Transcript July 28, 2008 Discussion Section Foreign Direct Investment; Political Economy of FDI; Foreign Exchange; International Monetary System.

July 28, 2008
Discussion Section
Foreign Direct Investment; Political Economy of FDI;
Foreign Exchange; International Monetary System
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Chapters 3,4,5,6 in a nutshell
Tips for future assignment
Review Chapters 7
◦ Discussion Questions
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Review Chapter 9, 10
◦ Discussion Questions
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Q&A regarding the Midterm
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Chapter 3:
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Chapter 4:
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Chapter 5:
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Chapter 6:
◦ What is culture? What are the determinants of culture? How
does culture affect business?
◦ What are ethical dilemmas? How do ethical dilemma’s arise?
What are some of the standards used to evaluate ethics?
Which ones are “straw men” arguments?
◦ What are the theories that explain the observed pattern of
international trade?
◦ 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?
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(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
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(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.
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(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
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(3) Failure to cite theories/ethical constructs in the text
◦ The textbook is not intended to be used solely as a paperweight
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(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
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(5) Lack of structure/organization
◦ Run-on diatribes are hard to read
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(6) Please dispense with irrelevant facts
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Include only those facts to support your claim. Avoid making
mistakes of facts.
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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 it’s 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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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.
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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 firm’s only social
responsibility is to increase profits and stay within the law. If Nike’s 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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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
government’s 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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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
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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;
(Knickerkbocker’s“Multipoint Competition Theory)
 Vernon’s “Product Life Cycle Theory”
◦ The “Eclectic Paradigm” (combines the two sets of theories
above)
 Dunning: location-specific advantages; externalities
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Political Ideology and FDI
◦ Radical View
◦ Free Market View
◦ Pragmatic Nationalism
Benefit
Cost
Host
Country
Resource-Transfer effects;
employment effects;
balance-of-payment effects;
effect on competition and
economic growth
Adverse effect on competition;
effect on balance of payments;
effect on national sovereignty
and autonomy
Home
Country
Inward cash flow;
employment effects; skills
learned from abroad
Balance of payments;
employment effects
(outsourcing)
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Government Response
◦ Encourage/restrict outward FDI
◦ Encourage/restrict inward FDI
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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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Compare and contrast these explanations of
FDI: internalization theory, Vernon's product
life cycle theory, and Knickerbocker's theory
of FDI. Which theory do you think offers the
best explanation of the historical pattern of
FDI? Why?
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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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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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Firms should not be investing abroad when
there is a need for investment to create jobs
at home. Discuss.
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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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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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What is the FOREX market for?
◦ Currency conversion; insuring against foreign exchange
risk (using spot exchange, forward exchange, or currency
swaps)
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Arbitrage in FOREX markets
Theories about how FOREX rates are determined
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Forecasting in FOREX markets
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FOREX Exposures and Multinational Firms
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◦ 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
 Efficient v. Inefficient Schools; Approaches
 Transaction, Translation, Economic
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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 Acme's. They are willing to buy Acme's 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 Acme's
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.
Acme's 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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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
$1 = W1,200. Forecast the spot exchange
rate one year from today. Explain the logic of
your answer
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The international Fisher effect suggests that the
exchange rate will change in an equal amount but
in an opposite direction to the difference in
nominal interest rates. Hence since the nominal
interest rate is 3% higher in the US than in South
Korea, the dollar should depreciate by 3% relative
to the South Korean Won. Using the formula from
the book: (S1 - S2)/S2 x 100 = i$ - iWon and
substituting 7 for i$, 4 for iWon, and 1200 for S1,
yields a value for S2 of $1=W1165.
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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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(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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You manufacture wine goblets. In mid-June
you receive an order for 10,000 goblets from
Japan. Payment of ¥400,000 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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(1) The simplest solution would be to just wait until December, take the
¥400,000 and convert it at the spot rate at that time, which you assume will
be $1=¥100.
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(2) Forward Contract
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In this case you would have $4,000 in mid-December.
If the current 180-day forward rate is lower than 100¥/$, 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/$, then whether you choose to lock in the forward rate or wait and see
what the spot does will depend upon your risk aversion.
(3) Borrow Money
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There is a third possibility also. You could borrow money from a bank that you will pay back with
the ¥400,000 you will receive (400,000/1.03 = ¥388,350 borrowed), convert this today to US$
(388,350/130 = $2,987), 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 (4,000 - 2,987 = $1,013),
which would turn out to be an annual rate of 51% ((1,013/4000) * 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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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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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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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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Different exchange rate regimes:
◦ Fixed
◦ Floating: pegged; dirty float
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Fixed versus Floating Exchange Rates
◦ Why choose floating exchange rates?
 Monetary policy autonomy
 Trade balance adjustments
◦ Why choose fixed exchange rates?
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Monetary discipline
Speculation
Uncertainty
Trade Balance Adjustment
◦ Who is right?
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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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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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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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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 you're 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 10:30 a.m. to 1:00 p.m. for
the morning class, and from 3:30 p.m. to 6:00 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 1:30 p.m. to 3:00 p.m. at Cafe Strada (located on
Bancroft X College Ave)
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