...Introduction - Purchasing Power Parity PPP Theory The first original reference of PPP Theory was made by David Ricardo. However, Gustav Cassel popularized this theory in 1918. According to PPP theory, when exchange rates are of a fluctuating nature, the rate of exchange between two currencies in the long run will be fixed by their respective purchasing powers in their own nations. Foreign currency is demanded by the people because it has some purchasing power in its own nation. Also domestic currency has a certain purchasing power, because it can buy some amount of goods/services in the domestic economy. Thus, when home currency is exchanged for any foreign currency, in fact the domestic purchasing is being exchanged for the purchasing power, because it can buy some amount of goods/ services in the domestic economy. Thus, when home currency is exchanged for any foreign currency, in fact the domestic purchasing power is being exchanged for the purchasing power of that foreign currency. This exchange of the purchasing power takes place at some specified rare where purchasing of two currencies nations gets equalized. Thus, the relative purchasing power of the two currencies determines the exchange rate. The exchange rate under this theory is in equilibrium when their domestic purchasing powers at that rate of exchanges are equivalent e.g., Suppose certain bundle of goods/ services in U.S.A. costs U.S. $ 10 and the same bundle in India costs, Rs. 450/- then the exchange rate...
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...Trade surplus is an excess of exports over imports. P. 660. vi. Trade deficit is an excess of imports over exports. P. 661. vii. Balanced trade is a situation in which exports equal imports. P. 661. b. Case Study: The Increasing Openness of the U.S. Economy, P. 661. i. Over the last 50 years, both exports and imports as a share of GDP have more than doubled due to improvements in (1) transportation, (2) telecommunications, (3) technological progress and (4) the movement toward freer trade. ii. Figure 1: The Internationalization of the U.S. Economy. P. 661. iii. In the News: The Changing Nature of US Exports, P. 662. c. The Flow of Financial Resources: Net Capital Outflow i. Net Capital Outflow (NCO) is the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners. P. 664. ii. The flow of capital abroad takes two...
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...Chapter 18 (31) Practice Test Multiple Choice Identify the choice that best completes the statement or answers the question. ____ 1. International trade a. | raises the standard of living in all trading countries. | b. | lowers the standard of living in all trading countries. | c. | leaves the standard of living unchanged. | d. | raises the standard of living for importing countries and lowers it for exporting countries. | ____ 2. Net exports of a country are the value of a. | goods and services imported minus the value of goods and services exported. | b. | goods and services exported minus the value of goods and services imported. | c. | goods exported minus the value of goods imported. | d. | goods imported minus the value of goods exported. | Table 31-1 Argentinean Trade Flows | Goods | | Services | | PurchasedAbroad | $40 billion | PurchasedAbroad | $20 billion | Sold Abroad | $10 billion | Sold Abroad | $25 billion | ____ 3. Refer to Table 31-1. What are Argentina’s exports? a. | $60 billion | b. | $35 billion | c. | $10 billion | d. | None of the above are correct. | ____ 4. Refer to Table 31-1. What are Argentina’s imports? a. | $60 billion | b. | $35 billion | c. | $40 billion | d. | None of the above are correct. | ____ 5. Refer to Table 31-1. What are Argentina’s net exports? a. | $30 billion | b. | $5 billion | c. | -$5 billion | d. | -$25 billion | ____ 6. Sonya, a citizen of...
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...observed as emerging market, many investors recognize the potentially attractive return characteristics and diversification benefits of this asset class. However, most pension plans and other institutions currently allocate less than 5% of their overall portfolio to emerging market equities. In Russia there is by now momentous verification of the growth of consumerism throughout the history decade. Parallel trends are observing in China and India, where middle classes growth is very quick. It is anticipated that within a decade, each of BRIC countries will demonstrate higher profits, amplified demand for capital, and stronger state currencies. As a result, overseas firms will desire to observe foremost financial pointers, as Purchasing Power Parity, Gross National Income and Human Development Index, in addition to developments in the cultural, political, and legal environments of those countries The BRIC thesis posits that China and India will become the world's dominant suppliers of manufactured goods and services, respectively, while Brazil and Russia will become similarly Dominant as suppliers of raw materials. It's important to note that the Goldman Sachs thesis isn't that these countries are a political alliance (like the European Union) or a formal trading association - but they have the potential to form a powerful economic bloc. BRIC is now also used as a more generic marketing term...
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...MGEC61 – International Economics: Finance Introduction International finance is a study of problems and policies of an open economy. International finance studies the issues like unemployment, savings, trade imbalances, money and price levels (include exchange rates). Organization of the course 1) Introduction – chapter 13 2) Interest rate parity (how exchange rate is determined by the flows of capital) and exchange rate overshooting – chapters 14 & 15 3) Purchasing power parity and the exchange rate in the long run (how exchange rate is determined by the flows of goods and the determinants of exchange rate in the long run) – chapter 16 4) The DD-AA model (the model that explains how exchange rate and output are determined in general equilibrium setting) – chapters 17 &18 Flexible exchange rate – chapter 17 Fixed exchange rate – chapter 18 5) International macroeconomic policy – chapters 19 & 21 Arguments for and against flexible exchange rates – chapter 19 Interdependence of macroeconomic policies – chapter 19 Arguments for and against common currency – chapter 21 MGEC61 – Chapter 13 © Iris Au 1 Chapter 13: National Income Accounting and the Balance of Payments The National Income Identity for an Open Economy The national income identity for an open economy is: Output (Y) = C + I + G + (EX – IM) A country’s current account (CA) balance shows the difference between exports of goods and services and imports of goods and services (including...
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...Purchasing power parity dates back several centuries but was actually introduced after World War 1. Before the war, gold standards were used but after the war it was difficult to continue this way because speculators were afraid countries would ask for high revenues after devaluing their currencies. Therefore, Cassel developed Purchasing Power Parity during the international policy debate when they were discussing about the nominal exchange rates and what the appropriate level would be. Gustav Cassel has created the modern definition of purchasing power parity; ‘When measured in the same unit, the monies of different countries should have the same purchasing power and command the same basket of goods.’ In simpler terms it means, that in its absolute version, when expressed in a common currency the price levels should be equal worldwide. The theory is developed from the law of one price. The law of one price is the main building block of purchasing power parity. ‘The law states that once converted to a common currency, the same good should sell for the same price in different countries’ (Mkenda 2001 pg 6). That is for any good: P* = SP** Where; P* is the domestic price of the good P** is the foreign price for the good S is the domestic nominal exchange rate. (Mkenda 2001 pg 6-7). Under the law of one price it assumes that the there is perfect competition, hence no transportation costs, trade barriers or tariffs. Purely free trade, which makes the price of goods in...
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...Groupe Ariel SA: Parity Conditions and Cross-Border Valuation Hints to case study questions: 1. Compute the NPV of Ariel-Mexico's recycling equipment in pesos by discounting incremental peso cash flows at a peso discount rate. How this NPV should be translated into Euros? Assume expected future inflation for France is 3% per year. 1.1. Review principles of estimating project cash flows. Suggested reading: Ch. 9 “Capital Budgeting and Cash Flow Analysis” in “Contemporary Financial Management”, 11th ed. by Moyer, McGuigan, and Kretlow. a. Project Net Investment (NINV): NINV=Capital Expenditure-ATSVold , where ATSVold = After-Tax Salvage Value of the old equipment. ATSVold=MVold+BVold-MVoldt , where MVold = Market Value of the old equipment;BVold = Book Value of the old equipment; t = tax rate; BVold-MVoldt = tax gains. b. Project Net Cash Flows (NCF): NCF=∆R-∆O-∆D1-t+∆D-∆NWC, where R = Revenues; O = Operating Costs; D = Depreciation, NWC = Net Working Capital; t = the tax rate. In Case 1, R = 0; NWC = 0. Therefore, NCF=-∆O-∆D1-t+∆D, or NCF=-∆O1-t+t∆D, where t∆D is the depreciation tax shield. c. Specifics of Case 1: i. -∆O = Incremental Cost Savings; -∆O1-t= Incremental Cost Savings after tax ii. ∆D=DNew-DOld, where DNew = Depreciation of the new equipment; DOld = Depreciation of the old equipment. Thus, the depreciation tax shield includes two components: t∆D=tDNew-tDOld, where tDNew...
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...Economics 2410-001 Multiple Choice You have 2 hours to complete the following multiple choice examination. There are a total of 50 questions worth 2 points each. Identify the letter of the choice that best completes the statement or answers the question. You are expected to complete your work in accordance with the honor code. ____ 1. If there are diminishing returns to capital, then a. increases in the capital stock increase output by ever smaller amounts. b. increases in the capital stock eventually decrease output. c. capital produces fewer goods as it ages. d. old ideas are not as useful as new ones. ____ 2. The real exchange rate is the nominal rate exchange defined as foreign currency per dollar times a. U.S. prices minus foreign prices. b. foreign prices divided by U.S. prices. c. prices in the United States divided by foreign prices. d. None of the above is correct. ____ 3. The local Chevrolet dealership has an increase in inventory of 25 cars in 2006. In 2007 it sells all 25 cars. Which of the following statements is correct? a. The full value of the increased inventory will be counted as part of GDP in 2006, and the value of the cars sold in 2007 will not cause 2007 GDP to increase. b. The value of the increased inventory will be counted as part of 2006 GDP and the value of the cars sold in 2007 will increase 2007 GDP. c. The value of the increased inventory will not affect 2006 GDP; instead, the full value of the inventory will...
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...against the €, or the € is said to depreciate against the USD. Point: Appreciation for one country’s currency implies depreciation for the other country’s currency. 2. Foreign Exchange Markets The price of one country’s currency in terms of another country’s currency will be along the vertical axis. Below this is the # of € that must be given up per USD. The quantity of dollars (USD) will be along the horizontal axis. There will be a downward sloping demand for USD and an upward sloping supply of USD. Question: Who demands USD? Answer: European people demand dollars to (and supply €): a) finance their purchases of U.S. goods and services b) purchase U.S. assets and to invest in the U.S. c) visit the U.S. Question: Who supplies USD? Answer: Americans Supply dollars to (and demand €): d) to pay for their imports from Europe e) purchase European assets and to invest in the Europe f) visit Europe The interaction of demand and supply of dollars in foreign exchange markets determines the current equilibrium exchange rate. Point: Exchange rates are mostly market determined. Governments can, and do, intervene and buy or sell foreign exchange in an attempt to alter the...
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...should then equal the difference in the inflation rate between the two countries. Exchange Rates: Nominal exchange rate simple states how much of one currency can be traded for a unit of another currency. The real exchange rate, describes how many of a good or service in one country can be traded for one of that good or service in another country. * For example, a real exchange rate might state how many European bottles of wine can be exchanged for one US bottle of wine. Real exchange rates can be thought of as answering the following question: If you took an item produced domestically, sold it at the domestic market price, exchanged the money you got for the item for foreign currency, and then used that foreign currency to purchase units of the equivalent item produced in the foreign country, how many units of the foreign good would you be able to buy? The units on real exchange rates, therefore, are units of foreign good over units of domestic (home country) good, since real exchange rates show how many foreign goods you can get per unit of domestic...
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...MFI 442 International Finance-Individual Assignments I Name Institution MFI 442 International Finance-Individual Assignments I Most corporations expand beyond their local boundaries to become multinationals. There are myriad reasons behind this (Wells & Wint, 2000). The biggest of all these reasons is to gain access to international markets and perhaps invest in economic zones that have high investment returns as compared to home countries (Fu, 2000). The trend of globalization has made most firms become multinational corporations. The most common method for MNCs is through franchises (Jones, 2005). In line with this, economists have put up theories explaining why businesses expand beyond their national boundaries (Hicks, 2000). My primary objective in this paper, therefore, is to discuss international finance and other macroeconomics policies. To foresee this goal, I will delve into foreign exchange market and operations of multinational corporations (MNCs). Theories Explaining Why Corporations Expand to become Multinationals a). Financial economists have brought forward three key arguments that enumerate why companies expand their operations to global markets. These theories are; the imperfect markets theory, the comparative advantage theory and the product cycle theory (Levi, 2004). i).The Comparative Advantage Theory This theory is among the most important concepts in international trade. It states that economic welfare increases when countries specialize...
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.... 1St Unit – Introduction to International finance ‘A’ section. G01 1) What is the objective of International Business? 2) What is MNC? 3) What are the components of Input market? 4) Name the various sources at the micro level of a company? 5) As for as India is concerned what is the Macro view of foreign flow? 6) What you mean by output market? G02 1) What you mean by sectoral Interdependence? 2) What is Foreign exchange risk and Political risk? 3) How licensing and franchising are different? 4) What motivates International Business? Section B G03. 1) Bring out the various factors of differences leading to interdependence. 2) At the micro level of a company what are the sources of Finances? 3) What are the significance of input market and output market? 4) What is the relevance of international finance to a corporate executive? G04 1. What are the distinguishing features of International finance? 2. What are the key decision areas in International Financial Management? 3. What is market imperfection in international finance? 4. What are the various risks involved in international finance? 5. What is the scope of international finance? Section C G05 1) “The emergence of International trade is attributed to sectoral...
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...Taynan Ramos International Economics Professor Nicole Soto 02/15/15 Exchange Rates With regard to currencies, exchange rates, as well as any other price, are determined by supply and demand. The supply and demand of currencies depends on many factors which can be grouped as follows: * the monetary system, which places the political structure in relation to exchange rates; * economic data as the trade balance, inflation and the national product. Fundamental analysis is based on the observation and evaluation of these economic data, as has been proved in the past, has influenced exchange rates. Taking into account these correlations optimal analysis can be done to give an indication of the long-term trend of exchange rates; * technical factors. historical rate fluctuations and volumes are examined and analyzed. Some models, which are expected to repeat themselves over time, can be used as a predictive criterion for short-term trends (technical analysis); * expectations. activities of financial operators are not the only based on known economic data, but also on their expectations of future trends; * political events / psychological factors, such as elections, political tensions, etc. Fundamental analysis is based on the study of the economy. It is based on the assumption that the supply and demand of currencies is the result of economic processes that can be observed in practice and can be predictable. Fundamental analysis studies the relationship between...
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...Manoa Brown Friday, May 3, 13 Principles of Macroeconomics Exchange Rates People, firms and nation exchange products for money and use the money to buy other products to pay for the use of resources. Within an economy, prices are stated in the domestic currency, such as US dollars to European euros. Buyers use their currency to purchase goods. International markets are different. Producers in other countries who export goods want to be paid in their own currencies so they can carry out transactions. As a result, a foreign exchange market develops where national currencies can be exchanged. Such markets serve the need of all international buyers and sellers. The equilibrium prices in these markets are called exchange rates. An exchange rate is the rate at which the currency of one nation is exchanged for the currency of another. The foreign exchange market is the financial relationship between countries that makes it possible for international trade to be accomplished more efficiently than barter. Because each nation uses its own monetary unit, people in one country who want to purchase something in another country must exchange their own currency for the other to accommodate the transaction. Many travelers will research foreign exchange rates before purchasing cheap airline tickets or other means of travel to other countries. Depending on the destination, some travelers can benefit greatly from exchanging currencies .The foreign exchange market is where one nation's currency...
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...The Depreciation of the RMB against the USD By: Hasnaa Taih Course: ECN 450 Date: 28/03/2011 China has a high level of policy intervention in the depreciation of the Renminbi (RMB) or (CNY). The depreciation of the RMB against the United States of America’s Dollar (USD) puts the USA’s firms and factories at a massive competitive disadvantage (China Currency Overview, 2010). There are two economists’ viewpoints when it comes to the undervaluation or overvaluation of the RMB against the USD and against other world currencies. There are economists that argue that the RMB is overvalued against some world currencies beside the Euro and the USD (Yuan is Overvalued, not Undervalued: report, 2010). Other economists argue that the RMB is undervalued against the USD, and this would be the major focus of this research paper. The RMB’s depreciation allows China to unfairly gain trade advantages over other trading nations. Economists views varies on the level at which the RMB’s undervaluation affect other Chinese trading partners. But most economists agree that currency flexibility would be of great help to decrease global imbalances (China Currency Overview, 2010). This research paper will discuss the different component of the Chinese protectionism policy for its exchange rate, and its effects on other nations such as the USA. The focus will be in showing the advantages and disadvantage for the USA and China in the trading balance. Historical background of the RMB: ...
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