into a foreign currency

 Managers need to consider three types of foreign exchange risk

(exposure)

I. Transaction exposure: the extent to which the income from

individual transactions is affected by fluctuations in foreign
exchange values. (Can lead to a real monetary loss).
II. Translation exposure: the impact of currency exchange rate
changes on the reported financial statements of a company
(Deals with the present measurement of past events, Gains
and losses from translation exposure are reflected only on
paper).
III. Economic exposure: the extent to which a firm’s future
international earning power is affected by changes in
exchange rates. (Concerned with the long-term effect of
changes in exchange rates on future prices, sales, and costs).

 Minimize Exchange Rate Risk

I. To minimize transaction and translation exposure:
 Buy forward, Use swaps, Lead and lag payables and
receivables (paying suppliers and collecting payment from
customers early or late depending on expected exchange rate
movements).
II. To reduce economic exposure
Distribute productive assets to various locations so the firm’s
long-term financial well-being is not severely affected by
changes in exchange rates.
 Chapter 11: International Monetary
system
 The international monetary system refers to the institutional arrangements
that countries adopt to govern exchange rates.
 A floating exchange rate system exists in countries where the foreign
exchange market determines the relative value of a currency.
I. Examples - the U.S. dollar, the European Union’s euro, the
Japanese yen, and the British pound
 A pegged exchange rate system exists when the value of a currency is fixed to
a reference country and then the exchange rate between that currency and
other currencies is determined by the reference currency exchange rate
I. Many developing countries have pegged exchange rates
 A dirty float exists when the value of a currency is determined by market
forces, but with central bank intervention if it depreciates too rapidly against
an important reference currency. A dirty float is also known as a "managed
float”.
I. China adopted this policy in 2005
 With a fixed exchange rate system countries fix their currencies against each
other at a mutually agreed upon value
I. euro, some European Union countries operated with fixed
exchange rates within the context of the European Monetary
System (EMS)
 The evolution of the international monetary system
I. The Gold Standard
II. The Bretton Woods system
 The International Monetary Fund
 The World Bank
 The gold standard refers to a system in which countries peg currencies to gold
and guarantee their convertibility.
 In the 1880s, most nations followed the gold standard $1 = 23.22 grains of
“fine” (pure) gold
 The gold par value refers to the amount of a currency needed to purchase one
ounce of gold.
 Balance-of-trade equilibrium - when the income a country’s residents earn
from its exports is equal to the money its residents pay for imports.
 A new international monetary system was designed in 1944 in Bretton Woods,
New Hampshire.

 IMF (International Monetary Fund) promotes global economic growth and

financial stability, encourages international trade, and reduces poverty around
the world and maintains international monetary system.
 The World Bank is an international organization dedicated to providing
financing, advice, and research to developing nations to aid their economic
advancement.
 Differences Between IMF and World Bank

Definition of IMF vs. World Bank Function of IMF vs. World Bank
IMF is an organization that IMF focuses on economic stability,
controls the International poverty reduction and a steady
Monetary System while World economic growth of the member
Bank is a global financial states. World Bank on the other
institution that lends money to hand focuses on economic
developing member countries so development of developing
as to eradicate poverty and countries and provides channels
promote economic development. for borrowing.
 A country with a currency board commits to converting its domestic
currency on demand into another currency at a fixed exchange rate. A
currency board is an extreme form of a pegged exchange rate. Hong Kong
has a currency board that maintains a fixed exchange rate between the U.S.
It has to reserve 100 % of foreign currency of domestic currency. Dollar and
the Hong Kong dollar. Hong Kong's currency board has a 100% reserve
requirement, so all Hong Kong dollars are fully backed with U.S. dollars. A
currency board is a monetary authority which is required to maintain a
fixed exchange rate with a foreign currency. Like a central bank, a currency
board is a country's monetary authority that issues notes and coins. Unlike
a central bank, however, a currency board is not the lender of last resort,
nor is it what some call 'the government's bank.' A currency board can
 function alone or work in parallel with a central bank, although the latter
arrangement is uncommon.
 Managed float - government intervention can influence exchange rates.
Managed float regime is the current international financial environment in
which exchange rates fluctuate from day to day, but central banks attempt
to influence their countries' exchange rates by buying and selling currencies
to maintain a certain range. A dirty float is also known as a "managed
float”.
 A clean float, also known as a pure float exchange rate or free float occurs
when the value of a currency, or its exchange rate, is determined purely by
supply and demand in the market. A clean float is the opposite of a dirty
float, which occurs when government rules or laws affect the pricing of
currency
 Crawling peg is a monetary regime that allows the national currency
exchange rate to fluctuate in a specific range (band). A point on a scale of
exchange rates in which a currency's value is allowed to go up or down
frequently by small amounts within overall limits. A crawling peg is an
exchange rate system mainly defined by two characteristics: a fixed par
value of the currency which is frequently revised and adjusted due to
market factors such as inflation; and a band of rates within which it is
allowed to fluctuate.
 Chapter 12: The Global Capital Market
 Capital markets bring together investors and borrowers

 investors - corporations with surplus cash, individuals, and non-bank

financial institutions

 borrowers - individuals, companies, and governments

 markets makers - the financial service companies that connect

investors and borrowers, either directly (investment banks) or
indirectly (commercial banks)

 capital market loans can be equity or debt

 lowers the cost of capital & diversify portfolios and lower risk

 Deregulation is the reduction or elimination of government power in a

particular industry, usually enacted to create more competition within the
industry.
 Eurocurrency is currency deposited by national governments or corporations,
outside of its home market. Eurocurrency is any currency banked outside its
country of origin.
I. For example US dollars held in a UK bank would also be considered
Eurocurrency. And Euros held in an Asian bank would be considered
Eurocurrency, too.
 A bond is an instrument of indebtedness of the bond issuer to the holders. (An
investor loans money to an entity - corporate or governmental).
 International Bond is a debt obligation that is issued in a country by a non-
domestic entity. International bonds are bonds issued by a country or
company that is not domestic for the investor.
 There are two or three or four or many types of international bonds:
I. Domestic bonds: Issued locally by a domestic borrower and usually
denominated in the local currency.
II. Foreign bonds: Issued in a domestic country by a foreign company,
using the regulations and currency of the domestic country.
III. Eurobonds are underwritten by a syndicate of banks and placed in
countries other than the one in whose currency the bond is
denominated. Eurobonds are underwritten by an international
company using domestic currency and then traded outside of the
country’s domestic market.
IV. Global bonds are similar to Eurobonds, but they can also be traded
and issued in the country whose currency is used to value the bond.

For example:

 Domestic bonds: A British company issues debt in the United Kingdom with
the principal and interest payments based or denominated in British
pounds. A US dollar bond issued in the USA by a US company.

 Foreign bonds: A British company issues debt in the United States with the
principal and interest payments denominated in dollars. A US dollar bond
issued in the USA by a Non-US company is a foreign bond. An example
would be a French Company (A) issuing a US dollar bond in the US.

 Eurobonds: An example would be a Spanish Bank (A) issuing a Japanese

yen-denominated bond (B) in London (C).

 Global bonds: An example would be an Australian Bank (A) issuing a GBP

Bond (B’s currency) in London (B’s country) and in Japan (C). The French
company issues bond denominated in the U.S. dollar and offers the bonds
in both Japan and America.
 Chapter 13: The strategy of
International Business
 A firm’s strategy refers to the actions that managers take to attain the goals of
the firm.
 Profitability is the rate of return the firm makes on its invested capital.
 Profit growth is the percentage increase in net profits over time.
 To increase profitability and profit growth firms can

I. add value III. sell more in existing markets

II. lower costs IV. expand internationally

 The firm’s value creation is the difference between V (the price that the firm
can charge for that product given competitive pressures) and C (the costs of
producing that product)
I. A firm has high profits when it creates more value for its customers and
does so at a lower cost.

 Profits can be increased by

I. Using a differentiation strategy
 adding value to a product so that customers are willing to pay more for
it
II. Using a low cost strategy
  lowering costs
 A firm’s operations are like a value chain composed of a series of distinct value
creation activities such as:
I. Primary activities
 R&D (Research and Development)
 Production
 marketing and sales
 customer service
II. Support activities
 information systems
 logistics (Logistics is the overall process of managing how resources are
acquired, stored, and transported to their final destination)
 human resources
 A value chain is a step-by-step business model for transforming a product or
service from idea to reality.

 Differences between Value chain and Supply chain management:

I. The value chain is a process in which a company adds value to its raw
materials to produce products eventually sold to consumers.
II. The supply chain represents all the steps required to get the product to
the customer.
 III. The value chain gives companies a competitive advantage in the
industry, while the supply chain leads to overall customer satisfaction.

 Differences among Supply chain management, logistics, distribution and

transportation:
 The term competency relates to anything that a firm does well.
Competency of the firm can considered as the ability of the companies to
carry out the activities in an effective manner.
 A core competency relates to anything that is central to the core of the
business. A manufacturing company with a low defect rate may not rely
heavily on this low-defect rate as part of its primary business strategy. If
this is the case, this low-defect rate is a core competency. If, on the other
hand, this company held itself out to the market as a reliable manufacturer
of quality products, this could easily be a core competency, because the
ability to consistently provide quality products is a key to its business
model.
 A distinctive competency is a quality (the resources - tangible such as land,
equipment etc. and intangible such as brand name etc., and capabilities –
company’s skill or management skill, organization structure, hiring system,
control systems etc.) that differentiates a company from its competitors. It
is identified that distinctive competency is more effective than the core
competency. While a distinctive competency can be any competency, core
or otherwise, it is typically a core competency that truly distinguishes a
company from the rest of the competition. For example, one of Google's
distinctive competencies is its name recognition and status as the most
notable search engine. This competency is difficult for competitors to
imitate and sets Google apart from the rest of the market.
 Location economies - firms can lower the costs of value creation and achieve a
low cost position or Cost advantages from performing a value creation activity
at the optimal location for that activity.
 The experience curve - the systematic reductions in production costs that
occur over the life of a product.

 Learning effects - cost savings that come from learning by doing.

 Economies of scale - the reductions in unit cost achieved by producing a
large volume of a product.
 Two Competitive pressures :
i) Pressures for cost reductions/global integration/efficiency/lower cost
 force the firm to lower unit costs
ii) Pressures to be locally responsive (quick response or differenciation)
 require the firm to adapt its product to meet local demands in each
market, but raise costs
 There are four basic strategies to compete in international markets :
(1) Global standardization: (High Integration and Low
Responsiveness) A firm using a global strategy sacrifices
responsiveness to local requirements within each of its markets in
favor of emphasizing efficiency. This strategy is the complete
opposite of a multi-domestic strategy. Such as Pharmaceutical
companies such as Pfizer.
(2) Localization/Multinational: (Low Integration and High
Responsiveness)
A firm using a multi-domestic strategy sacrifices efficiency in favor of
emphasizing responsiveness to local requirements within each of its
markets. Rather than trying to force all of its American-made shows
on viewers around the globe, MTV customizes the programming that
is shown on its channels within dozens of countries, including New
Zealand, Portugal, Pakistan, and India.

(3) Transnational: (High Integration and High Responsiveness)

A firm using a transnational strategy seeks a middle ground between
a multi-domestic strategy and a global strategy. Such a firm tries to
balance the desire for efficiency with the need to adjust to local
preferences within various countries. For example, large fast-food
chains such as McDonald’s and KFC rely on the same brand names
and the same core menu items around the world. These firms make
some concessions to local tastes too. Many industries are now so
competitive that firms must adopt a transnational strategy by
focusing on reducing cost, transferring skills and products, and
boosting local responsiveness.

(4) International: (Low Integration and Low Responsiveness)

An international company therefore has little need for local adaption
and global integration. For example exporting or importing of goods
or services.
 Types of companies in international business:
i) International companies are importers and exporters; they have no
investment outside of their home country.
ii) Multinational companies have investment in other countries, but do
not have coordinated product offerings in each country, more focused
on adapting their products and service to each individual local market.
iii) Global companies have invested and are present in many countries.
They market their products through the use of the same coordinated
image/brand in all markets. Generally one corporate office that is
responsible for global strategy, emphasis on volume, cost management
and efficiency.
iv) Transnational companies are much more complex organizations. They
have invested in foreign operations, have a central corporate facility but
give decision-making, R&D and marketing powers to each individual
foreign market.
 Chapter 14: The Organization of
International Business
 Organizational architecture is the totality of a firm’s organization including

1. Organizational structure: An organizational structure outlines how

certain activities are directed to achieve the goals of an organization.

2. Control systems and incentives

3. Processes, organizational culture, and people

 Organizational structure has three dimensions

i) Vertical differentiation - location of decision-making responsibilities
within a structure.
 Centralized decision-making
 Decentralized decision-making
ii) Horizontal differentiation - formal division of the organization into sub-
units.
iii) Integrating mechanisms - the mechanisms for coordinating sub-units.
Chapter 15: Entry strategy and strategic
alliances
 Different Modes of Entry or entry strategies into International Business:

a) Exporting is directly selling goods from one country into others. Exporting
can be direct (there is no intermediary; goods are sold from the company
headquarters directly) or indirect (goods are sold to an intermediary who
then is responsible for the sale of these goods in the foreign market with
lower risk).
b) Licensing - a licensor grants the rights to intangible property to the licensee
for a specified time period, and in return, receives a royalty fee from the
licensee
i) Patents, inventions, formulas, processes, designs, copyrights,
trademarks, technical know how
 ii) By manufacturing firma (products or goods)
iii) Low financial risks
iv) Little or no control over licensee
v) PepsiCo
c) Franchising - a specialized form of licensing in which the franchisor not only
sells intangible property to the franchisee, but also insists that the
franchisee agree to abide by strict rules as to how it does business

(1) used primarily by service firms (services)

(2) more control over the Franchisee
(3) use brand name, manufacturing process, products, trademarks
and other intellectual properties
(4) McDonald

 Specialized Entry modes

a) Contract manufacturing is outsourcing entire or part of manufacturing
operations.
  The iPad and iPhone, which are products from Apple Inc., are
manufactured in China by Foxconn. Hence, Foxconn is a contract
manufacturer and Apple benefits from a lower cost of manufacturing
devices.
b) A management contract is an agreement between two companies
whereby one company provides managerial assistance, technical expertise
and specialized services to the second company for a certain period of time
in return for monetary compensation.
 Eg. Schools, sports facilities, hospitals
c) A turnkey project is a contract under which a firm agrees to fully design,
construct and equip a manufacturing/business/service facility and turn the
project over to the purchaser when it’s ready for operation, for
remuneration. Many government-owned public housing projects are
turnkey projects. A private developer undertakes all activities necessary to
producing the project, including land purchases, permits, plans, and
construction, and sells the project to the housing authority.
 Padma Bridge
 FDI without alliances Companies enter the international market through FDI,
invest their money, establish manufacturing and marketing facilities through
ownership and control. Greenfield and brownfield investments are two types
of foreign direct investment.
a) Greenfield strategy (wholly owned subsidiary)- the term Greenfield refers
to starting of the operations of a company from scratch in a foreign market.
Greenfield and brownfield investments are two types of foreign direct
investment.
 With Greenfield investing, a company will build its own, brand new
facilities from the ground up.
 FDI with strategic alliances: Strategic alliance is a cooperative and
collaborative approach to achieve the larger goals.

a) Brownfield investment happens when a company purchases or leases an

existing facility. It can be both (a) Mergers and (b) acquisitions.
 Mergers and acquisitions (brown field):
 A  merger  or brown field occurs when two separate entities combine
forces to create a new, joint organization or entity. A merger is the
combination of two firms, which subsequently form a new legal entity
under the banner of one corporate name.
 Meanwhile, an  acquisition or takeover or brown field refers to the
takeover of one entity by another. In an acquisition, one company
purchases the other outright. The acquired firm does not change its
legal name or structure but is now owned by the parent company,
established itself as the new owner.

b) A joint venture is an entity formed between two or more parties to

undertake economic activity together.
 Sony-Ericsson is a joint venture by the Japanese consumer electronics
company Sony Corporation and the Swedish telecommunications
company Ericsson to make mobile phones.
 Most joint ventures are 50:50 partnerships.
c) Wholly owned subsidiary - the firm owns 100 percent of the stock
 set up a new operation (greenfield without alliances)
 acquire an established firm (acquisition/brown field with strategic
alliances)