International Finance Exam 1 Notes PDF

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Topic 1:  The evolution of credit and debt was an important as any technological innovation in the rise of civilization  The theory of comparative advantage states that every country should specialize and produce only those products which it can produce relatively cheaper than other countries  Heavy specialization may be good for business, but bad for the psyche  Labor abundant countries will export labor intensive products while well-educated, human-capital intensive countries will export high tech products  Multinational corporations use unit labor costs to determine where to locate labor intensive production abroad  Unit labor costs = ($/output)/(output/hour) = $/output  A country has an absolute advantage in the production of a product when it is more efficient than any other country in producing it  4 rules: 1. Global markets are the most competitive 2. More price volatility 3. Competition drives market to equilibrium 4. Equilibrium markets become predictable  2 indicators of the strength of the US economy: stock market rising, and the labor unemployment rate falling  Market price does not reveal gains from trade  Gain to the buyer = their maximum willingness to pay or “reserve price” less the market price they pay, the gain to the seller = the market price they pay less their minimum acceptable “reserve price”  Demand curve represents the maximum willingness to pay by all buyers while the supply curve represents the minimum willingness to accept by all sellers  US has high costs relative to the industry and a low profit margin it should sell to the US market  You will have greater money trading in highly volatile markets compared to calm markets  The best predictor of the value of the Euro tomorrow is today’s price  2008 value of the dollar was at a low  After big stock market crashes, US unemployment rates start to rise Topic 2:  Domesticated wolves were the first lawyers  Invention of private property was the greatest social breakthrough in human history allowed economic specialization, growth of cities  The word pecunia (pecuniary, relating to money) came to mean land rather than money  Shortages of money for millennia have also led to war  Money is more efficient than barter  Major social institutions are barter inefficient: job markets, relationships  Business deals are like barter  Quantitative easing: increasing the money supply to stimulate exports and limit imports  Gresham’s Law: “bad money drives out good money”  The strong Euro plus Greece’s high unit labor costs prevents it from exporting its goods both within Europe and outside Europe. Greece would be much better with its own currency that it could depreciate and become competitive globally Topic 3:  Credits are cash flows into the US, Debits are cash flows out of the US  Increased US exports (credits) strengthen the $ and increased US imports (debits) weaken the $  Current account deficits: M-X = [(G-T) + (I-S)] o M = imports, S = savings, T = taxes, X = exports, I = producing investment goods, G = producing government services  A drop in the FX rate causes the trade balance to go down initially and then go up eventually  Current account balance = Exports – Imports Topic 4  Milton Friedman said economic freedom was more important than political freedman for an economy  Globalization increases wage equality in the world but increases inequality in the advanced countries

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Three winners globally (US, Japan, Germany) have economic freedom and a strong rule of law. Share of world output US 24% Japan 6% Germany 5% China 15% (not politically free) US trade deficit increases as the $ gets stronger Economic downturns have historically led to trade wars and declines in global trade The world’s most valuable resource is no longer oil, but IP and data

   Topic 5  Three functions of money: Medium of exchange (cash is easier barter), Unit of account function (money a measuring stick of value) , and Store of value (money can be held as an asset like gold)  Reserve currencies are defined as what central banks settle balance of payments imbalances with. The $ replaced gold after 1945 as the world’s reserve currency  Currency ETFs facilitate investing in currencies  Foreign exchange markets open first each morning in the world in Wellington Topic 6  Graham Allison says war with China is a “yes” the “Thucydides Trap”  Five country risks: economic risks, financial risk, regulatory/legal risk, political risk, and social risk  Three ways analysts quantify country risks: competitiveness rankings of countries, moody’s country risk ratings, and sovereign risk: syndicated loan markups over LIBOR  Operational hedges for country risk: geographic diversification, minimize exposure, and insure with US OPIC (Overseas Private Investment Corporation)  Risk premium reflects default risk in the markup over US treasuries for London’s syndicated Topic 7  Ken Rogoff and Carmen Reinhart found that large increases in debt precede financial bubbles  Recessions start after actual GDP rises to potential GDP: that happened in Sept 2018  Recessions average about every 7 years  We have had 3 deep recessions since 1970: low risk now of deep one Topic 8  Availability heuristic: people give greater weight to latest news if all talking heads say things are bad  In recessions, businesses are excessively risk averse while in booms they take excessive risks. To counter this, smart people do “contrarian investing”  Reasons inflation still below the FED’s target of 2% o China and import competition keeps US prices low, labor unions weak, consumer comparison shopping on the internet, low price expectations after a decade of low prices, oil prices have fallen and are lower recently, reduced US income  Deflation is self-reinforcing. With negative inflation, people postpone consumption another year, thinking they can buy cheaper next year  Quantity theory of money: MV = PQ o M = money, V = velocity, P = price, Q = output o Q real GDP, PQ nominal GDP...