User:Jukeboksi/BBA studies/Economics

“Economics is the social science that analyzes the production, distribution, and consumption of goods and services. ”

~ Wikipedia on economics

“Business economics is a field in applied economics which uses economic theory and quantitative methods to analyze business enterprises and the factors contributing to the diversity of organizational structures and the relationships of firms with labour, capital and product markets.”

~ Wikipedia on business economics

“Taloustiede on yhteiskuntatiede, joka tutkii lähinnä taloudellisia päätöksiä tekevien toimijoiden kannustimia ja käyttäytymistä, sekä niiden perusoletuksista johdettuilla malleilla ja teorioilla erilaisia taloudellisia ilmiöitä. Tavallisia tutkimuksen kohteita ovat hyödykkeiden kulutus, tuotanto ja allokointi, markkinoiden toiminta sekä aina kokonaistalouteen liittyvät kysymykset kuten talouskasvu ja inflaatio. Suomeksi taloustiedettä sanotaan myös kansantaloustieteeksi erotuksena liiketaloustieteestä. ”

~ Suomenkielinen Wikipedia on taloustiede

w:Outline of economics is a good introductory text to economics if you don't know what it comprises and what kind of issues it deals with. Template:Economic systems sidebar

Economics is divided to the study of w:microeconomics an w:macroeconomics with various sub-fields.

w:Microeconomics ( w:fi:Mikrotaloustiede ) (from Greek prefix micro- "μικρό" meaning "small" + "economics"- "οικονομια") is a branch of economics that studies the behavior of individual households and firms in making decisions on the allocation of limited resources. ( Wikipedia )

w:Macroeconmics ( w:fi:Makrotaloustiede ) (from Greek prefix "makros-" meaning "large" + "economics") is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole, rather than individual markets. ( Wikipedia )

Business Economics

Week 43 - Markets, scarcity and decisions

• In w:markets ( w:fi:Markkinat (taloustiede) ) w:demand and supply control the prices and goods that are produced. This is the model of w:Supply and demand ( w:fi:Kysyntä ja tarjonta ) .
• w:Scarcity ( w:fi:Niukkuus ) of resources affects production decisions.
• All production decisions have an w:opportunity cost ( w:fi:Vaihtoehtoiskustannus ).
• w:Market equilibrium ( w:fi:Taloudellinen tasapaino ) refers to a condition where a market price is established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers. ( Wikipedia ) Market equilibrium is where the w:demand curve and the supply curve intersect.

The w:demand curve is the graph depicting the relationship between the price of a certain commodity and the amount of it that consumers are willing and able to purchase at that given price. ( Wikipedia ).

• The w:law of demand is an economic law, which states that consumers buy more of a good when its price is lower and less when its price is higher (w:ceteris paribus). ( Wikipedia )

• w:Substitution effect and w:income effect explain the law of demand

• w:Normal goods are any goods for which demand increases when income increases and falls when income decreases but price remains constant, i.e. with a positive w:income elasticity of demand. ( Wikipedia ) vs. an w:inferior good is a good that decreases in demand when consumer income rises, unlike normal goods, for which the opposite is observed. ( Wikipedia )

Week 44 - Economies of scale, utility, elasticities

w:Economies of scale In microeconomics, economies of scale are the cost advantages that an enterprise obtains due to expansion. There are factors that cause a producer’s average cost per unit to fall as the scale of output is increased. w:Diseconomies of scale are the forces that cause larger firms and governments to produce goods and services at increased per-unit costs. The concept is the opposite of economies of scale. ( Wikipedia )

In economics, w:returns to scale ( w:fi:Skaalaetu ) and economies of scale are related terms that describe what happens as the scale of production increases in the long run, when all input levels including physical capital usage are variable (chosen by the firm).

w:Utility ( w:fi:Hyöty ) to w:consumer is a representation of preferences over some set of goods and services. ( Wikipedia )

w:Marginal utility ( w:fi:Rajahyöty ) - In economics, the marginal utility of a good or service is the gain (or loss) from an increase (or decrease) in the consumption of that good or service. ( Wikipedia )

w:Elasticity (economics) ( w:fi:Jousto ) is the measurement of how changing one economic variable affects others. ( Wikipedia )

w:Price elasticity of demand ( w:fi:Kysynnän hintajousto ) (PED or Ed) is a measure used in economics to show the responsiveness, or elasticity, of the quantity demanded of a good or service to a change in its price. ( Wikipedia )

w:Price elasticity of supply (PES or Es) is a measure used in economics to show the responsiveness, or elasticity, of the quantity supplied of a good or service to a change in its price. ( Wikipedia )

w:Income elasticity of demand ( w:fi:Kysynnän tulojousto ) measures the responsiveness of the demand for a good to a change in the income of the people demanding the good, ceteris paribus.

w:Cross elasticity of demand or cross-price elasticity of demand measures the responsiveness of the demand for a good to a change in the price of another good. ( Wikipedia )

There are more elasticies in the w:Elasticity (economics)

Week 45 - Market structures, competitions and costs

w:Total cost == w:fixed cost + w:variable costs

A w:production function ( w:fi:Tuotantofunktio ) is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs. ( Wikipedia )

w:Marginal product of labor also known as MPL is the change in output that results from employing an added unit of labor.( Wikipedia )

w:Marginal cost ( w:fi:Rajakustannus ) is the change in total cost that arises when the quantity produced changes by one unit. That is, it is the cost of producing one more unit of a good. ( Wikipedia )

w:Average cost or unit cost is equal to total cost divided by the number of goods produced (the output quantity, Q). It is also equal to the sum of average variable costs (total variable costs divided by Q) plus average fixed costs (total fixed costs divided by Q). ( Wikipedia )

w:Market structure is the number of firms producing identical products which are homogeneous. The types of market structures include the following:

• w:Monopolistic competition ( w:fi:Monopolistinen kilpailu ) , also called competitive market, where there is a large number of firms, each having a small proportion of the market share and slightly differentiated products.
• w:Oligopoly ( w:fi:Oligopoli ) , in which a market is dominated by a small number of firms that together control the majority of the market share.
  • w:Duopoly, a special case of an oligopoly with two firms.
• w:Monopsony, when there is only one buyer in a market.
• w:Oligopsony, a market where many sellers can be present but meet only a few buyers.
• w:Monopoly ( w:fi:Monopoli ) , where there is only one provider of a product or service and w:Barriers to entry prohibit entering the market for other businesses.
  • w:Natural monopoly, a monopoly in which w:economies of scale cause efficiency to increase continuously with the size of the firm. A firm is a natural monopoly if it is able to serve the entire market demand at a lower cost than any combination of two or more smaller, more specialized firms.
• w:Perfect competition, a theoretical market structure that features no w:barriers to entry, an unlimited number of producers and consumers, and a perfectly elastic w:demand curve.

All definitions of market structure from Wikipedia article w:market structure

The w:Herfindahl index ( w:fi:Herfindahlin indeksi ) (also known as Herfindahl–Hirschman Index, or HHI) is a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them. ( Wikipedia )

w:Game theory ( w:fi:Peliteoria ) is a study of strategic decision making. More formally, it is "the study of mathematical models of conflict and cooperation between intelligent rational decision-makers."

Week 46 - Macroeconomics

w:Macroeconomics

w:Gross domestic product (GDP) ( w:fi:Bruttokansantuote ) is the market value of all officially recognized final goods and services produced within a country in a given period of time. ( Wikipedia )

w:Circular flow of income or circular flow refer to a simple economic model which describes the reciprocal circulation of income between producers and consumers. ( Wikipedia ) which is used to calculate the GDP.

Consumer expendiatures are divided to the w:services, w:durable goods and w:consumables ( a.k.a. non-durables )

w:Unemployment ( w:fi:Työttömyys )

w:Frictional unemployment

w:Structural unemployment

Cyclical unemployment

w:Business cycle (or economic cycle) ( w:fi:Suhdannevaihtelu ) refers to economy-wide fluctuations in production or economic activity over several months or years. These fluctuations occur around a long-term growth trend, and typically involve shifts over time between periods of relatively rapid economic growth (an expansion or boom), and periods of relative stagnation or decline (a contraction or recession). ( Wikipedia )

w:Consumer price index (CPI) ( w:fi:Kuluttajahintaindeksi ) measures changes in the price level of consumer goods and services purchased by households. ( Wikipedia )

Week 47 - Financial markets, job markets

• w:Financial markets ( w:fi:Rahoitusmarkkinat ) are important for enabling financing of w:investments ( w:fi:Investointi )

• w:Industrial revolution ( 1750-1850 ) ( w:fi:Teollinen vallankumous )

• Economics growth model is affected by w:labor productivity and w:technological change.

• w:Human capital is the stock of competencies, knowledge, social and personality attributes, including creativity, embodied in the ability to perform labor so as to produce economic value. ( Wikipedia )

• w:Creative destruction ( w:fi:Luova tuho ), sometimes known as Schumpeter's gale, is a term in w:economics which has since the 1950s become most readily identified with the Austrian American economist w:Joseph Schumpeter,who adapted it from the work of w:Karl Marx and popularized it as a theory of economic innovation and the w:business cycle.

• Lack of w:Property rights (economics) and w:rule of law is keeping the poor countries poor.

Notes

Chapter 3

• Demand schedule != demand curve. Demand schedule is a table, not a curve
• In w:economics, a complementary good is a good ( w:fi:Investointi ) with a negative w:cross elasticity of demand, in contrast to a w:substitute good.
• w:Normal goods are any goods for which demand increases when income increases and falls when income decreases but price remains constant, i.e. with a positive income elasticity of demand. ( Wikipedia )

Chapter 6

• A w:budget constraint represents the combinations of goods and services that a consumer can purchase given current prices with his or her income. ( Wikipedia )
• A w:Giffen good ( w:fi:Investointi ) is one which people paradoxically consume more of as the price rises, violating the law of demand. In normal situations, as the price of a good rises, the substitution effect causes consumers to purchase less of it and more of substitute goods. In the Giffen good situation, the income effect dominates, leading people to buy more of the good, even as its price rises. ( Wikipedia )
• In economics and business, a w:network effect ( w:fi:Verkostovaikutus ) (also called network externality or demand-side economies of scale) is the effect that one user of a good or service has on the value of that product to other people.
• w:Path dependence ( w:fi:Polkuriippuvuus ) explains how the set of decisions one faces for any given circumstance is limited by the decisions one has made in the past, even though past circumstances may no longer be relevant. ( Wikipedia )
• w:Sunk costs are retrospective (past) costs that have already been incurred and cannot be recovered. ( Wikipedia )

Chapter 10

w:Allocative efficiency ( w:fi:Allokointitehokkuus ) is a type of economic efficiency in which economy/producers produce only those types of goods and services that are more desirable in the society and also in high demand.( Wikipedia )

Chapter 13

w:Potential output (also referred to as "natural gross domestic product" or "Potential GDP")) refers to the highest level of real Gross Domestic Product output that can be sustained over the long term. ( Wikipedia + term Potential GDP as per book )

Chapter 16

• w:Procyclical is a term used in economics to describe how an economic quantity is related to economic fluctuations. It is the opposite of countercyclical. However, it has more than one meaning. ( Wikipedia )
• w:Monetarism ( w:fi:Monetaristinen taloustiede ) is a tendency in economic thought that emphasizes the role of governments in controlling the amount of money in circulation. It is the view within monetary economics that variation in the money supply has major influences on national output in the short run and the price level over longer periods and that objectives of monetary policy are best met by targeting the growth rate of the money supply. ( Wikipedia )
• w:Taylor rule is a monetary-policy rul

More information

• w:Category:Business economics ( w:Business economics is much wider definition then we had. )
• w:Category:Commerce ( w:Commerce )

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International Economics

Week 35 - Trade overview

• Business cycles (or economic cycles) refer to economy-wide fluctuations in production, trade and economic activity in general over several months or years in an economy organized on free-enterprise principles. ( Wikipedia )

• Keynesian economics (keɪnziən) or Keynesianism is the view that in the short run, especially during recessions, economic output is strongly influenced by aggregate demand (total spending in the economy). ( Wikipedia )

• Monetarism is a school of economic thought that emphasizes the role of governments in controlling the amount of money in circulation. It is the view within monetary economics that variation in the money supply has major influences on national output in the short run and the price level over longer periods and that objectives of monetary policy are best met by targeting the growth rate of the money supply. ( Wikipedia )

• w:Exchange rate policy or an exchange-rate regime is the way an authority manages its currency in relation to other currencies and the foreign exchange market. It is closely related to monetary policy and the two are generally dependent on many of the same factors. ( Wikipedia )

• A w:Taylor rule is a monetary-policy rule in economics that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. ( Wikipedia )

Template:Foreign exchange Template:International trade

Week 36 - Classical trade theories

• “Factors of production are the inputs to the production process. Finished goods are the output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function. There are three basic (AKA classical) factors of production: land, labor, capital”

  ~ Wikipedia on factors of production

• Gross domestic product (GDP) is the market value of all officially recognized final goods and services produced within a country in a given period of time. GDP per capita is often considered an indicator of a country's standard of living ( Wikipedia )

• David Ricardo (18 April 1772 – 11 September 1823) was a British political economist. He was often credited with systematizing economics, and was one of the most influential of the classical economists, along with Thomas Malthus, Adam Smith, and John Stuart Mill... ( Wikipedia )

• International trade is the exchange of capital, goods, and services across international borders or territories ( Wikipedia )

• • History of international trade

• Income distribution is how a nation’s total GDP is distributed amongst its population. Income and distribution has always been a central concern of economic theory and economic policy. Classical economists such as Adam Smith, Thomas Malthus and David Ricardo were mainly concerned with factor income distribution, that is, the distribution of income between the main factors of production, land, labour and capital. ( Wikipedia )

• Exchange rates

• Terms of trade (TOT) refers to the relative price of exports in terms of imports. It can be interpreted as the amount of import goods an economy can purchase per unit of export goods. ( Wikipedia )

• Devaluation in modern monetary policy is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged. ( Wikipedia )

• Productivity is the ratio of output to inputs in production; it is a measure of the efficiency of production. ( Wikipedia )
  • Sources of productivity

• w:Heckscher-Ohlin can refer to either
  • Heckscher–Ohlin model (H–O model) is a general equilibrium mathematical model of international trade, developed by Eli Heckscher and Bertil Ohlin at the Stockholm School of Economics. It builds on David Ricardo's theory of comparative advantage by predicting patterns of commerce and production based on the factor endowments of a trading region.
  • Heckscher–Ohlin theorem is one of the four critical theorems of the Heckscher–Ohlin model. It states that a country will export goods that use its abundant factors intensively, and import goods that use its scarce factors intensively.

• Comparative advantage refers to the ability of a party to produce a particular good or service at a lower marginal and opportunity cost over another. ( Wikipedia )

Week 37 - Modern trade theories, trade policy

• Vernon's Product life-cycle theory is an economic theory that was developed by Raymond Vernon in response to the failure of the Heckscher-Ohlin model to explain the observed pattern of international trade. The theory suggests that early in a product's life-cycle all the parts and labor associated with that product come from the area in which it was invented. After the product becomes adopted and used in the world markets, production gradually moves away from the point of origin. ( Wikipedia )

• Economies of scope are conceptually similar to economies of scale. Whereas economies of scale for a firm primarily refers to reductions in the average cost (cost per unit) associated with increasing the scale of production for a single product type, economies of scope refers to lowering the average cost for a firm in producing two or more products.

• In economics, internalization can refer to the practice of multinational enterprises (MNEs) to execute transactions within their organization rather than relying on an outside market. ( Wikipedia )

• The eclectic paradigm is a theory in economics and is also known as the OLI-Model or OLI-Framework. It is a further development of the theory of internalization and published by John H. Dunning in 1980. ( Wikipedia )

Export based methods

indirect w:exporting is done by

1. ) An export house buys products from a domestic firm and sells them abroad on its own account ( teacher )
2. ) A w:confirming house is a specialised UK agency that purchases and arranges the w:export of goods on the behalf of overseas buyers. They finance the movement of goods into the country by offering short-term credit to importers and guaranteeing, or confirming, payment to the suppliers in the suppliers own domestic currency. The confirming house usually negotiates the price with the suppliers, ships, insures and provides information on the goods on the overseas buyers behalf. ( Wikipedia )
3. ) A buying house performs similar functions to those of the confirming house but is more active in seeking out sellers to match the buyer’s particular needs ( teacher )

In direct exporting a firm is distributing and selling its own products to the foreign market

Non-equity methods

A firm sells technology or know-how under some form of contract, often involving patents, trademarks and copyrights (intellectual property rights) ( teacher )

1. ) licensing
2. ) franchising
3. ) management contracting
4. ) technical service agreements
5. ) strategic alliances

Trade policy

“A commercial policy (also referred to as a trade policy or international trade policy) is a set of rules and regulations that are intended to change international trade flows, particularly to restrict imports.”

~ Wikipedia on trade policy

• Various instruments of trade policy: including tariffs, quotas, export subsidies, voluntary export restraints and local content requirements.

• The effects of these policies on prices and trade volumes

• Consumer and producer surplus: welfare effects of various protectionist measures

• The political economy of trade theory: why certain restrictions exist

• Optimum tariff: countries can improve their terms of trade and their national welfare
• If labor market is not functioning properly (market failure), the theory of second best, marginal social benefit - considerations of income distribution

• GATT, WTO, customs union, free trade areas

Week 39 - Finance

Finance is the science of funds management, or the allocation of assets and liabilities over time under conditions of certainty and uncertainty. A key point in finance is the time value of money, which states that a unit of currency today is worth more than the same unit of currency tomorrow. Finance aims to price assets based on their risk level, and expected rate of return. Finance can be broken into three different sub categories: public finance, corporate finance and personal finance. ( Wikipedia ) What financial managers do?

• Treasurer: company – markets, external
• Controller / comptroller: business units, internal
• Others: Credit manager, cash management, risk management, insurance management

• Markets

• money market: < 1 year
• capital market: > 1 year

Price of money: Interest rate + bank margin|

Markets in Financial Instruments Directive (MiFID)

Markets in Financial Instruments Directive (MiFID)

Financial analysis

• Financial analysis (also referred to as financial statement analysis or accounting analysis or Analysis of finance) refers to an assessment of the viability, stability and profitability of a business, sub-business or project. ( Wikipedia )

• balance sheet, profit and loss account

• horizontal: trend over the years
• vertical: internal structure of balance sheet or income statement

• ratio analysis: liquidity, activity, leverage, profitability, market value

Why? because markets make valuations based on financial analysis.

• Financial forecasting, budgeting

• sales, production, inventory, materials, labor, factory overhead, selling and administrative expenses -> pro forma income statement
• financial budget: cash budget, pro forma balance sheet

Balance sheet items

• working capital == current assets ~ what you have (liquid)
• current assets == cash, accounts receivable, inventory
• total assets == current assets (fairly liquid) + capital assets (machines, equipment, not liquid)

• Liabilities|:

• • current| (short term)
  • long-term|, stockholders equity|

• Current liabilities ~ what you owe (short term)

• Trade credit == accounts payable

• Bank loans

• Bankers’ acceptances

• commercial finance company loans

• commercial paper

• receivable financing

• inventory financing

• Time value of money: especially when long-term financing, -> interest

• future values (compounding)
• present values (discounting)

Risk, return and valuation

• Risk, return and valuation

• probability, “expected”

• measuring: standard deviation

• business risk, liquidity risk, default risk, market risk, interest rate risk, purchasing power risk (inflation)

Risk of a portfolio| (combination of several items)

• portfolio return, risk: correlation

• diversifiable risk (using correlation information) + nondiversifiable risk (not unique to a given security)

• business, liquidity, default: diversifiable

• market, interest rate, inflation: nondiversifiable

• Capital asset pricing model (CAPM), APM

Bond and stock valuation

Bond and stock valuation

• bond: present value of periodical interest payments + principal

• stock: present value of periodical dividends

• what is the discounting rate? interest rate? rate of return?

Capital budgeting, long-term financial decisions

Capital budgeting, long-term financial decisions

• discounting

Cash flow forecasting or cash flow management is a key aspect of financial management of a business, planning its future cash requirements to avoid a crisis of liquidity. ( Wikipedia )

• measuring (planning, guessing) cash flows: future!

• payback period, NPV, IRR, profitability index

• mutually exclusive investments

• lease-purchase decision

• capital budgeting and inflation

Capital budgeting under risk

• probability distributions, risk-adjusted discount rate, certainty equivalent, simulation, sensitivity analysis, probability trees

Cost of capital?

• cost of debt

• cost of equity capital

Leverage and capital structure

• leverage? since fixed costs

• break-even analysis'

does capital structure matter?

International finance

The world of international finance

• growth of international trade versus domestic trade

• increased globalization of financial and real-asset markets

• increased volatility of exchange rates

• increased importance of multinational corporations and transnational alliances

• The markets for foreign exchange

An introduction to exchange rates

• spot foreign exchange market

• direct versus indirect exchange and cross exchange rates

Forward market

• forward exchange premiums and discounts

• forward rates versus expected future spot rates

• flexibility of forward exchange

• forward quotation|s

Currency futures and options markets

• currency future

• futures contracts versus forward contracts

• • A futures contract (more colloquially, futures) is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality for a price agreed upon today (the futures price or strike price) with delivery and payment occurring at a specified future date, the delivery date. ( Wikipedia )
  • A forward contract or simply a forward is a non-standardized contract between two parties to buy or to sell an asset at a specified future time at a price agreed upon today. ( Wikipedia )

• currency options

Week 40 - Exchange rate determination

• Trade balance == exports - imports

>0 leads to spot rate revaluation

<0 leads to spot rate devaluation

• Balance of payments (BoP) accounts are an accounting record of all monetary transactions between a country and the rest of the world. These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers. ( Wikipedia )

• Current account is one of the two primary components of the balance of payments, the other being capital account. It is the sum of the balance of trade (i.e., net revenue on exports minus payments for imports), factor income (earnings on foreign investments minus payments made to foreign investors) and cash transfers. ( Wikipedia )

• Capital account (also known as financial account) is one of two primary components of the balance of payments, the other being the current account. Whereas the current account reflects a nation's net income, the capital account reflects net change in ownership of national assets. ( Wikipedia )

• Spot market or cash market is a public financial market, in which financial instruments or commodities are traded for immediate delivery. It contrasts with a futures market in which delivery is due at a later date. ( Wikipedia )

• Spread is the difference in price between related securities ( Wikipedia )

• Interest rate parity is a no-arbitrage condition representing an equilibrium state under which investors will be indifferent to interest rates available on bank deposits in two countries. ( Wikipedia )

• A futures market, a futures exchange or futures market is a central financial exchange where people can trade standardized futures contracts; that is, a contract to buy specific quantities of a commodity or financial instrument at a specified price with delivery| set at a specified time in the future. ( Wikipedia )

• • The forward exchange market is a market for contracts that ensure the future delivery of a foreign currency at a specified exchange rate. The price of a forward contract is known as the forward price. ( Wikipedia )
  • The forward price (or sometimes forward rate) is the agreed upon price of an asset in a forward contract. ( Wikipedia )

• Arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices. ( Wikipedia )

Week 41 - Risk and risk management

Risk and risk management

Risk is the potential of loss (an undesirable outcome, however not necessarily so) resulting from a given action, activity and/or inaction. ( Wikipedia )

Risk management is the identification, assessment, and prioritization of risks| (defined in ISO 31000 as the effect of uncertainty on objectives, whether positive or negative) followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events ( Wikipedia )

'Managing foreign exchange risk and exposure

• using international financial market to deal with the special opportunities and risks of international trade and investments

• foreign exchange exposure – a measure of the sensitivity of changes in domestic currency values of assets, liabilities, or operating incomes to unanticipated changes in exchange rates

• both domestic and foreign financial instruments and incomes can face foreign exchange exposure

• exchange rate risk: variability of domestic-currency values of assets, liabilities, and incomes

• exchange rate exposure: the amount at risk

• international accounting principles: in financial statements accounting exposure – real exposure is the underlying exposure

• the effect of exchange rates on sales and operating profitability: operating exposure

• management of exposure and risk: means of dealing with risk and exposure – hedging

Risk management

• it is possible to use borrowing, investing, and the spot exchange market to achieve the same result as would be obtained by using the forward market

• importer that must pay its currency trade loan within 30 days: borrow in home currency (€, 30 days), buy the foreign exchange on the spot market ($), invest in foreign exchange (in New York, for 30 days), use foreign currency for paying the trade loan ($, after 30 days), and repay the domestic currency debt (€, after 30 days)

• exporter that receives a foreign-currency payment after 60 days: borrow in the foreign currency that is to received ($, 60 days), sell the borrowed foreign currency spot ($ à €), invest or otherwise employ domestic currency at home (€, 60 days), receive the payment from abroad ($ after 60 days), and repay the foreign currency debt with export earnings ($ after 60 days)

• hedging via currency of invoicing – by invoicing in own currency: no transaction risk nor exposure but the economic exposure still remains (if exchange rates change, the customer abroad faces changed prices, and according to price elasticity, the quantity demanded will change)

• hedging via mixed-currency invoicing – composite currency (SDR), currency baskets (e.g. ½ dollars, ½euros) or ”cocktails”, usually this results in risk and exposure reduction since they offer some diversification risk (if the value of dollar goes up, usually the value of euro goes down)

• hedging via selection of supplying country: sourcing – use domestic inputs or inputs from EMU-area

• Use forwards' or currency options

Home exam

1. ) Explain why neighboring countries tend to trade extensively with each other.
2. ) Compare Ricardo’s comparative advantage theory and Heckscher-Ohlin endowment model as explanations for international trade.
3. ) Vernon’s product life-cycle theory explaining exports.
4. ) External economies of scale explaining intraindustry trade.
5. ) What are the welfare effects of w:tariffs?
6. ) What are various forms of trade barriers?
7. ) Arguments for protection(ism).
8. ) Compare predatory dumping and international price discrimination.
9. ) Preferential trade arrangements.
10. ) Why there is foreign exchange risk?
11. ) How is private saving related to the current account?
12. ) Compare spot rates, forward rates and swaps.
13. ) Explain how a call (foreign-currency) option is useful in international trade.
14. ) Explain how a put (foreign-currency) option is useful in international trade.
15. ) Purchasing power parity and interest parity explaining exchange forward exchange rates.
16. ) What are the three concepts of exchange rate exposure?
17. ) What are the causes of currency crises?
18. ) What is the Marshall-Lerner condition?
19. ) Different approaches to the balance of payments.
20. ) The monetary approach explaining exchange rates.

Finance

• Finance