International Business

MGT-413

1.(a) What is Globalization? How have changes in technology contributed to the

globalization of markets and production?
Answer: Globalization refers to the fundamental shift toward a more integrated and
interdependent world economy.
It has several dimensions including the following:
➢ Globalization of Markets and
➢ Globalization of Production
Globalization of Markets: It refers to the merging of national markets which were
historically distinct and separated.
It only occurs when there is
➢ Declining barriers to cross-border trade and investment and
➢ Advanced technology in communication, transportation and information
process.
But it is not that the national markets are giving way to the global market. Because of it
the taste and preferences of consumers in different nations are beginning to converge.
But the most global markets are not typically markets for consumer products but for
industrial products. In global markets, the same firms frequently confront each other as
competitors. As a result, greater uniformity replaces diversity.

Globalization of Production: Globalization of production refers to the sourcing of goods

and services from locations around the globe. The main purpose of it is to take advantage
of national differences in the cost and quality of factors of production. Such as labor,
energy, land and capital. It helps the companies to lower their total cost of production and
improve the functionality of their product.

Contribution of Technological Changes globalization of markets and production

The lowering of trade barriers made globalization of markets and production a theoretical
possibility. Technological change has made it a tangible reality. Since the end of World
War II, the world has seen major advances in communication, information processing,
and transportation technology, including the explosive emergence of the Internet and
World Wide Web. Telecommunications is creating a global audience. Transportation is
creating a global village. From Buenos Aires to Boston, and from Birmingham to Beijing,
ordinary people are watching MTV, they're wearing blue jeans, and they're listening to
iPods as they commute to work.

Globalization is brought about by the new inventions; it may be divided into two
globalizations of the market as well as globalization of products. New technologies, for
example, the Internet has enabled information to be passed faster to large masses of
people due to usage of equipment’s like microcomputers.

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People who are far and wide in many parts of the world are able to get information about
is certain products, which may not be in production in their areas. As a result, global inter-
dependence then arises where people all over the world are able to advertise and market
their products to people far and wide

Globalization in markets has arisen due to change of technology and new ones coming
along. By definition, globalization of markets can be defined as the formation of a huge
market place due to merging of different, separate markets. The global market has
developed in such a way that it offers the needs of each and every individual all over the
world.

Technology changes have lead to better ways of production. The new technologies have
lead to globalization in production. By definition, globalization in production is taking
advantages of the national differences between countries and enjoys cheap and quality
resources through sourcing them in counties that they are cheaper.

The establishment of the networks in different parts of the world has brought about
interaction between many different cultures and people. The interaction between the
various technologies used in various regions has lead to better technological
developments. Ultimately development of a globalized market and production is the
resultant.

(b) Describe the main drivers of globalization.

Answer: Two macro factors underlie the trend toward greater globalization.
The first is the decline in barriers to the free flow of goods, services and capital that has
occurred since the end of world war II. During the 1920s and 30s many of the world's
nation-states erected formidable barriers to international trade and foreign direct
investment. International trade occurs when a firm exports goods or services to
consumers in another country. Foreign direct investment (FDI) occurs when a firm
invests resources in business activities outside its home country.

After the Great Depression and the Second World War, developed countries have opted
to remove barriers to international trade and foreign direct investment. This resulted in
the GATT (General Agreement on Tariffs and Trade). There were a number of rounds of
negotiations between countries which ensued and these led to further reductions and also
extended GATT to cover services, intellectual property rights and eventually to the
establishment of the World Trade Organization (WTO) following the Uruguay Round in
1994. The WTO is a permanent body that is responsible for establishing and further
entrenching rule-based trade and for managing the rule-based world-trading system (Hill,
2003).

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These developments have contributed to the reduction of trade and investment barriers
and lower restrictions on capital flow. These have in turn facilitated the globalization of
markets and production. In addition to reducing trade barriers, many countries have also
been progressively removing restrictions to foreign direct investment that has further
boosted world trade growth.

However, whether the removal of those barriers to trade is a good thing is a debatable
issue. Many developing countries would argue that given their intrinsically different
economic underpinnings, it will be almost impossible for them to compete on a level
playing field as is propounded by globalization. They have further advanced that these
barriers or protectionist measures are extremely important in that they provide in most
cases a market for the developing countries’ exports.

The second factor is technological change, particularly the dramatic developments in

recent decades in communication, information processing and transportation
technologies.

Over the last decades there has been significant technological advancement. The
microprocessor revolution is perhaps the one that has had the most significant impact.
Microprocessors are the underlying components that have fueled the advancement in
global communications. These include satellite, optic fiber and wireless communications
as well as the computing revolution that has borne the Internet, the worldwide web and
provided the possibilities of e-commerce. These technological developments have
contributed to the globalization of markets and production, through better communication,
and integration of worldwide activities. It has also facilitated the speedy global transfer of
funds and capital, which further fuels globalization.

Other technological advancements that have contributed to globalization include that of

jet travel and containerization. Jet travel has enabled the rapid and widespread movement
of people and goods across national borders (Hill, 2003). This has facilitated the setting
up of new businesses, partnerships and negotiations across borders and has also helped
in the co-ordination and integration of worldwide business activities.

The explosive growth of the World Wide Web since 1994 when the first web browser was
introduced is the latest expression of this development. The web makes it much easier
for buyers and sellers to find each other, wherever they may be located and whatever
their size. It allows businesses, both small and large, to expand their global presence at
a lower cost than ever before. It enables enterprises to coordinate and control a globally
dispersed production system in a way that was not possible 20 years ago.

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As transportation costs associated with the globalization of production have declined,

dispersal of production to geographically separate locations became more economical.
As a result of the technological innovations discussed above, the real costs of information
processing and communication have fallen dramatically in the past two decades. These
developments make it possible for a firm to create and then manage a globally dispersed
production system, further facilitating the globalization of production. A worldwide
communications network has become essential for many international businesses.

In addition to the globalization of production, technological innovations have facilitated

the globalization of markets. Low-cost global communications networks such as the
World Wide Web are helping to create electronic global marketplaces. As noted above,
low-cost transportation has made it more economical to ship products around the world,
thereby helping to create global markets.

(c) What are the benefits and costs of outsourcing in case of tangible products.
Answer: International businesses frequently face make-or-buy decisions, decisions
about whether they should perform a certain value creation activity themselves or
outsource it to another entity.26 Historically, most outsourcing decisions have involved
the manufacture of physical products. Most manufacturing firms have done their own final
assembly, but have had to decide whether to vertically integrate and manufacture their
own component parts or outsource the production of such parts, purchasing them from
independent suppliers. Such make-or-buy decisions are an important aspect of the
strategy of many firms. Outsourcing occurs when a company purchases products or
services from an outside supplier, rather than performing the same work within its own
facilities, in order to cut costs. The decision to outsource is a major strategic one for most
companies, since it involves weighing the potential cost savings against the
consequences of a loss in control over the product or service.

Outsourcing implies getting work done from the outside bodies. The companies generally
use this process to deploy the non-core but relevant sector of their business. For this, two
companies draft a legal agreement for the exchange of payments and services.

Outsourcing means a contract with an outside organization regarding business functions.

The simple making and buying decisions regarding a product, whether it should be
produced by a firm or outsourced by another firm who is best in providing such products
is the basis of the outsourcing process.

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For an action to be called ‘outsourced’ it should be:

1. A recurring action.
2. An action that the firm presently furnishes for itself or is commonly scheduled to
implement for itself.
Let us understand outsourcing with an example:
Company A is having expertise in manufacturing the medicine but does not have any
experience of manufacturing the packaging bottles without which medicines cannot be
sold in the market. However, another company B has expertise in manufacturing the
bottles. Thus, company A can outsource their non-core work of manufacturing the
packaging bottles to company B, whose core area of service is manufacturing the bottles.
This will reduce the unnecessary cost of Company A and increases the profit of both
companies.

Benefits of Outsourcing
Following are the benefits of outsourcing:
➢ Better Quality: Sometimes, another firm is just superior at delivering a service or
building products than your firm. Thus, it is the best option to outsource that service
to another firm for getting the best possible results from that service or product.
➢ Improved return on investment: A pillar of outsourcing is its ability to shorten the
investment in equipment and plants required for the production of the products. If
you can maintain the volume of the profits for the product and not waste too much
on supplier margins than the return on investment of the firm will increase.
➢ Lower cost: Some suppliers have a business in their support; outsourcing to low-
cost labor can minimize the labor cost of the firm. For example: In India labor cost
is much cheaper than the USA; thus, various companies from the USA outsource
their low skill works to the low-cost companies in India.
➢ FOCUS ON CORE AREAS: Outsourcing your business processes would free your
energies and enable you to focus on building your brand, invest in research and
development and move on to providing higher value-added services.
➢ Risk Management: A hidden benefit of outsourcing is that if a company by any
chance faces problems due to natural calamities, technical crisis or market
fluctuations. Then the offshore outsource partners can still keep working on their
assignments. This especially beneficial in bringing back the company back on
track.

Costs of Outsourcing
Although making a product or component part in-house-vertical integration-is often
undertaken to lower costs, it may have the opposite effect. When this is the case,
outsourcing may lower the firm's cost structure. Making all or part of a product in-house

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increases an organization's scope, and the resulting increase in organizational complexity

can raise a firm's cost structure. There are three reasons for this.

First, the greater the number of subunits in an organization, the more problems
coordinating and controlling those units. Coordinating and controlling subunits require top
management to process large amounts of information about subunit activities. The
greater the number of subunits, the more information top management must process and
the harder it is to do well. Theoretically, when the firm becomes involved in too many
activities, headquarters management will be unable to effectively control all of them, and
the resulting inefficiencies will more than offset any advantages derived from vertical
integration. This can be particularly serious in an international business, where the
problem of controlling subunits is exacerbated by distance and differences in time,
language, and culture.

Second, the firm that vertically integrates into component part manufacture may find that
because its internal suppliers have a captive customer in the firm, they lack an incentive
to reduce costs. The fact that they do not have to compete for orders with other suppliers
may result in high operating costs. The managers of the supply operation may be tempted
to pass on cost increases to other parts of the firm in the form of higher transfer prices,
rather than looking for ways to reduce those costs.

Third, vertically integrated firms have to determine appropriate prices for goods
transferred to subunits within the firm. This is a challenge in any firm, but it is even more
complex in international businesses. Different tax regimes, exchange rate movements,
and headquarters' ignorance about local conditions all increase the complexity of transfer
pricing decisions. This complexity enhances internal suppliers' ability to manipulate
transfer prices to their advantage, passing cost increases downstream rather than looking
for ways to reduce costs.

The firm that buys its components from independent suppliers can avoid all these
problems and the associated costs. The firm that sources from independent suppliers has
fewer subunits to control. The incentive problems that occur with internal suppliers do not
arise when independent suppliers are used. Independent suppliers know they must
continue to be efficient if they are to win business from the firm. Also, because
independent suppliers' prices are set by market forces, the transfer pricing problem does
not exist.

In sum, the bureaucratic inefficiencies and resulting costs that can arise when firms
vertically integrate backward and produce their own components are avoided by buying
component parts from independent suppliers.

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2 (a)Free market economies stimulate greater economic growth, whereas state-

directed economics stifle growth. Discuss.
Answer: Free Market Economy is acknowledged as an economy where all business and
productions are owned privately, as opposed to state directed economy. In this system
all productions of products and services takes place freely based on market demands
and hence amount produced are not just planned by an entity on top rather they are all
set through the market forces (Bremmer, 2012). Production is truly dependent on just
market’s supply and demand through a well-established pricing system. There are held
no constraints on supply when working under this free market economy. Monopoly is the
only situation in which the supply of the market can be manipulated and controlled.
Monopoly is the only situation in free market which presents disadvantage. This
competition is bad for the health of the society, and there arise a need for the role of
government to enhance the dynamic competition among private businesses and owners.
Hence, enhanced competition in the free market and private possessions support
enthusiastic rivalry and in urn enhanced economic growth and efficiency (Schuman,
2011).
On the other hand, an economic system is state directed where the decisions relating
economy are based on resource allocations, pricing, investments, and production which
are truly under the control of the state government or some other authoritative entity
(Bremmer, 2012). Traditionally it was believed that the economy which is planned
centrally would enhance the trade compared to an economy which if free and unplanned.
A directed economy is under the control of the government and hence holds controls on
all production possessions although business is private. A state directed economy is a
more strict form of a planned economy and hence the state owns and controls all
production means and properties. It is believed that the choices that are necessary for
economic planning are considered to be time taken and no exact in a free market state
because of many people holding interests which are always opposing (Schuman, 2011).
It is declared through past examples that state directed economies or dictatorships are
always leading to economic disturbances and misbalanced and now economies are
moving towards free market to enhance their economic growth. Even though it can be
considered as a critical ideal, a system which is built on the idea of asking individuals to
only work for welfare and health of society in contrast to offering them possessions of
wealth and economies is no longer an impressive idea. Free market economies offer the
immense motivations for the business people and other working individuals to enhance
productions and build in efficiencies to enhance their personal growth which in turn will
enhance economic growth. In conclusion it is stated that the state directed economies as
contrast to free market economies are typically generating slow economic growth as well
as less efficiencies because of lower motivations and enhanced control.

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(b)If you are the CEO of a company that has to choose between making a 10- crore
investment in India or China. Both investments promise the same long-run return,
so your choice is driven by risk considerations. Assess the various risks of doing
business in each of these nations. Which investment would you favor and why?
Answer:

3. (a) Outline why the culture of a country might influence the costs of doing
business in that country. Illustrate your answer with examples.
Answer: Doing business globally is a common practice these days. As we break the
technological barriers and accelerate towards building a global economy we are faced
with challenges of cultural diversity among countries.
Today Business environment has become more dynamic, more competitive and
increasingly complex and add a little of cultural diversity to the mix, we have a whole new
ball game on our hands. The challenges of cultural diversity not only influence the way
we conduct Business international but it also impacts the cost of running business
overseas. China being one of the upcoming global business market contenders has
opens its business door to the western world. Coming from an age of communism,
conducting business practices for international companies have become more
challenging, especially the costs of running business. In order to establish a reputation
companies, need to heavy invest in learning the way each country does business, it might
be a classic case of business deals happening at the dinner table so to speak. Most deals
regardless of the cultural influence do tend to occur outside the more conventional office
environments.
Sometimes it pays to know the correct approach and the right people, as they say in the
game it’s not what you know but rather whom you know. We face challenges to
understand cultural diversity and become more dynamic, more competitive in an
increasingly complex business environment.
This implies closer attention to be given to understanding the needs of customers around
the world, building new relationships and capabilities in diverse markets, evaluating the
work force to balance talent and productivity with cost and competitiveness and
navigating a regulatory environment with consistent standards of integrity across the
globe.
Sometimes cultural difference between countries can cause a negative impact when
conducting free market businesses. According to the textual evidence, economic
advancement and globalization may be important factors in society change. The culture of
societies may also change as they become richer because economic progress affects a
number of other factors, which in turn influence culture. One example is the Japanese
culture. They take very seriously about having their own corporations run their country. It is
very difficult for outsiders to go business there. Japan has a very large IT distribution sector
and the largest IT distribution corporation that generates $40 billion in revenues

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headquartered in America is not able to set-up shop in that country. Japanese culture
simply believes that it is best if their corporation, their employees and their stockholders
benefit from doing business within. It is very interesting because Japan does an amazing
job at selling its products and technology outside. In fact, they have already successfully
started robotics assistance for the elderly. Something that the rest of the world will slowly
catch-up on.
There has being recent interest even within Australia to expand it aligns with India for
information and operational management and in China for labor management. In return
the countries are gaining reputable opportunities to expand them aligns internationally.
It’s no secret that China has request the talents of Australian sporting officials to assist
their preparation towards 2008 Olympics. This has provided Australia with an opportunity
to learn the Chinese culture and their method of doing business. Both countries are
benefiting from this exchange of skills for opportunities. The benefits of cultural influence
have shown that the initial invest may lead to large gain just like the fruits of labor

(b) Choose two countries that appear to be culturally diverse. Compare the cultures
of those countries and then indicate how cultural differences influence business
practices.
Answer: I would like to choose two countries such as America and China that appear
to be culturally diverse in terms of cost involved, future economic development, and
business practices. In the United States, doing business can be very easy as everyone
does businesses in comparison to China. However, cultural differences teach different
values, norms, beliefs, language, educational institutes, religions, and aesthetics etc. so
that for instance what might be polite in the U.S. could be highly insulting in China. Some
of the major cultural differences between America and China are as follows:

➢ Cost of doing business in each country: In the US, it could be easy to set up
any businesses due to liberal policies regarding business activities whereas China
has strict policies to open up new businesses. Unlike the US, China has more
economical factors of production such as men, machine, material and
management. China has totalitarian economic system so that it could take years
to get permissions for doing business activities. On the contrary, America has free
market economic system so that running everything is quite easy but of course
labor costs are very high in the US.
➢ The likely future economic development: Although there are no much more
differences in the economic growth, according to world bank report, economic
growth of China were10.6% in 2010, 9.5% in 2011, 7.8% in 2012, 7.7% in 2013,
and 7.4% in 2014 whereas American’s economic growth were 2.5% in 2010, 1.6%
in 2011, 2.3 % in 2012, 2.2% in 2013, and 2.4% in 2014 respectively. The

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difference in economic growth indicates that China is going to be world’s economic

growth by 2025, followed by the US, India and Japan respectively.
➢ Business Practices: Chinese businessmen want to value more on building
relationship with buyers but American don’t like to do so. In the same way, Chinese
want to interact face-to-face whereas American avoids this system. While this can
slow down the pace of business, trust is at a premium in the Chinese business
culture. Don't be surprised if a business partner asks you about your personal life
or even your finances. This is a sign of interest, not indication of rudeness or
disrespect. While making business decisions, Chinese believe in group decision,
and finally say by the “boss”, American, on the other hand, believe in individual
and made by a single person. Chinese are quiet, reserved and often make a
clumsy communication but most of American are outspoken, eloquent and make
an effective communication.

In short, we can say that there will always be differences in doing businesses in different
cultures or nations. Thus, businessmen should be able to address these differences
before entering into an international business so that they can be successful and achieve
a competitive advantage over its rivals.

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4. (a) What is balance of payment? What items are included in the current and
capital account when calculating balance of payments?
Answer: The balance of payments of a country is the difference between all money
flowing into the country in a particular period of time (e.g., a quarter or a year) and the
outflow of money to the rest of the world. These financial transactions are made by
individuals, firms and government bodies to compare receipts and payments arising out
of trade of goods and services.

Balance-of-payments accounts National accounts that track both payments to and

receipts from foreigners.

The balance of payments divides transactions into two accounts: the current account and
the capital account. Sometimes the capital account is called the financial account, with a
separate, usually very small, capital account listed separately. The current account
reflects a country's net income, while the capital account reflects the net change in
ownership of national assets.

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The current account includes transactions in goods, services, investment

income, and current transfers.
The current account records transactions that pertain to three categories, the first
category, goods, refers to the export or import of physical goods (e.g., agricultural
foodstuffs, autos, computers, chemicals). The second category is the export or import of
services (e.g., intangible products such as banking and insurance services). The third
category, income receipts and payments, refers to income from foreign investments and
payments that have to be made to foreigners investing in a country.
A current account deficit occurs when a country imports more goods, services, and
income than it exports. A current account surplus occurs when a country exports more
goods, services, and income than imports.

The capital account, broadly defined, includes transactions in financial instruments and
central bank reserves. Narrowly defined, it includes only transactions in financial
instruments. The current account is included in calculations of national output, while the
capital account is not.

The capital account records one-time changes in the stock of assets. As noted above,
until recently this item was included in the current account. The capital account includes
capital transfers, such as debt forgiveness and migrants' transfers (the goods and
financial assets that accompany migrants as they enter or leave the country).

The financial account (formerly the capital account) records transactions that involve the
purchase or sale of assets. The flow of funds from and to foreign countries through various
investments in real estates, business ventures, foreign direct investments etc. is
monitored through the financial account. This account measures the changes in the
foreign ownership of domestic assets and domestic ownership of foreign assets. On
analyzing these changes, it can be understood if the country is selling or acquiring more
assets (like gold, stocks, equity etc.)

(b)"Forward Exchange rate and Currency Swap are two important methods of
avoiding foreign exchange risk". Prove this statement with an example.
Answer: Foreign exchange risk refers to the losses that an international financial
transaction may incur due to currency fluctuations. Foreign exchange risk can also affect
investors, who trade in international markets, and businesses engaged in the
import/export of products or services to multiple countries.
Foreign Exchange Risk Example
An American liquor company signs a contract to buy 100 cases of wine from a French
retailer for €50 per case, or €5,000 total, with payment due at the time of delivery. The
American company agrees to this contract at a time when the Euro and the US Dollar are

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of equal value, so €1 = $1. Thus, the American company expects that when they accept
delivery of the wine, they will be obligated to pay the agreed upon amount of €5,000,
which at the time of the sale was $5,000.
However, it will take a few months for delivery of the wine. In the meantime, due to
unforeseen circumstances, the value of the US Dollar depreciates versus the Euro to
where at the time of delivery €1 = $1.10. The contracted price is still €5,000 but now the
US Dollar amount is $5,500, which is the amount that the American liquor company will
have to pay.
Forward exchange rate The exchange rates governing forward exchange transactions.
A forward exchange occurs when two parties agree to exchange currency and execute
the deal at some specific date in the future. Exchange rates governing such future
transactions are referred to as forward exchange rates. For most major currencies,
forward exchange rates are quoted for 30 days, 90 days, and 180 days into the future. In
some cases, it is possible to get forward exchange rates for several years into the future.
When a firm enters into a forward exchange contract, it is taking out insurance against
the possibility that future exchange rate movements will make a transaction unprofitable
by the time that transaction has been executed. Although many firms routinely enter into
forward exchange contracts to hedge their foreign exchange risk, there are some
spectacular examples of what happens when firms don't take out this insurance.
Currency forwards contracts and future contracts are used to hedge the currency risk.
For example, a company expecting to receive €20 million in 90 days, can enter into a
forward contract to deliver the €20 million and receive equivalent US dollars in 90 days at
an exchange rate specified today. This rate is called forward exchange rate. Forward
exchange rates are determined by the relationship between spot exchange rate and
interest or inflation rates in the domestic and foreign countries.
A currency swap is the simultaneous purchase and sale of a given amount of foreign
exchange for two different value dates. Swaps are transacted between international
businesses and their banks, between banks, and between governments when it is
desirable to move out of one currency into another for a limited period without incurring
foreign exchange risk. A common kind of swap is spot against forward. Consider a
company such as Apple Computer. Apple assembles laptop computers in the United
States, but the screens are made in Japan. Apple also sells some of the finished laptops
in Japan. So, like many companies, Apple both buys from and sells to Japan. Imagine
Apple needs to change $1 million into yen to pay its supplier of laptop screens today.
Apple knows that in 90 days it will be paid ¥120 million by the Japanese importer that
buys its finished laptops. It will want to convert these yen into dollars for use in the United
States. Let us say today's spot exchange rate is $1 = ¥120 and the 90-day forward
exchange rate is $1 = ¥110. Apple sells $1 million to its bank in return for ¥120 million.
Now Apple can pay its Japanese supplier. At the same time, Apple enters into a 90-day
forward exchange deal with its bank for converting ¥120 million into dollars. Thus, in 90

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days Apple will receive $1.09 million (¥120 million/110 = $1.09 million). Since the yen is
trading at a premium on the 90-day forward market, Apple ends up with more dollars than
it started with (although the opposite could also occur). The swap deal is just like a
conventional forward deal in one important respect: It enables Apple to insure itself
against foreign exchange risk. By engaging in a swap, Apple knows today that the ¥120
million payment it will receive in 90 days will yield $1.09 million.

(c) A consistent prediction of the exact level of the future exchange rate is
impossible. How to forecast exchange rate? Discuss.
Answer: A company's need to predict future exchange rate variations raises the issue of
whether it is worthwhile for the company to invest in exchange rate forecasting services
to aid decision making. Two schools of thought address this issue. The efficient market
school argues that forward exchange rates do the best possible job of forecasting future
spot exchange rates, and, therefore, investing in forecasting services would be a waste
of money. The other school of thought, the inefficient market school, argues that
companies can improve the foreign exchange market's estimate of future exchange rates
(as contained in the forward rate) by investing in forecasting services. In other words, this
school of thought does not believe the forward exchange rates are the best possible
predictors of future spot exchange rates. That’s why I think, “a consistent prediction of the
exact level of the future exchange rate is impossible.”
International transactions are usually settled in the near future. Exchange rate forecasts
are necessary to evaluate the foreign denominated cash flows involved in international
transactions. Thus, exchange rate forecasting is very important to evaluate the benefits
and risks attached to the international business environment. A forecast represents an
expectation about a future value or values of a variable. The expectation is constructed
using an information set selected by the forecaster. Based on the information set used by
the forecaster, there are two pure approaches to forecasting foreign exchange rates:
➢ The fundamental approach.
➢ The technical approach.
The fundamental approach is based on a wide range of data regarded as fundamental
economic variables that determine exchange rates. These fundamental economic
variables are taken from economic models. Usually included variables are GNP,
consumption, trade balance, inflation rates, interest rates, unemployment, productivity
indexes, etc. In general, the fundamental forecast is based on structural (equilibrium)
models. These structural models are then modified to consider statistical characteristics
of the data and the experience of the forecasters. It is a mixture of art and science.
Practitioners use structural model to generate equilibrium exchange rates. The
equilibrium exchange rates can be used for projections or to generate trading signals. A
trading signal can be generated every time there is a significant difference between the
model-based expected or forecasted exchange rate and the exchange rate observed in

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the market. If there is a significant difference between the expected foreign exchange rate
and the actual rate, the practitioner should decide if the difference is due to a mispricing
or a heightened risk premium. If the practitioner decides the difference is due to
mispricing, then a buy or sell signal is generated.

The technical approach (TA) focuses on a smaller subset of the available data. In general,
it is based on price information. The analysis is "technical" in the sense that it does not
rely on a fundamental analysis of the underlying economic determinants of exchange
rates or asset prices, but only on extrapolations of past price trends. Technical analysis
looks for the repetition of specific price patterns. Technical analysis is an art, not a
science.

Technical analysis uses price and volume data to determine past trends, which are
expected to continue into the future. This approach does not rely on a consideration of
economic fundamentals. Technical analysis is based on the premise that there are
analyzable market trends and waves and that previous trends and waves can be used to
predict future trends and waves. Since there is no theoretical rationale for this assumption
of predictability, many economists compare technical analysis to fortune-telling. Despite
this skepticism, technical analysis has gained favor in recent years.

5) a) What is meant by Foreign Direct Investment (FDI)? Differentiate between

Greenfield investment and Acquisition.
Answer: Foreign direct investment (FDI) occurs when a firm invests directly in facilities
to produce or market a product in a foreign country. Once a firm undertakes FDI, it
becomes a multinational enterprise. Walmart first became a multinational in the early
1990s when it invested in Mexico.

FDI takes on two main forms. The first is a greenfield investment, which involves the
establishment of a new operation in a foreign country. The second involves acquiring or
merging with an existing firm in the foreign country (Walmart's entry into Japan was in the
form of an acquisition). Acquisitions can be a minority (where the foreign firm takes a 10
percent to 49 percent interest in the firm's voting stock), majority (foreign interest of 50
percent to 99 percent), or full outright stake (foreign interest of 100 percent).

FDI can take the form of a greenfield investment in a new facility or an acquisition of or a
merger with an existing local firm. The majority of cross-border investment is in the form
of mergers and acquisitions rather than greenfield investments. UN estimates indicate
that some 40 to 80 percent of all FDI inflows were in the form of mergers and acquisitions
between 1998 and 2009. In 2001, for example, mergers and acquisitions accounted for
some 78 percent of all FDI inflows. In 2004, the figure was 59 percent, while in 2008 it

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was 40 percent, although the figure slumped to just 22 percent in 2009 reflecting the
impact of the global financial crisis and the difficulties of financing acquisitions through
the public capital markets. However, FDI flows into developed nations differ markedly
from those into developing nations. In the case of developing nations, only about one third
of FDI is in the form of cross-border mergers and acquisitions. The lower percentage of
mergers and acquisitions may simply reflect the fact that there are fewer target firms to
acquire in developing nations.

First, mergers and acquisitions are quicker to execute than greenfield investments. This
is an important consideration in the modem business world where markets evolve very
rapidly. Many firms apparently believe that if they do not acquire a desirable target firm,
then their global rivals will. Second, foreign firms are acquired because those firms have
valuable strategic assets, such as brand loyalty, customer relationships, trademarks or
patents, distribution systems, production systems, and the like. It is easier and perhaps
less risky for a firm to acquire those assets than to build them from the ground up through
a greenfield investment. Third, firms make acquisitions because they believe they can
increase the efficiency of the acquired unit by transferring capital, technology, or
management skills. However, there is evidence that many mergers and acquisitions fail
to realize their anticipated gains.

The majority of cross-border investment is in the form of mergers and acquisitions rather
than Greenfield investments because:
➢ it is quicker to execute than greenfield investments
➢ those firms have valuable strategic assets
➢ it can increase the efficiency of the acquired unit by transferring capital,
technology, or management skills.

(b) Discuss the Host Country's benefits and costs of FDI. Provide suitable
examples with firms and countries in mind.
Answer: The main benefits of inward FDI for a host country arise from resource-transfer
effects,
employment effects, balance-of-payments effects, and effects on competition and
economic
growth.
Host Country's benefits
Resource-Transfer Effects
Foreign direct investment can make a positive contribution to a host economy by
supplying capital, technology, and management resources that would otherwise not be
available and thus boost that country's economic growth rate.

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Many MNEs, by virtue of their large size and financial strength, have access to financial
resources not available to host-country firms. These funds may be available from internal
company sources, or, because of their reputation, large MNEs may find it easier to borrow
money from capital markets than host-country firms would.
Technology can be incorporated in a production process (e.g., the technology for
discovering, extracting, and refining oil) or it can be incorporated in a product (e.g.,
personal computers). However, many countries lack the research and development
resources and skills required to develop their own indigenous product and process
technology. This is particularly true in less developed nations. Such countries must rely
on advanced industrialized nations for much of the technology required to stimulate
economic growth, and FDI can provide it.

Employment Effects
Another beneficial employment effect claimed for FDI is that it brings jobs to a host country
that would otherwise not be created there. The effects of FDI on employment are both
direct and indirect. Direct effects arise when a foreign MNE employs a number of host-
country citizens. Indirect effects arise when jobs are created in local suppliers as a result
of the investment and when jobs are created because of increased local spending by
employees of the MNE. The indirect employment effects are often as large as, if not larger
than, the direct effects.
When FDI takes the form of an acquisition of an established enterprise in the host
economy as opposed to a greenfield investment, the immediate effect may be to reduce
employment as the multinational tries to restructure the operations of the acquired unit to
improve its operating efficiency. However, even in such cases, research suggests that
once the initial period of restructuring is over, enterprises acquired by foreign firms tend
to grow their employment base at a faster rate than domestic rivals.

Balance-of-Payments Effects
FDI's effect on a country's balance-of-payments accounts is an important policy issue for
most host governments. A country's balance-of-payments accounts track both its
payments to and its receipts from other countries. Governments normally are concerned
when their country is running a deficit on the current account of their balance of payments.
The current account tracks the export and import of goods and services. A current account
deficit, or trade deficit as it is often called, arises when a country is importing more goods
and services than it is exporting. Governments typically prefer to see a current account
surplus than a deficit. The only way in which a current account deficit can be supported
in the long run is by selling off assets to foreigners.
First, if the FDI is a substitute for imports of goods or services, the effect can be to improve
the current account of the host country's balance of payments.

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A second potential benefit arises when the MNE uses a foreign subsidiary to export goods
and services to other countries.

Effect on Competition and Economic Growth

Economic theory tells us that the efficient functioning of markets depends on an adequate
level of competition between producers. When FDI takes the form of a greenfield
investment, the result is to establish a new enterprise, increasing the number of players
in a market and thus consumer choice. In turn, this can increase the level of competition
in a national market, thereby driving down prices and increasing the economic welfare of
consumers. Increased competition tends to stimulate capital investments by firms in plant,
equipment, and R&D as they struggle to gain an edge over their rivals. The long-term
results may include increased productivity growth, product and process innovations, and
greater economic growth.

HOST-COUNTRY COSTS
Three costs of FDI concern host countries. They arise from possible adverse effects on
competition within the host nation, adverse effects on the balance of payments, and the
perceived loss of national sovereignty and autonomy.

Adverse Effects on Competition

Host governments sometimes worry that the subsidiaries of foreign MNEs may have
greater economic power than indigenous competitors. If it is part of a larger international
organization, the foreign MNE may be able to draw on funds generated elsewhere to
subsidize its costs in the host market, which could drive indigenous companies out of
business and allow the firm to monopolize the market. Once the market is monopolized,
the foreign MNE could raise prices above those that would prevail in competitive markets,
with harmful effects on the economic welfare of the host nation. This concern tends to be
greater in countries that have few large firms of their own (generally less developed
countries). It tends to be a relatively minor concern in most advanced industrialized
nations.
In general, while FDI in the form of greenfield investments should increase competition,
it is less clear that this is the case when the FDI takes the form of acquisition of an
established enterprise in the host nation, as was the case when Cemex acquired RMC in
Britain (see the Management Focus). Because an acquisition does not result in a net
increase in the number of players in a market, the effect on competition may be neutral.
When a foreign investor acquires two or more firms in a host country, and subsequently
merges them, the effect may be to reduce the level of competition in that market, create
monopoly power for the foreign firm, reduce consumer choice, and raise prices.

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Adverse Effects on the Balance of Payments

The possible adverse effects of FDI on a host country's balance-of-payments position are
twofold. First, set against the initial capital inflow that comes with FDI must be the
subsequent outflow of earnings from the foreign subsidiary to its parent company. Such
outflows show up as capital outflow on balance-of-payments accounts. Some
governments have responded to such outflows by restricting the amount of earnings that
can be repatriated to a foreign subsidiary's home country. A second concern arises when
a foreign subsidiary imports a substantial number of its inputs from abroad, which results
in a debit on the current account of the host country's balance of payments.

National Sovereignty and Autonomy

Some host governments worry that FDI is accompanied by some loss of economic
independence. The concern is that key decisions that can affect the host country's
economy will be made by a foreign parent that has no real commitment to the host
country, and over which the host country's government has no real control. Most
economists dismiss such concerns as groundless and irrational.

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(c) Illustrate the Decision framework of FDI.

Answer:

6) (a) Discuss the importance of foreign trade of Bangladesh

Answer: International trade plays a significant role in economic growth of a country and
in modern economy both international trade and economic growth are the most popular
concepts. The term international trade is used to indicate the buying and selling of
goods and services between countries for satisfying the needs of its population.
International trade enables the countries to sell their domestically produced goods and

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services to other countries. Economic growth helps to increase the real per capital
income of a population of the country which can be sustained over a long period of
time. The neo-classical and classical economists attributed so much relevance to
international trade in a development process of a nation which is regarded as an
engine of growth. Over the past years, the nations of the world have been immensely
linked together through globalization and international trade(Afolabi, Danladi, &
Azeez, 2017). Economic growth is one of the most vitaldeterminants of economic
growth of a country and the relationship between international trade and economic
growth is a frequent topic of discussion, when economists try to explain the different
levels of economic growth between countries as well as exports of goods and
services represent one of the most significant sources of foreign exchange income
that ease the pressure on the balance of payments and create employment opportunities
for the population of a nation that ultimately increase the socio-economic conditions
of people(Shihab, Soufan, & Abdul-Khaliq, 2014). International trade in recent decades
has considerable growth and it is evident that most conducted traded in this area is
associated with monetary and financial system and many banks and financial
institutions do financing the exchange of goods and services(Levine & Renelt,
1992). Over the past years, it has been witness gradual development of integrated global
economic system and developing of science and technology in the various areas
has followed different conditions of business in these years(Sala-i-Martin & V Artadi,
2003). Communications development and widespread access of customer to
information, has changed markets face and influenced their demands as well as
production based on advanced technology and improved methods provides possible
of respond to the changing demands of customers(Frankel & Rose, 1998). International
trade fosters innovation, the discrimination of technological progress through exposure
to new goods and imports of high-tech inputs and efficient production (Daumal,
2010).
Several studies address the impact of international trade on economic growth of a
country. The findings of these studies indicate that international trade i.e. exports and
imports has a statistically significant positive impact on economic growth (GDP) of a
country. Some of these studies that have addressed the issue of causality between
international trade and economic growth as follows: International trade contains
efficiency and welfare achievement to all countries regardless of their initial
conditions, technological capabilities, development level, and resources endowments
(Helpman, 1987).International trade affects the economic growth of nations via the
attraction of FDI. A study found that the main boulevards through which FDI
impacts positively to economic growth are access to international market, job creation,
technology transfer, capital accumulation, marketing and managerial practices(Lall,
2003). Researchers investigated the causal links between trade, economic growth
and inward foreign direct investment (FDI) in China at the aggregate level and the
study found bidirectional causality between economic growth, FDI and exports(Shan
& Sun, 1998).A study on the long run effect of FDI and trade on economic growth in

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Ghana for the period 1970 and 2002.The researchers discovered a long-run
relationship between determinants of economic growth and economic growth itself in
their model and the findings of that study indicated a negative and positive growth
impact of trade and FDI respectively(Frimpong Magnus & Oteng-Abayie). A study
that examined the impact of export composition on economic growth, indicated that
not all exports contribute equally to economic growth. Many developing countries
depend on exports of primary products, which are subject to excessive price fluctuations
and this category of exports had negligible impact on economic growth, while
manufactured exports had a positive and significant effect on economic growth(Kim
& Lin, 2009). A study found that government earn revenue through international
trade activities. International trade, as a major factor of openness, has made an
increasingly significant impact to economic growth (Sun & Heshmati, 2010).The
mercantilist doctrine attributed great importance to foreign trade, in other words; the
international exchange process of capital accumulation, which is a notable
requirement for economic growth(Tapşın, 2016). Some researchers conducted a
research on the relationship between foreign trade and the GDP growth of East China
for a period 1981-2008. Using the unit root test, co-integration analysis and error
correction model, they found out that foreign trade is the long-term and short-term
reason of GDP growth, but no evidence proved that there exists long-term stationary
causality between import trade and GDP(Li, Chen, & San, 2010).

(b) Explain the reasons that are responsible for the trade deficit of
Bangladesh.
Answer:

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