Lecture 6: More International Business

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UGBA 10 Module 5

• Lecture 6 More International Business
• Dec. 3, 2008

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Module Overview

• Strategy
• International Business
• Why trade?
• Foreign currency exchange
• Managing currency risk
• Doing business abroad
• Entrepreneurship

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Currencies Fluctuate

• Dollar versus the Euro

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An Example

• Your firm sells European toys
• Suppose exchange rate today is about 1.50/
• Have to order toys today, but you pay for them
  later.
• Consider a particular toy that a German firm
  sells for 20.
• Your demand for the toy is 50,000 - 1000Price

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Profit Maximization

• Profit (Price - Unit Cost) Demand
• Profit (Price - Unit Cost) (50,000 -
  1000Price)
• Choke price price that makes demand 0 50
• Formula Profit-maximizing price (given linear
  demand and constant unit cost) is (Choke Price
  Unit Cost)/2 25 Unit Cost/2.
• Formula Profit-maximizing quantity Demand at
  profit-maximizing price 50,000 - 1000PMP.

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Example Continued

• Assume 50 chance dollar depreciates to 2.00/
  50 chance it remains at 1.50/.
• Timing Place order today. Pay on delivery.
  Price the toy. Get profits.
• How much do you order?

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Example Continued

• If knew exchange rate would stay 1.50/, unit
  cost would be 30 ( 1.50/ 20). PMP 40?
  Order 50,000 - 100040 10,000.
• If knew exchange rate would jump to 2/, unit
  cost would be 40. PMP 45? Order 50,000 -
  100045 5,000.
• Moral Decision making complicated by
  exchange-rate risk.

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A Solution

• Can be shown optimal response to uncertainty is
  order the average (7500).
• Price 42.50.
• Profit (42.50 - 30) 7500 93,750 with
  probability 1/2.
• Profit (42.50 - 40) 7500 18,750
• Moral Your profits can fluctuate a lot with
  currency risk (a 33 possible appreciation could
  lower your profit 80!)

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A Better Solution

• Rather than sit around waiting for risk to
  resolve itself, lock-in exchange rate today!
• That is, buy your euros now at 1.50/.
• Unit cost 30.
• PMP 40 Units (order) 10,000.
• Profit 100,000 (40 - 30)10,000.

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LessonYou Can Manage Your Exchange Risk

• Even better than buying euros today Buy safe
  instruments denominated in euros.
• Alternatively, do a swap If you want 10,000
  toys, you owe 20,000 (worth 30,000 today). Find
  a European firm that will owe 30,000 when you
  will owe the 20,000. Swap obligations.
• Reality market for swaps (dont have to find
  your own partner).

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Another Example

• You expect to receive 8 in the future.
• At current exchange rate worth 12.
• But dollar could appreciate 50 chance that when
  you wish to sell your euros, exchange rate will
  be 1/. Theres a 50 chance it stays where it
  is.
• For 1.95, I will sell you the right to be able
  to sell euros in the future for 1.50/.

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LessonFuture Contracts Can Limit FX Risk
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Doing Business Globally
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Not in Kansas AnymorE!
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The 5 Ds

• Dealing with trade rules
• Different protections of property
• Different legal systems
• Different cultures and cultural sensitivities
• Domestic repercussions.

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Dealing with Trade Rules

• Tariffs
• Quotas
• Content law
• National security restrictions
• Health safety regulation

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Fish
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Content LawsCanadian Radio


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Different Protections of Property
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• Nationalization
• Civil unrest

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Lack of IP Protection
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Risk to human assets
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Country risk assessment
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COUNTRY RATINGS (from Coface, France's export
credit underwriter, offering insurance against
the risk that a foreign company won't pay its
bills (for whatever reason -- from bankruptcy to
international war).AFGHANISTAN Rating DA
high-risk political and economic situation and an
often very difficult business environment can
have a very significant impact on corporate
payment behaviour. Corporate default probability
is very high.
CANADA Rating A1Rating watchlisted with
negative implications since March 2008The
political and economic situation is very good. A
quality business environment has a positive
influence on corporate payment behaviour.
Corporate default probability is very low on
average..
HUNGARY Rating A3Changes in generally good
but somewhat volatile political and economic
environment can affect corporate payment
behaviour. A basically secure business
environment can nonetheless give rise to
occasional difficulties for companies. Corporate
default probability is quite acceptable on
average.
UNITED STATES Rating A2The political and
economic situation is good. A basically stable
and efficient business environment nonetheless
leaves room for improvement. Corporate default
probability is low on average. .
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Different Legal Systems

• Efficiency and honesty of governments

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US Law ? Universal Law

• Workplace and environmental regulations
• Labor law
• Civil rights
• Tort and other liability law

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Integrity of Legal System Government

• Bribery rampant in some countries
• Length of time to gain permissions, resolve court
  cases, etc., varies across countries.

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Even if bribery is how things get done in a
foreign country, engaging in bribery can expose
you to both criminal sanctions there and here.
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US Law The Foreign Corrupt Practices Act (FCPA)
prohibits the bribing of foreign officials (see
http//www.usdoj.gov/criminal/fraud/docs/statue.ht
ml)
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Culture

• Dont be a jerk!

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Cultural Differences Sensitivities

• Acceptable products
• Advertising
• Negotiations
• Work attitudes
• Perceptions of employer obligations

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Cultural Connotations Vary
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Domestic repercussions

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Protests Bad Press
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Boycotts