International Business and Trade Terminology PDF

TERMINOLOGY International portfolio investment refers to the passive ownership of foreign securities such as stocks and bonds to International Business and Trade - consists of...

TERMINOLOGY International portfolio investment refers to the passive ownership of foreign securities such as stocks and bonds to International Business and Trade - consists of gain financial returns. The foreign investor has a relatively transactions that are devised and carried out across short-term interest in the ownership of these assets. national borders to satisfy the objectives of individuals, companies, and organizations. Foreign Direct Investment (FDI) is an internationalization strategy in which the firm establishes a physical presence Foreign Direct Investment - is a company’s physical abroad through acquisition of productive assets such as investment such as into the building and facilities in the land, plant, equipment, capital, and technology. foreign country, and acts as a domestic business with a full scale of activity. Companies practice FDI to get benefits THE FOUR RISKS IN INTERNATIONALIZATION from cheaper labor costs, tax exemptions, and other Cross-cultural risk occurs when a cultural privileges in that foreign country. misunderstanding puts some human value at stake. Cross- Globalization - the process by which businesses or other cultural risk arises from differences in language, lifestyles, organizations develop international influence or start mind-sets, customs, and religion. Values unique to a operating on an international scale culture tend to be long lasting and transmitted from one generation to the next. Values influence the mind-set and International business refers to the overall performance of work style of employees and the shopping patterns of the trade and investment activities of firms across national buyers. borders. International business is characterized by six major dimensions. Country risk (also known as political risk) refers to the potentially adverse effects on company operations and A. International Trade profitability caused by developments in the political, legal, B. International Investment and economic environment in a foreign country. Country C. International Business Risks risk includes the possibility of foreign government D. Participants intervention in firms’ business activities. E. Foreign Market Strategies F. Globalization of Markets Currency risk (also known as financial risk) refers to the risk of adverse fluctuations in exchange rates. Fluctuation Globalization is a macro-trend of intense economic is common for exchange rates—the value of one currency in interconnectedness among the nations of the world. A terms of another. Currency risk arises because parallel trend is the ongoing internationalization of international transactions are often conducted in more countless firms and dramatic growth in the volume and than one national currency. variety of cross-border transactions in goods, services, and capital flows. Internationalization refers to the tendency of Commercial risk refers to the firm’s potential loss or failure companies to deepen their international business activities from poorly developed or executed business strategies, systematically. It has led to widespread diffusion of tactics, or procedures. Managers may make poor choices in products, technology, and knowledge worldwide. such areas as the selection of business partners, timing of market entry, pricing, creation of product features, and International trade describes the exchange of products promotional themes. Although such failures also exist in (merchandise) and services (intangibles) across national domestic business, the consequences are usually more borders. Exchange can occur through exporting, the sale of costly when committed abroad. products or services to customers located abroad from a base in the home country or a third country. WHO PARTICIPATES IN INTERNATIONAL BUSINESS? Exchange also can take the form of importing or global A focal firm is the initiator of an international business sourcing—the procurement of products or services from transaction; it conceives, designs, and produces offerings suppliers located abroad for consumption in the home intended for consumption by customers worldwide. Focal country or a third country. While exporting represents the firms take center stage in international business. outbound flow of products and services, importing is an A distribution channel intermediary is a specialist firm inbound activity. Both finished products and intermediate that provides various logistics and marketing services for goods (for example, raw materials and components) can be focal firms as part of international supply chains, both in the imported and exported focal firm’s home country and abroad. International investment refers to the transfer of assets to A facilitator is a firm or an individual with special expertise another country or the acquisition of assets in that country. in banking, legal advice, customs clearance, or related The two essential types of cross-border investment: support services that helps focal firms perform Financial Institution- is a company engaged in the international business transactions. business of dealing with financial and monetary transactions such as deposits, loans, investments, Governments, or the public sector, are also active in and currency exchange. international business as suppliers, buyers, and regulators. State-owned enterprises account for a substantial portion THE INTERNATIONAL FINANCIAL ENVIRONMENT (MNC) of economic value added in many countries, even rapidly liberalizing emerging markets such as Russia, China, and Multinational corporations (MNCs) are defined as firms Brazil. that engage in some form of international business. Their managers conduct international financial management, WHY DO FIRMS INTERNATIONALIZE? which involves international investing and financing decisions that are intended to maximize the value of the There are multiple motives for international expansion, MNC. The goal of their managers is to maximize the value of some strategic in nature, others reactive. An example of a the firm, which is similar to the goal of managers employed strategic, or proactive, motive is to tap foreign market by domestic companies. opportunities or to acquire new knowledge. An example of a reactive motive is the need to serve a key customer that Managing the MNC has expanded abroad. Specific motivations include the following: Facing Agency Problems Managers of an MNC may make decisions that conflict with the firm’s goal to maximize 1. Seek opportunities for growth through market shareholder wealth. This conflict of goals between a firm’s diversification. managers and shareholders is often referred to as the 2. Earn higher margins and profits. agency problem. 3. Gain new ideas about products, services, and business methods. Parent Control of Agency Problems. The parent can 4. Serve key customers better that have relocated oversee the subsidiary decisions to check whether the abroad. subsidiary managers are satisfying the MNC’s goals. The 5. Be closer to supply sources, benefit from global parent can also implement compensation plans that sourcing advantages, or gain flexibility in product reward the subsidiary managers who satisfy the MNC’s sourcing. goals. A common incentive is to provide managers with the 6. Gain access to lower-cost or better-value factors of MNC’s stock (or options to buy the stock at a fixed price) as production. part of their compensation, so that they benefit directly 7. Develop economies of scale in sourcing, from a higher stock price when they make decisions that production, marketing, and R&D. enhance the MNC’s value. 8. Confront international competitors more Corporate Control of Agency Problems. There are also effectively or thwart the growth of competition in various forms of corporate control that can help prevent the home market. agency problems and therefore ensure that managers make 9. Invest in a potentially rewarding relationship with a decisions to satisfy the MNC’s shareholders. If the MNC’s foreign partner. managers make poor decisions that reduce its value, TERMINOLOGY another firm may be able to acquire it at a low price and will likely remove the weak managers. They may attempt to Deposit – a sum of money paid into bank or enact changes in a poorly performing MNC, such as the building society account. removal of high-level managers or even board members. Loan – an act of lending something to someone or The institutional investors may even work together when to some establishment. Loan is any property or demanding changes in an MNC because an MNC would not money which is borrowed to someone or to an want to lose all of its major shareholders. establishment, which is expected to be paid back Theory of Comparative Advantage with interest. Interest – Interest is the money paid regularly at a Imperfect Markets Theory The unrestricted mobility of particular rate for the use of money lent, or for factors would create equality in costs and returns and delaying the repayment of a debt or loan. remove the comparative cost advantage, the rationale for Lender – the lender is an organization or an international trade and investment. However, the real world individual that borrows money in financial suffers from imperfect market conditions where factors of institution. production are somewhat immobile. There are costs and often restrictions related to the transfer of labor and other period t are equal to the sum of the products of cash flows resources used for production. denominated in each currency j times the expected exchange rate at which currency j could be converted into Product Cycle Theory One of the more popular dollars by the MNC at the end of period t. explanations as to why firms evolve into MNCs is the product cycle theory. According to this theory, firms TERMINOLOGY become established in the home market as a result of some perceived advantage over existing competitors, such as a Capital- a bank’s capital can be trough of as the need by the market for at least one more supplier of the margin to which creditors are covered if the bank product. Because information about markets and would liquidate its assets. competition is more readily available at home, a firm is Funds – all the financial resources of the firm, such likely to establish itself first in its home country. as cash in hand, bank balance, account receivable. Any change in these resources is reflected in the International Trade firm’s financial position. Stocks and Bonds – the difference between stocks International trade is a relatively conservative approach and bonds is that stocks are shares in the that can be used by firms to penetrate markets (by ownership of a business, while bond are a form of exporting) or to obtain supplies at a low cost (by importing). debt that the issuing entity promises to repay at Licensing obligates a firm to provide its technology some point in the future. (copyrights, patents, trademarks, or trade names) in Network- a group or a system of interconnected exchange for fees or some other specified benefits. people or thing Franchising obligates a firm to provide a specialized sales International Flow of Funds or service strategy, support assistance, and possibly an Financial managers of MNCs monitor the balance of initial investment in the franchise in exchange for periodic payments so that they can determine how the flow of fees. international transactions is changing over time. The A Joint Venture is a venture that is jointly owned and balance of payments can indicate the volume of operated by two or more firms. Many firms penetrate foreign transactions between specific countries and may even markets by engaging in a joint venture with firms that reside signal potential shifts in specific exchange rates. in those markets. Balance of Payments Establishing New Foreign Subsidiaries. Firms can also The balance of payments is a summary of transactions penetrate foreign markets by establishing new operations in between domestic and foreign residents for a specific foreign countries to produce and sell their products. Like a country over a specified period of time. It represents an foreign acquisition, this method requires a large accounting of a country’s international transactions for a investment. period, usually a quarter or a year. Valuation Model for an MNC The value of an MNC is The Current Account represents a summary of the flow of relevant to its shareholders and its debt holders. When funds between one specified country and all other managers make decisions that maximize the value of the countries due to purchases of goods or services, or the firm, they maximize shareholder wealth (assuming that the provision of income on financial assets. decisions are not intended to maximize the wealth of debtholders at the expense of shareholders). Payments for Merchandise and Services. Domestic Model Before modeling an MNC’s value, Merchandise exports and imports represent consider the valuation of a purely domestic firm that does tangible products, such as computers and not engage in any foreign transactions. The value (V) of a clothing, that are transported between countries. purely domestic firm in the United States is commonly Service exports and imports represent tourism and specified as the present value of its expected cash flows, other services, such as legal, insurance, and where the discount rate used reflects the weighted average consulting services, provided for customers based cost of capital and represents the required rate of return by in other countries. The difference between total investors exports and imports is referred to as the balance of trade. Valuing International Cash Flows The foreign currency Factor Income Payments. A second component cash flows will be converted into dollars. Thus, the of the current account is factor income, which expected dollar cash flows to be received at the end of represents income (interest and dividend  payments) received by investors on foreign 4. The firms in one country receive subsidies from the investments in financial assets (securities). government, as long as they export the products. Transfer Payments. A third component of the These firms may be able to sell their products at a current account is Transfer payments, which lower price than any of their competitors in other represent aid, grants, and gifts from one country to countries. another. 5. The firms in one country receive tax breaks if they are in specific industries. This practice is not The Capital Account represents a summary of the flow of necessarily a subsidy, but it still is a form of funds resulting from the sale of assets between one government financial support. specified country and all other countries over a specified period of time. Using the Exchange Rate as a Policy. At any given point in time, a group of exporters may claim that they are being Direct Foreign Investment. Direct foreign mistreated and lobby their government to adjust the investment represents the investment in fixed currency so that their exports will not be so expensive for assets in foreign countries that can be used to foreign purchasers. conduct business operations. Portfolio Investment. Portfolio investment Outsourcing affects the balance of trade because it means represents transactions involving long-term that a service is purchased in another country. This form of financial assets (such as stocks and bonds) international trade allows MNCs to conduct operations at a between countries that do not affect the transfer of lower cost. control. Using Trade Policies for Political Reasons. International Other Capital Investment. A third component of trade policy issues have become even more contentious the financial account consists of other capital over time as people have come to expect that trade policies investment, which represents transactions will be used to punish countries for various actions. People involving short-term financial assets (such as expect countries to restrict imports from countries that fail money market securities) between countries. to enforce environmental laws or child labor laws, initiate Errors and Omissions and Reserves. If a country has a war against another country, or are unwilling to participate negative current account balance, it should have a positive in a war against an unlawful dictator of another country. capital and financial account balance. This implies that Factors Affecting International Trade Flows while it sends more money out of the country than it receives from other countries for trade and factor income, it Impact of Inflation- If a country’s inflation rate increases receives more money from other countries than it spends relative to the countries with which it trades, its current for capital and financial account components, such as account will be expected to decrease, other things being investments. equal. Trade Friction Impact of National Income - If a country’s income level (national income) increases by a higher percentage than International trade policies partially determine which those of other countries, its current account is expected to firms get most of the market share within an industry. These decrease, other things being equal. As the real income level policies affect each country’s unemployment level, income (adjusted for inflation) rises, so does consumption of goods level, and economic growth. Consider the following situations that commonly occur: Impact of Exchange Rates- Each country’s currency is valued in terms of other currencies through the use of 1. The firms based in one country are not subject to exchange rates, so that currencies can be exchanged to environmental restrictions and, therefore, can facilitate international transactions. As the currency produce at a lower cost than firms in other strengthens, goods exported by that country will become countries. more expensive to the importing countries. As a 2. The firms based in one country are not subject to consequence, the demand for such goods will decrease. child labor laws and are able to produce products at a lower cost than firms in other countries by Factors Affecting International Trade Flows relying mostly on children to produce the products. Impact of Government Policies- A country’s government 3. The firms based in one country are allowed by their can have a major effect on its balance of trade due to its government to offer bribes to large customers when pursuing business deals in a particular policies on subsidizing exporters, restrictions on imports, or lack of enforcement on piracy. industry.  Interest Rates. Portfolio investment can also be affected by interest rates. Money tends to flow to Subsidies for Exporters. Some governments offer countries with high interest rates, as long as the subsidies to their domestic firms, so that those local currencies are not expected to weaken. firms can produce products at a lower cost than Exchange Rates. When investors invest in a their global competitors. Thus, the demand for the security in a foreign country, their return is affected exports produced by those firms is higher as a by (1) the change in the value of the security and (2) result of subsidies. the change in the value of the currency in which the Restrictions on Imports. If a country’s security is denominated. If a country’s home government imposes a tax on imported goods currency is expected to strengthen, foreign (often referred to as a tariff), the prices of foreign investors may be willing to invest in the country’s goods to consumers are effectively increased. securities to benefit it from the currency movement Lack of Restrictions on Piracy. In some cases, a government can affect international trade flows by its lack of restrictions on piracy. Correcting a Balance-of-Trade Deficit- A balance-of-trade deficit is not necessarily a problem, as it may enable a country’s consumers to benefit from imported products that are less expensive than locally produced products. However, the purchase of imported products implies less reliance on domestic production in favor of foreign production. Thus, it may be argued that a large balance-of- trade deficit causes a transfer of jobs to some foreign countries. Why a Weak Home Currency Is Not a Perfect Solution Counter-pricing by Competitors. When a country’s currency weakens, its prices become more attractive to foreign customers, and many foreign companies lower their prices to remain competitive with the country’s firms. Impact of Other Weak Currencies. The currency does not necessarily weaken against all currencies at the same time. Prearranged International Transactions. Many international trade transactions are prearranged and cannot be immediately adjusted. Thus, exporters and importers are committed to continue the international transactions that they agreed to complete. Intra-company Trade. A fourth reason why a weak currency will not always improve a country’s balance of trade is that importers and exporters that are under the same ownership have unique relationships. Factors Affecting International Portfolio Investment Tax Rates on Interest or Dividends. Investors normally prefer to invest in a country where the taxes on interest or dividend income from investments are relatively low. Investors assess their potential after-tax earnings from investments in foreign securities.