SOM 354 final exam questions and
answers already passed
What are the benefits to a host country of inward FDI? - correct answer ✔✔(BEER)
Balance of payment effects:
Balance of payment account tracks payments to and receipts from other countries. Current
account deficit (aka trade deficit) arises when country imports more than it exports.
Governments want a current account surplus, so to fix a current account deficit they sell
countries assets to other countries, which is bad.
FBI can help because...
Substitute for importing, so it improves the current account of host balance of payments
MNE could use a foreign subsidiary to export
Effects on competition and economic growth:
FDI as Greenfield investment ➡ increase competition in national market ➙drive down prices ➙
increase economic welfare of customers
Higher competition ➡ stimulates capital investment as firms work to compete ➙ increased
productivity ➙ product and process innovation
Employment effects: brings jobs to host
Directly ⇒ firm hires locally
Indirectly ⇒ jobs are created in foreign firms suppliers or because of increased local spending by
MNE employees
Resource transfer effects: supplying capital, technology, and management resources otherwise
not available and boost that country's economic growth rate.
Capital ⇒ MNEs are usually bigger and more financially strong so they have access to more
financial resources than host country firms
Technology ⇒ new tech can stimulate economic development and industrialization
Management ⇒ foreign managers can bring new things to a host country, local managers can
teach foreigners about the country and can learn from it to establish other firms later,
,What are the costs to a host country of inward FDI? - correct answer ✔✔CAB
Adverse effects on Competition:
MNE could be so powerful they drive local companies out of business and monopolize the
market. They could then raise prices and negatively affect customers economic welfare.
Autonomy and national sovereignty ⇒ loss of economic independence
Decisions affecting host are made by foreign parent with no real commitment and host has no
control
Adverse effects on the Balance of payments
In order to offset BoA, initial capital inflow of FDI must be set against the subsequent outflow of
earnings from foreign firm to host country. Some governments control outflows by restricting
amount of capital that can be put back into MNEs home country.
Foreign sub could import a substantial amount of inputs and cause debit on current account of
hosts BoA
What are the benefits to a home country of outward FDI by firms based in that nation? - correct
answer ✔✔BER
Balance of Accounts benefits from inward flow of foreign earnings and could benefit from
exporting materials to the firm.
Employment effects home-country exports also mean more jobs in home country.
Reverse resource transfer effect means exposure to a foreign market is a learning opportunity
from which valuable skills can be applied to home country
What are the costs to a home country of outward FDI by firms based in that nation? - correct
answer ✔✔BE
Balance of accounts could suffer from initial capital outflow, if purpose of MNE is low-cost
production location, or if FDI is a substitute for direct exports
Employment suffers if FDI is seen as a substitute for domestic production and because home
loses jobs to foreign countries
,What does instrumental trade theory teach us about the benefits and costs of FDI? - correct
answer ✔✔tell us that the home country concerns about negative economic effects of offshore
production (FDI undertaken to serve home market) may be misplaced. FDI may stimulate
economic growth and employment in home country by freeing home resources to let home
focus on the market where it has comparative advantages, and home consumers benefit if price
falls due to FDI. Plus a firm may lose market share if international competitors reap advantages
of low cost production locations.
The Law of One Price - correct answer ✔✔in competitive markets free of transportation costs
and barriers to trade, identical products sold in different countries must sell for the same price
when their price is expressed in the same currency.
Purchasing Power Parity (PPP) - correct answer ✔✔PPP says that given relatively efficient
markets (with few
impediments to international trade) the price of a basket of goods should be roughly the same
in each country (though exchange rate will change if relative prices change)
What is the relationship between price inflation and exchange rates? - correct answer ✔✔Since
PPP theory states that changes in relative price will result in a change in exchange rates, a
country where price inflation is running wild should see its currency depreciate in countries
where inflation rates are lower.
What is the relationship between interest rates and exchange rates? - correct answer
✔✔(Fisher) interest rates reflect expectations about likely future inflation rates.
(PPP) link between inflation and exchange rates. (International Fisher Effect) for any 2 countries,
spot exchange rate should change in an equal amount but in the opposite direction to the
different in nominal interest rates between countries.
How might investor psychology influence exchange rates? - correct answer ✔✔Various
psychological factors play a role in determining the expectations of market traders as to likely
future exchange rates. In turn, these expectations have a tendency to become self-fulfilling
prophecies. For example, the bandwagon effect is when traders move in the same direction at
, the same time and the expectations that triggered the movement becomes self-fulfilling. Such
as in 1992 when international financier Soros made a bet against the british pound. He started
shortening it and when other traders who knew his reputation saw, they did the same. This
triggered the bandwagon effect and the pound declined in value, not because of some
macroeconomic shift, but because the massive selling forced the value of the pound down.
Hence, a self-fulfilling prophesy.
Outline the advantages and disadvantages of exporting as an entry strategy? - correct answer
✔✔Advantages: avoids substantial costs of establishing manufacturing facilities in a foreign
country and helps firm achieve experience curve and location economies
Disadvantages: may not be appropriate if lower-cost production location is available, high
transportation costs, tariff barriers can make it uneconomical
Outline the advantages and disadvantages of licensing and franchising? - correct answer
✔✔Advantages:
The firm doesn't have to bear development costs and risks associated with opening in a foreign
market (good for firms who don't have the capital to develop operations overseas) The firm
doesn't have to commit substantial financial resources to unfamiliar or politically volatile foreign
market. It is a way to get around barriers to investments. It is way to develop intangible
property for business application without firm doing it itself
Disadvantages:
Firm has little control over manufacturing, marketing, and strategy required for realizing
experience curve and location economies. Limits firms ability to coordinate strategic moves
across countries by using products in one country to support competitive attacks in another
(licensee won't want to use its royalties to support licensing in a different country). Firm can
lose control over how its licensed technology is used
Outline the advantages and disadvantages of joint ventures? - correct answer ✔✔Advantages:
local partners knowledge, split development costs/risks of opening in a foreign market, lower
risk of being subject to nationalization or adverse gov. interference
Disadvantages:
answers already passed
What are the benefits to a host country of inward FDI? - correct answer ✔✔(BEER)
Balance of payment effects:
Balance of payment account tracks payments to and receipts from other countries. Current
account deficit (aka trade deficit) arises when country imports more than it exports.
Governments want a current account surplus, so to fix a current account deficit they sell
countries assets to other countries, which is bad.
FBI can help because...
Substitute for importing, so it improves the current account of host balance of payments
MNE could use a foreign subsidiary to export
Effects on competition and economic growth:
FDI as Greenfield investment ➡ increase competition in national market ➙drive down prices ➙
increase economic welfare of customers
Higher competition ➡ stimulates capital investment as firms work to compete ➙ increased
productivity ➙ product and process innovation
Employment effects: brings jobs to host
Directly ⇒ firm hires locally
Indirectly ⇒ jobs are created in foreign firms suppliers or because of increased local spending by
MNE employees
Resource transfer effects: supplying capital, technology, and management resources otherwise
not available and boost that country's economic growth rate.
Capital ⇒ MNEs are usually bigger and more financially strong so they have access to more
financial resources than host country firms
Technology ⇒ new tech can stimulate economic development and industrialization
Management ⇒ foreign managers can bring new things to a host country, local managers can
teach foreigners about the country and can learn from it to establish other firms later,
,What are the costs to a host country of inward FDI? - correct answer ✔✔CAB
Adverse effects on Competition:
MNE could be so powerful they drive local companies out of business and monopolize the
market. They could then raise prices and negatively affect customers economic welfare.
Autonomy and national sovereignty ⇒ loss of economic independence
Decisions affecting host are made by foreign parent with no real commitment and host has no
control
Adverse effects on the Balance of payments
In order to offset BoA, initial capital inflow of FDI must be set against the subsequent outflow of
earnings from foreign firm to host country. Some governments control outflows by restricting
amount of capital that can be put back into MNEs home country.
Foreign sub could import a substantial amount of inputs and cause debit on current account of
hosts BoA
What are the benefits to a home country of outward FDI by firms based in that nation? - correct
answer ✔✔BER
Balance of Accounts benefits from inward flow of foreign earnings and could benefit from
exporting materials to the firm.
Employment effects home-country exports also mean more jobs in home country.
Reverse resource transfer effect means exposure to a foreign market is a learning opportunity
from which valuable skills can be applied to home country
What are the costs to a home country of outward FDI by firms based in that nation? - correct
answer ✔✔BE
Balance of accounts could suffer from initial capital outflow, if purpose of MNE is low-cost
production location, or if FDI is a substitute for direct exports
Employment suffers if FDI is seen as a substitute for domestic production and because home
loses jobs to foreign countries
,What does instrumental trade theory teach us about the benefits and costs of FDI? - correct
answer ✔✔tell us that the home country concerns about negative economic effects of offshore
production (FDI undertaken to serve home market) may be misplaced. FDI may stimulate
economic growth and employment in home country by freeing home resources to let home
focus on the market where it has comparative advantages, and home consumers benefit if price
falls due to FDI. Plus a firm may lose market share if international competitors reap advantages
of low cost production locations.
The Law of One Price - correct answer ✔✔in competitive markets free of transportation costs
and barriers to trade, identical products sold in different countries must sell for the same price
when their price is expressed in the same currency.
Purchasing Power Parity (PPP) - correct answer ✔✔PPP says that given relatively efficient
markets (with few
impediments to international trade) the price of a basket of goods should be roughly the same
in each country (though exchange rate will change if relative prices change)
What is the relationship between price inflation and exchange rates? - correct answer ✔✔Since
PPP theory states that changes in relative price will result in a change in exchange rates, a
country where price inflation is running wild should see its currency depreciate in countries
where inflation rates are lower.
What is the relationship between interest rates and exchange rates? - correct answer
✔✔(Fisher) interest rates reflect expectations about likely future inflation rates.
(PPP) link between inflation and exchange rates. (International Fisher Effect) for any 2 countries,
spot exchange rate should change in an equal amount but in the opposite direction to the
different in nominal interest rates between countries.
How might investor psychology influence exchange rates? - correct answer ✔✔Various
psychological factors play a role in determining the expectations of market traders as to likely
future exchange rates. In turn, these expectations have a tendency to become self-fulfilling
prophecies. For example, the bandwagon effect is when traders move in the same direction at
, the same time and the expectations that triggered the movement becomes self-fulfilling. Such
as in 1992 when international financier Soros made a bet against the british pound. He started
shortening it and when other traders who knew his reputation saw, they did the same. This
triggered the bandwagon effect and the pound declined in value, not because of some
macroeconomic shift, but because the massive selling forced the value of the pound down.
Hence, a self-fulfilling prophesy.
Outline the advantages and disadvantages of exporting as an entry strategy? - correct answer
✔✔Advantages: avoids substantial costs of establishing manufacturing facilities in a foreign
country and helps firm achieve experience curve and location economies
Disadvantages: may not be appropriate if lower-cost production location is available, high
transportation costs, tariff barriers can make it uneconomical
Outline the advantages and disadvantages of licensing and franchising? - correct answer
✔✔Advantages:
The firm doesn't have to bear development costs and risks associated with opening in a foreign
market (good for firms who don't have the capital to develop operations overseas) The firm
doesn't have to commit substantial financial resources to unfamiliar or politically volatile foreign
market. It is a way to get around barriers to investments. It is way to develop intangible
property for business application without firm doing it itself
Disadvantages:
Firm has little control over manufacturing, marketing, and strategy required for realizing
experience curve and location economies. Limits firms ability to coordinate strategic moves
across countries by using products in one country to support competitive attacks in another
(licensee won't want to use its royalties to support licensing in a different country). Firm can
lose control over how its licensed technology is used
Outline the advantages and disadvantages of joint ventures? - correct answer ✔✔Advantages:
local partners knowledge, split development costs/risks of opening in a foreign market, lower
risk of being subject to nationalization or adverse gov. interference
Disadvantages:
