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Eoc Qa l2 Sample Questions and Answers Related To Week 2 Material

This document contains sample questions and answers related to international financial management topics from week 2 course material. It includes questions about the effects of inflation on trade balances, exchange rate effects on trade balances, the impact of increased international trade over time, effects of the Euro currency, and exchange rate effects on trade. The answers provide concise explanations of the concepts and relationships between economic factors.

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Tanvir Ahmed Chowdhury
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44 views

Eoc Qa l2 Sample Questions and Answers Related To Week 2 Material

This document contains sample questions and answers related to international financial management topics from week 2 course material. It includes questions about the effects of inflation on trade balances, exchange rate effects on trade balances, the impact of increased international trade over time, effects of the Euro currency, and exchange rate effects on trade. The answers provide concise explanations of the concepts and relationships between economic factors.

Uploaded by

Tanvir Ahmed Chowdhury
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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EOC Q&A L2 - Sample questions and answers related to


week 2 material
Intl Financial Management (University College Dublin)

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End of Chapter 2 – Questions and Answers

Inflation Effect on Trade.

a. How would a relatively high home inflation rate affect the home country’s
current account, other things being equal?

ANSWER: A high inflation rate tends to increase imports and decrease exports,
thereby increasing the current account deficit, other things equal.

b. Is a negative current account harmful to a country? Discuss.

ANSWER: This question is intended to encourage opinions and does not have a
perfect solution. A negative current account is thought to reflect lost jobs in a
country, which is unfavorable. Yet, the foreign importing reflects strong
competition from foreign producers, which may keep prices (inflation) low.

Exchange Rate Effect on Trade Balance

Would the U.S. balance of trade deficit be larger or smaller if the dollar
depreciates against all currencies, versus depreciating against some currencies
but appreciated against others? Explain.

ANSWER: If the dollar weakens against all currencies, the U.S. balance of trade
deficit will likely be smaller. Some U.S. importers would have more seriously
considered purchasing their goods in the U.S. if most or all currencies
simultaneously strengthened against the dollar. Conversely, if some currencies
weaken against the dollar, the U.S. importers may have simply shifted their
importing from one foreign country to another.

Impact on International Trade

Why do you think international trade volume has increased over time? In general,
how are inefficient firms affected by the reduction in trade restrictions among
countries and the continuous increase in international trade?

ANSWER. International trade volume has increased because of the reduction in


trade restrictions over time. It may have also increased for many other reasons,
such as increased information flow (via Internet etc.) between firms in different
countries. Inefficient firms are adversely affected if they have to face tougher
competition from foreign firms as a result of a reduction in trade restrictions.

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Effects of the Euro


Explain how the existence of the euro may affect U.S. international trade.

ANSWER: The euro allowed for a single currency among many European
countries. It could encourage firms in those countries to trade among each other
since there is no exchange rate risk. This would possibly cause them to trade less
with the U.S. The euro can increase trade within Europe because it eliminates the
need for several European countries to exchange currencies when trading with
each other.

Currency Effects
When South Korea’s export growth stalled, some South Korean firms suggested
that South Korea’s primary export problem was the weakness in the Japanese
yen. How would you interpret this statement?

ANSWER: One of South Korea’s primary competitors in exporting is Japan,


which produces and exports many of the same types of products to the same
countries. When the Japanese yen is weak, some importers switch to Japanese
products in place of South Korean products. For this reason, it is often suggested
that South Korea’s primary export problem is weakness in the Japanese yen.

Free Trade

There has been considerable momentum to reduce or remove trade barriers in an


effort to achieve “free trade.” Yet, one disgruntled executive of an exporting firm
stated, “Free trade is not conceivable; we are always at the mercy of the exchange
rate. Any country can use this mechanism to impose trade barriers.” What does
this statement mean?

ANSWER: This statement implies that even if there were no explicit barriers, a
government could attempt to manipulate exchange rates to a level that would
effectively reduce foreign competition. For example, a U.S. firm may be discour-
aged from attempting to export to Japan if the value of the dollar is very high
against the yen. The prices of the U.S. goods from the Japanese perspective are
too high because of the strong dollar. The reverse situation could also be possible
in which a Japanese exporting firm is priced out of the U.S. market because of a
strong yen (weak dollar). [Answer is based on opinion.]

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International Investments

U.S.-based MNCs commonly invest in foreign securities.

a. Assume that the dollar is presently weak and is expected to strengthen over
time. How will these expectations affect the tendency of U.S. investors to invest in
foreign securities?

ANSWER: The expectations of a strong dollar would discourage U.S. investors


from investing abroad. If the dollar is relatively weak now, U.S. investors need
more dollars to make purchase foreign currency (when investing). If the dollar
strengthens over their investment horizon, they will exchange the
foreign currency (as the investment is liquidated) into dollars at a less favorable
exchange rate than the exchange rate at which they converted dollars into the
foreign currency. That is, the exchange rate effect would reduce the yield that they
earn on their investment.

b. Explain how low U.S. interest rates can affect the tendency of U.S.-based
MNCs to invest abroad.

ANSWER: Low U.S. interest rates can encourage U.S.-based MNCs to invest
abroad, as investors seek higher returns on their investment than they can earn in
the U.S.

c. In general terms, what is the attraction of foreign investments to U.S.


investors?

ANSWER: The main attraction is potentially higher returns. The international


stocks can outperform U.S. stocks, and international bonds can outperform U.S.
bonds. However, there is no guarantee that the returns on international
investments will be so favorable. Some investors may also pursue international
investments to diversify their investment portfolio, which can possibly reduce
risk.

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Exchange Rate Effects on Trade

a. Explain why a stronger dollar could enlarge the U.S. balance of trade deficit.
Explain why a weaker dollar could affect the U.S. balance of trade deficit.

ANSWER: A stronger dollar makes U.S. exports more expensive to importers


and may reduce imports. It makes U.S. imports cheap and may increase U.S.
imports. A weaker home currency increases the prices of imports purchased by
the home country and reduces the prices paid by foreign businesses for the home
country’s exports. This should cause a decrease in the home country’s demand
for imports and an increase in the foreign demand for the home country’s
exports, and therefore increase the current account. However, this relationship
can be distorted by other factors.

b. It is sometimes suggested that a floating exchange rate will adjust to reduce or


eliminate any current account deficit. Explain why this adjustment would
occur.

ANSWER: A current account deficit reflects a net sale of the home currency in
exchange for other currencies. This places downward pressure on that home
currency’s value. If the currency weakens, it will reduce the home demand for
foreign goods (since goods will now be more expensive), and will increase the
home export volume (since exports will appear cheaper to foreign countries).

c. Why does the exchange rate not always adjust to a current account deficit?

ANSWER: In some cases, the home currency will remain strong even though a
current account deficit exists, since other factors (such as international capital
flows) can offset the forces placed on the currency by the current account.

China - U.S. Balance of Trade

There is an ongoing debate between the U.S. and China regarding whether the
Chinese yuan's value should be revalued upward. The cost of labor in China is
substantially lower than that in the U.S.

a. Would the U.S. balance of trade deficit in China be eliminated if the yuan was
revalued upward by 20%? Or by 40%? Or by 80%?

ANSWER: This is an open question without a perfect answer. Yet, it should at


least make students realize that a small increase in the value of the yuan is not
going to make Chinese products more expensive than U.S. products in labor-

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intensive industries, given that Chinese wages may be less than one-tenth of U.S.
wages in these industries.

b. If the yuan was revalued to the extent that it substantially reduced the U.S.
demand for Chinese products, would this shift the U.S. demand toward the U.S.
or toward other countries where wage rates are relatively low? In other words,
would the correction of the U.S. balance of trade deficit have a major impact on
U.S. productivity and jobs?

ANSWER: To the extent that there are decent substitute products in other low
wage countries, it seems likely that U.S. consumers would just shift their demand
toward the products in these countries. If so, a correction in the U.S. balance of
trade deficit with China would shift jobs to other low-wage countries rather than
to the U.S.

≤ ≥

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