《跨国公司财务管理基础》教师手册与PPTch

CHAPTER1:INTRODUCTION1

CHAPTER1

INTRODUCTION

Chapter1emphasizestheinternationalizationofbusinessandeconomicactivitythathasoccurredsincetheendofWorldWarII.Althoughinternationalbusinessactivitieshaveexistedforcenturies,primarilyintheformofexportingandimporting,onlyinthepostwarperiodhavemultinationalfirmsbecomepreeminent.ThedistinguishingcharacteristicoftheMNCisitsemphasisonglobal,ratherthanaffiliate,performance.Specifically,MNCsask,“Whereintheworldshouldwebuildourplants,sellourproducts,raisecapital,andhirepersonnel?”ThusthetrueMNCischaracterizedmorebyattitudethanthephysicalrealityofanintegrated,globalsystemofmarketingandproductionactivities.Itinvolveslookingbeyondtheboundariesofthehomecountryandtreatingtheworldas“ouroyster.”

AfterstimulatingstudentinterestwiththisvisionoftheMNC,IthenintroducethefinancialdecisionsthatMNCsmustmake.Ibeginbydiscussingthekeyconceptsandlessonsfromdomesticfinancethatapplydirectlytointernationalcorporatefinance.Thelessonsincludetheemphasisoncashflowratherthanaccountingearnings,thetimevalueofmoney,theimportanceoftaxes,andtheunwillingnessofinvestorstorewardcompaniesforactivities(likecorporatediversification)thatinvestorscouldreplicateforthemselvesatnogreatercost.

Thekeyconcepts,whichIpointoutwillarisetimeandagaininthecourse,arearbitrage,marketefficiency,andtheseparationofriskintosystematicrisk,whichmustberewarded,andunsystematicrisk,whichisnotrewarded.Thelatterconcept,ofcourse,istheintuitionunderlyingboththecapitalassetpricingmodel(CAPM)andthearbitragepricingtheory(APT).Althoughimperfect,thetheoreticalframeworkofdomesticcorporatefinanceprovidesausefulframeofreference,andunderstandingitisessentialbeforeproceedingwiththemorecomplexaspectsofinternationalfinancialmanagement.Idevotesometimetoexplainingthattotalriskmatters,eveniftheCAPMorAPTholds.Otherwise,theastutestudentwillseeaconflictbetweentheirrelevanceofunsystematicriskandhedgingactivities.

Ithenoutlinethekeydecisionareasininternationalfinancialmanagement:foreignexchangeriskmanagement,managingworkingcapitalandtheinternalfinancialsystem,financingforeignunits,capitalbudgeting,andevaluationandcontrol.IemphasizetheadditionalparametersthatMNCfinancialexecutivesmustcopewith,includingmultiplecurrencies,ratesofinflation,taxsystems,andcapitalmarkets,aswellasforeignexchangeandpoliticalrisks.

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SUGGESTEDANSWERSTO“THEDEBATEOVEROUTSOURCING”

1.Whataretheprosandconsofoutsourcing?

ANSWER.PROS:OutsourcingenablesAmericanstobuyserviceslessexpensivelyabroad,increasesU.S.productivity,andenablesU.S.companiestocuttheircostswhileimprovingquality,timetomarket,andcapacitytoinnovate.ItalsoallowstheU.S.touseitscomparativeadvantageinfinancial,managerial,andtechnicalservicesbyspecializinginandexportingsuchservicesashigher-endcomputerprogramming,managementconsulting,engineering,banking,telecommunications,andlegalwork.

CONS:Aswithanykindoftrade,importingofservicesthroughoutsourcingresultsinthelossofjobsforAmericanspreviouslyemployedinprovidingthoseservices.OutsourcingmayalsocauseU.S.companiesthatprovidetheseservicestogooutofbusiness.

2.HowdoesoutsourcingaffectU.S.consumers?U.S.producers?

ANSWER.Astheanswertoparta)pointsout,outsourcingallowscompaniestobuyserviceslessexpensivelyabroad.Competitivepressuresforcecompaniestopassthesesavingsalongtoconsumersintheformoflower-pricedgoodsandservices.

U.S.producersareabletoboostproductivityandcutcostswhileimprovingquality,timetomarket,andcapacitytoinnovate.Assuch,Americancompaniesarebetterabletocompete.Thiscompetition,however,forcescompaniestopassmostoftheirsavingsfromoutsourcingthroughtotheircustomers.

3.Longerterm,whatisthelikelyimpactofoutsourcingonAmericanjobs?

ANSWER.Thelonger-termeffectofoutsourcingonU.S.jobsshouldbeinsignificant.Tradehaslittle,ifanything,todowiththequantityofjobsinaneconomybutratherthenatureanddistributionofthosejobsinvariousoccupations.OutsourcingshouldleadtohigheraverageproductivityofthosejobsthatAmericansworkatand,hence,tohigherwagesandbenefits.

4.Severalstatesarecontemplatinglegislationthatwouldbantheoutsourcingofgovernmentworktoforeignfirms.Whatwouldbethelikelyconsequencesofsuchlegislation?

ANSWER.Suchlegislationwouldresultinlessefficientandmoreexpensivegovernment.Theendresultwouldbehighertaxesor,iftaxpayersbalk,fewergovernmentservices.

SUGGESTEDANSWERSTOCHAPTER1QUESTIONS1.Explainhowglobalizationmayaffectevenasmallbusinessinyourlocalarea.

ANSWER.Globalizationentailsopeningnationalborderstoenablefreermovementofgoodsandservices.Duetotherapiddecreaseincommunicationandtransportationcostsoverthelastfewdecades,manyfirmsfinditcheapertosourceproductsfromforeigncountries.Also,firmsarenowawareofinternationalmarketopportunitiesandlocatetheirplantsandfacilitiesabroad.Asaresult,thecompetitionfacedbyanybusinessisnowmoreglobalratherthanmerelylocal.AsmallbusinessinanylocalareanowfacescompetitionfrombothlargeMNCsandsimilarlysituatedbusinessesthattakeadvantageoftheirinternationalexperienceaswellasinternationallysourcedproducts.

CHAPTER1:INTRODUCTION3

2.OpponentsofglobalizationandoutsourcingarguethatlocatingmanufacturingactivitiesabroadcausesalossofU.S.jobs.However,totalemploymentfiguresrevealthatratherthanresultinginanetlossofjobs,employmenthasactuallyincreased.Also,theaveragewagesofworkershaveincreased.Howwouldyouaccountforthisdiscrepancybetweenwhatthecriticssayandwhatstatisticsreveal?

ANSWER.Globalizationisatwo-waystreet.WhilesomeU.S.firmslocatetheirplantsoverseas,severalforeigncompanieshavealsoinvestedintheU.S.economyandlocatedtheirplantshere.Forexample,majorforeignautomobilemanufacturerssuchasToyotaandBMWhavesetupmanufacturingplantsintheU.S.andcreatednumerousU.S.jobs.Also,overthelast25years,theU.S.economyhasexperiencedunprecedentedproductivitygrowthduetotheincreaseintradefromglobalization.Thenetimpactofthisproductivitygrowthasmeasuredinoutputperhourhasbeensuchastoincreasetheinflation-adjustedworkercompensation.Thus,whilecriticsofglobalizationlookatonlyonesideofthepictureandpointtojoblossesduetooutsourcing,theyneglecttotakeintoaccountthejobcreationduetoforeigninvestmentintheU.S.andtheincreaseintradeduetoglobalization.Criticsalsoignorethefacttheincreasedopportunitiesfortradeduetoglobalizationresultinhigh-value-addedservicesbeingperformedintheU.S.andtheincreaseinproductivityoftheU.S.worker.Asaresult,workerwageshavealsogoneup.

3.Elaborateonthebenefitsofaproactiveapproachtoglobalizationandglobalcompetition.

ANSWER.Ratherthanreacttoglobalization,firmsbenefitbyfacingglobalizationandglobalcompetitionheadon.Globalizationandglobalcompetitionunleashtheforcesofcreativedestruction,wherebynewtechnologiesandnewmethodsofbusinessforceoutpoorlyperformingcompetitors.Totakeadvantageofthefullpotentialofglobalizationandtocounterglobalcompetition,manyfirmsadoptnewtechnologies,improveproductionmethods,explorenewmarkets,andintroducenewandbetterproducts.Theresultsofsuchimprovementsareclearintermsofthelowerpricesandexpandedchoicesforconsumers.Thus,proactivefirmsstayaheadoftheircompetitionbytakingadvantageofthevariousbenefitsofglobalizationandtheexpandedtradeopportunities.

4.Whatarethevariousreasonsfortheemergenceofmultinationalfirms?

ANSWER.TheprimaryreasonfortheemergenceofMNCsistheinternationalmobilityofseveralfactorsofproduction.MNCsemergetotakeadvantageofgloballyavailablerawmaterials,markets,specializedskills,andknowledge.Also,firmsmaybecomemultinationaltokeepdomesticcustomersthathavemovedabroadortoexploitfinancialmarketimperfections.Theseareelaboratedbelow.

SEARCHFORRAWMATERIALS.SomefirmsbecomeMNCstoexploittherawmaterialsthatcanbefoundoverseas,suchasoil,coal,minerals,andothernaturalresources.

MARKETSEEKING.SomefirmsbecomeMNCstoexploitforeignmarketsfortheirproducts.Sincethesameproductmaybedemandedindifferentcountries,MNCsnotonlytakeadvantageofthemarketingopportunities,butalsogainfromtheeconomiesofscaleobtainedbysellinglargevolumesacrossdifferentforeignmarkets.

COSTMINIMIZATION.CompaniesalsobecomeMNCstoseekoutlower-production-costsites.Specificskillsneededforproductionmaybeavailableatlowercostsinsomecountries,andMNCsmaylocateplantsspecializinginspecificaspectsofproduction,suchasassemblyorfabrication,inthosecountries.

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KNOWLEDGESEEKING.Somefirmsenterforeignmarketstogaininformationandexperiencethatareexpectedtoproveusefulelsewhere.Especiallyinindustriescharacterizedbyrapidproductinnovationandtechnicalbreakthroughs,firmsobtaintechnicalproductandprocessknowledge,whichtheyleverageinothercountries.

KEEPINGDOMESTICCUSTOMERS.SuppliersofgoodsorservicestoMNCsoftenfollowtheircustomersabroadtoguaranteethemacontinuingproductflow.Intheprocess,thesefirmsalsobecomeMNCs.

EXPLOITINGFINANCIALMARKETIMPERFECTIONS.Companiesmayfinditadvantageoustoreducetaxesandcircumventcurrencycontrolswhenoperatinginmultipleforeignmarkets.Doingsoenablesthemtoobtaingreaterprojectcashflowsandlowercostsoffundscomparedtoapurelydomesticfirm.

5.Giventheaddedpoliticalandeconomicrisksthatappeartoexistoverseas,areMNCsmoreorlessriskythanpurelydomesticfirmsinthesameindustry?Considerwhetherafirmthatdecidesnottooperateabroadisinsulatedfromtheeffectsofeconomiceventsthatoccuroutsidethehomecountry.

ANSWER.Individualforeignprojectsmayfacemorepoliticalandeconomicrisksthancomparabledomesticprojects.YetMNCsarelikelytobelessriskythanpurelydomesticfirmsbecausemuchoftheriskfacedoverseasisdiversifiable.Moreover,byoperatingandproducingoverseas,theMNChasdiversifieditscostandrevenuestructurerelativetowhatitwouldbeifitwereapurelydomesticfirmproducingandsellinginthehomemarket.Itisimportanttonotethatdomesticfirmsarenotinsulatedfromeconomicchangesabroad.Forexample,domesticfirmsfaceexchangeriskbecausetheircompetitivepositionsdependonthecoststructuresofbothforeignanddomesticcompetitors.Similarly,changesinthepriceofoilandothermaterialsabroadimmediatelyleadtochangesindomesticprices.

6.HowisthenatureofIBM’scompetitiveadvantagesrelatedtoitsbecominganMNC?

ANSWER.IBMissellingmorethanblackboxes;itissellingastreamofservicesassociatedwithitscomputers.Ineffect,customersarebuyingthecompany.Toprovidecustomerswithwhattheythinktheyarebuying,IBMmustbethereonthespot.ThisenablesIBMtoservicecustomers’machinesaswellastailorsoftwareandsystemstotheirspecifications.

7.Ifcapitalmarketswereperfect,i.e.,capitalcouldmovefreelyacrossnationalborders,wouldMNCsstillexist?Why?Or,whynot?

ANSWER.Evenifcapitalmovedfreelyacrossnationalborders,MNCswouldstillexist,becauseMNCsbringahostoffirm-specificknowledgeandadvantagesalongwithcapitaltothecountriesinwhichtheyoperate.Suchadvantagesmayincludeuniqueproducts,processes,technologies,patents,specificrights,orspecificknowledgeandskills.Theseadvantagescanbeusedprofitablyinforeignmarkets.Moreover,MNCsarebetterabletoapplytheknowledgeandskillsgainedintheirprioroperationsinothercountriestoeachnewcountrythattheyenter.Thus,fromthepointofviewofacountryattractingforeigncapital,thecapitalthatisbroughtinbyanMNCbringswithitfirm-specificadvantagesthatyieldbetterreturnsthanthecapitalthatissimplyborrowedfromaforeigncountry.

CHAPTER1:INTRODUCTION5

8.Whatarethevariouswaysinwhichdomesticfirmsenterinternationalmarkets?Whatarethebenefitsandrisksofeachstrategyofforeignmarketentry?

ANSWER.Threemajorwaysinwhichdomesticfirmsenterinternationalmarketsarethroughexporting,licensing,andoverseasproduction.Whenexporting,thedomesticfirmoperatesfromitshomecountryandmerelysendsitsproductsoverseas.Inlicensing,thedomesticfirmlicensesitsproduct,process,ortechnologytoaforeignfirminreturnforroyaltiesorotherformsofpayment.Inoverseasproduction,thedomesticfirmbecomesanMNCbysettingupacorporationoverseasandengaginginmanufacturingand/ormarketing.Thebenefitsandrisksofeachstrategyaresummarizedbelow.

Benefits

•Minimalcapitalrequirementsandstart-upcosts

•Riskislow

•Profitsareimmediate

•Learnaboutpresentandfuturesupplyanddemand,competition,distributionchannels,paymentconventions,financialinstitutions,andfinancialtechniquesinhostcountry

•Minimalinvestmentrequirements

•Fastermarket-entrytime

•Fewerfinancialandlegalrisks

•Thefirmcanmoreeasilystayabreastofmarketdevelopments,adaptitsproductsandproductionschedulestochanginglocaltastesandconditions,fillordersfaster,andprovidemorecomprehensiveafter-salesservice

•Firmcanexploitlocalskills,includingR&D

•Signalsagreatercommitmenttothelocalmarket,whichinturnincreasessalesandassuranceofsupplystability

Risks

•Relativelylowriskcomparedtootherentrystrategies

•Fullsalespotentialoftheproductisnotrealized

•Foreignimporterisingreatercontrolofmarketing,andthustheimage,ofthefirm’sbrandedproductsintheforeigncountry

•Cashflowisrelativelylow

•Maybeproblemsinmaintainingproductqualitystandards

•Foreignlicenseemayengageinunauthorizedexportsofthefirm’sproducts,resultinginlossoffuturerevenuesforthelicensingfirm

•Foreignlicenseemaybecomeastrongcompetitorwhenlicenseagreementends

•Tremendouscapitalandtopmanagementcommitmentisrequired

•Financialandoperationalrisksaregreaterthanthoseforotherentrystrategies

•Companiesfacegreaterpoliticalrisks,includingtheriskofexpropriationofplantsandfacilities

Entry

Exporting

Licensing

OverseasProduction

9.WhydofirmsfromeachofthefollowingcategoriesbecomeMNCs?IdentifythecompetitiveadvantagesthatafirmineachcategorymusthavetobeasuccessfulMNC.

a.Raw-materialsseekers

b.Marketseekers

c.Costminimizers

ANSWER.FDIismostlikelytobeeconomicallyviablewherethepossibilityofopportunismonthepartofunrelatedpartiesorcontractualdifficultiesmakeitespeciallycostlytocoordinateeconomicactivitiesviaarm’slengthtransactionsinthemarketplace.Firmsgooverseastomorefullyutilizetheirskillsandothertangibleandintangibleassets.

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RAWMATERIALSSEEKERS.Theexistenceoflow-costrawmaterialsoverseasisnotasufficientconditionforfirmstobecomeMNCs;theycouldjustimportrawmaterialsratherthansetupoperationsabroadtoextractthem.CompaniesthatbecomerawmaterialsMNCsmust

a)Haveintangiblecapabilitiesintheformoftechnicalskillsandfacecontractualdifficultiesintheformofaninabilitytopricetheirknow-howortowrite,monitor,andenforceuserestrictionsgoverningtechnologytransferarrangements;and

b)Faceproblemsofopportunismthatmakeitveryexpensivetoenterintolong-termpurchasecontractstofullyutilizetheirproductionordistributioncapability.Forexample,anoilrefininganddistributingfirmmayfindittooriskytoinvestinfurtherrefiningcapacitywithoutcontrollingitsownoilsupply.Anindependentsuppliermaydecidetobreakacontractualagreementandcutofftheflowofoiltotherefiner.

MARKETSEEKERS.Thesefirmsusuallyhaveintangiblecapitalintheformoforganizationalskillsthatareinseparablefromthefirmitself.Abasicskillinvolvesknowledgeabouthowbesttoserviceamarket,includingnewproductdevelopmentandadaptation,qualitycontrol,advertising,distribution,andafter-salesservice.Sinceitwouldbedifficult,ifnotimpossible,tounbundletheseservicesandsellthemapartfromthefirm,thisformofmarketimperfectionoftenleadstocorporateattemptstoexertcontroldirectlyviatheestablishmentofforeignaffiliates.

COSTMINIMIZERS.Thesefirmsseektoreducetheircostsbyproducingoverseas.Yettheexistenceoflower-costproductionsitesoverseasisnotsufficienttojustifyFDI.Sincelocalfirmshaveaninherentcostadvantageoverforeigninvestors,MNCscansucceedabroadonlyiftheproductionormarketingedgetheypossesscannotbepurchasedorduplicatedbylocalcompetitors.ThesuccessfulMNCinthiscategorywillpossessspecializeddesignormarketingskills,agooddistributionsystem,orownastrongbrandname.Excessprofitsareearnedontheseintangibleassets,notonthelowforeignlaborormaterialscosts.Overseasproductionjustenablesthemtobecostcompetitive;itdoesn'tgivethemanedgesinceanycompetitorcanreplicateitsproductionlocation.

10.Whatfactorshelpdeterminewhetherafirmwillexportitsoutput,licenseforeigncompaniestomanufactureitsproducts,orsetupitsownproductionorservicefacilitiesabroad?Identifythecompetitiveadvantagesthatleadcompaniestopreferonemodeofinternationalexpansionoveranother.

ANSWER.Herearesomefactorsinvolvedindecidinghowtoenteramarket:

i)PRODUCTIONECONOMIESOFSCALE.Iftheseareimportant,thenexportingmightbeappropriate.

ii)TRADEBARRIERS.Companiesthatmightotherwiseexporttoamarketmaybeforcedbyregulationstoproduceabroad,eitherinawhollyownedoperation,ajointventure,orthroughalicensingarrangementwithalocalmanufacturer.

iii)TRANSPORTATIONCOSTS.Thesehavethesameeffectastradebarriers.Themoreexpensiveitistoshipaproducttoamarket,themorelikelyitisthatlocalproductionwilltakeplace.

iv)SIZEOFTHEFOREIGNMARKET.Thelargerthelocalmarket,themorelikelylocalproductionwilltakeplace,particularlyifsignificantproductioneconomiesofscaleexist.Conversely,withsmallermarkets,exportingismorelikelytotakeplace.

CHAPTER1:INTRODUCTION7

v)PRODUCTIONCOSTS.Therealexchangerate,wagerates,andothercostfactorswillalsoplayapartindeterminingwhetherexportingorlocalproductiontakesplace.

vi)INTANGIBLECAPITAL.IftheMNC’sintangiblecapitalisembodiedintheformofproducts,exportingwillgenerallybepreferred.Ifintangiblecapitaltakestheformofspecificproductorprocesstechnologiesthatcanbewrittendownandtransmittedobjectively,foreignexpansionwillusuallytakethelicensingroute.Ifintangiblecapitaltakestheformoforganizationalskillsthatareinseparablefromthefirmitself,thenthefirmislikelytoexpandoverseasviadirectinvestment.

vii)NECESSITYOFAFOREIGNMARKETPRESENCE.Byinvestinginfixedassetsabroad,companiescandemonstratetolocalcustomerstheircommitmenttothemarket.Thiscanenhancesalesprospects.

11.TimeWarnermustdecidewhethertolicenseforeigncompaniestoproduceitsfilmsandrecordsorsetupforeignsalesaffiliatestosellitsproducts.Whatfactorsmightdeterminewhetheritexpandsabroadvialicensingorinvestinginitsownsalesforceanddistributionnetwork?

ANSWER.SomeofthefactorsthatWarnershouldconsiderindeterminingwhetheritexpandsabroadvialicensingorbyinvestinginitsownsalesforceanddistributionnetworkareasfollows:

a)SALESVOLUME.Itneedsacertainminimumvolumeofbusinesstojustifyitsownsalesforce.

b)POTENTIALPROBLEMSOFOPPORTUNISM.Howeasyisittomonitorandcontrolindependentproducersandsellersofitsfilmsandrecords?Theeasieritistomonitorandcontrolthem,thelessvaluethereisinhavingitsownsalesanddistributioncapability.

c)CONFLICTSOFINTEREST.HowmotivatedwillindependentsbeinpushingTimeWarner’sproductsversusthoseofothercompanies?

d)COLLATERALBENEFITSTOWARNER.TotheextentTimeWarnergetsotherbenefitsfromdistributingitsfilms(e.g.,thesaleoftoys)thataren’tcapturedbyindependents,theywillhavelessincentivetopushTimeWarner’sproductsthanTimeWarnerwillhave.Themorecollateralbenefits,themoreimportantitisforTimeWarnertocontrolitsownsales.

e)THEIMPORTANCEOFMARKETINFORMATION.Ifproductsmustbetailoredtotheforeignmarkets,TimeWarnershouldprobablydevelopitsownsalesforce.TimeWarnerwillfinditdifficulttogatherthenecessarymarketintelligencefromindependentdistributorsofitsproducts.

ADDITIONALCHAPTER1QUESTIONSANDANSWERS

1.a.WhatarethevariouscategoriesofMNCs?

ANSWER.Rawmaterialsseekers,marketseekers,andcostminimizers.

1.b.Whatisthemotivationforinternationalexpansionoffirmswithineachcategory?

ANSWER.Rawmaterialsseekersgoabroadtoexploittherawmaterialsthatcanbefoundthereandcan’tbefounddomestically.Marketseekersgooverseastoproduceandsellinforeignmarkets.Costminimizersinvestinlower-costproductionsitesoverseastoremaincostcompetitivebothathomeandabroad.Inallcases,thefirmsinvolvedrecognizethattheworldislargerthanthehomecountryandprovidesopportunitiestogainadditionalsupplies,sellmoreproducts,orfindlower-costsourcesofproduction.

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2.a.Howdoesforeigncompetitionlimitthepricesdomesticcompaniescanchargeandthewages

andbenefitsworkerscandemand?

ANSWER.Asdomesticproducersraisetheirprices,customersbeginsubstitutingless-expensivegoodsandservicessuppliedbyforeignproducers.Thelikelihoodoflosingsaleslimitsthepricesdomesticfirmscancharge.Foreigncompetitionalsolimitsthewagesandbenefitsworkerscandemand.Ifworkersdemandmoremoney,firmshavetwochoices:acquiescetothesedemandsorfightthem.Absentforeigncompetition,thecostofacquiescenceisrelativelylow,particularlyiftheindustryisunionized.Sinceallfirmswillfacethesamehighercosts,theycancoverthesehighercostsbyallsimultaneouslyraisingtheirpriceswithoutfearofbeingundercutorofbeingplacedatacompetitivedisadvantagerelativetotheirpeers.Foreigncompetitionchangesthepicturebecauseforeignfirms’costswillbeunaffectedbyhigherdomesticwagesandbenefits.Ifdomesticfirmsgiveinonwagesandbenefits,foreignfirmswillunderpricetheminthemarketandtakemarketshareaway.Inthiscase,higherdomesticcostswillputdomesticfirmsatadisadvantagevis-à-vistheirforeigncompetitors.Recognizingthis,domesticfirmsfacingforeigncompetitionaremorelikelytofightworkerdemandsforhigherwagesandbenefits.

2.b.Whatpoliticalsolutionscanhelpcompaniesandunionsavoidthelimitationsimposedby

foreigncompetition?

ANSWER.Theclassicpoliticalsolutionisprotectionism.Bylimitingforeigncompetitioneitherthroughtariffsorquotas,companiesandworkerslimittheabilityofforeigngoodstorestraindomesticpriceincreases.Thegovernmentcanalsosubsidizedomesticfirmscompetingagainstforeignfirms,allowingdomesticfirmsandunionstoperpetuateuneconomicworkrules,wages,andproductionsprocesses.

2.c.Whopaysforthesepoliticalsolutions?Explain.

ANSWER.Consumerspayforprotectionismintheformofhigherpricesfortheirgoodsandservices,fewerchoices,andlowerquality.Taxpayerspayforsubsidiesintheformofhighertaxesorfeweroftheotherservicesprovidedbygovernment.

3.a.WhatfactorsappeartounderlietheAsiancurrencycrisis?

ANSWER.Asiancountrieshadrunuphugedebts,mostlyindollars,andweredependingonthestabilityoftheircurrenciestorepaytheseloans.Worse,Asianbanks,urgedonbytheoften-corruptpoliticalleadership,weremakingloanstomoney-losingventurescontrolledbypoliticalcronies.Theresultwasfinanciallytroubledeconomiesthatcouldnotgeneratetheincomenecessarytorepaytheirdollarloans.

3.b.WhatlessonscanwelearnfromtheAsiancurrencycrisis?

ANSWER.Financialcrisescanbeavoidedormitigatediffinancialmarketsareopenandtransparent,therebyleadingtoinvestmentdecisionsbasedonsoundeconomicprinciplesratherthancronyismorpoliticalconsiderations.Countriescanstimulatehealthiereconomiesbyavoidingpoliciesthatsuppressenterprise,rewardcronies,andsquanderresourcesoneconomicallydubious,grandioseprojects.

4.a.Whatisanefficientmarket?

ANSWER.Anefficientmarketisoneinwhichnewinformationisreadilyincorporatedinthepricesoftradedsecurities.Inanefficientmarket,onecannotexpecttoprosperbyfindingovervaluedorundervaluedassets.Inaddition,allfundsrequirethesamerisk-adjustedreturns.Absenttaxconsiderationsorgovernmentinterve