Unit 4 international economy and business

UNIT 4 INTERNATIONAL ECONOMY AND BUSINESS

Getting started.

 

Since the 1970s the global environment has become increasingly unstable. In the 1960s a business could assume stable inflation, fixed exchange rates and stable oil prices. The governments of the major industrial economies successfully pursued macroeconomic policies, in the search of full and stable employment. These comfortable conditions no longer exist, and business must be prepared to respond to constant changes and fluctuations in all these variables, as well as fast changing consumer tastes.

National economies can no longer be isolated from change elsewhere, and in this sense every business, however small, is operating in global environment. It must be prepared for the sudden appearance of a new competing product or service, probably from another country, at any time. It follows that business planning must take international factors into account. Thus senior managers must be aware of changes in the following variables:

- the national economy’s performance in the world economy;

- major changes occurring in world markets;

- major changes in key economic variables, е.g. oil prices, exchange rates, etc.

- nature and role of multinational firms, and their current strategies;

- government economic policy on exchange rate and Balance of Payments issues, etc.

 

Discuss the following points.

1. What do you think were the reasons for the great changes in the global environment which has become increasingly unstable since the 1970s?

2. Why do you think business planning must take international factors into account?

 

Reading

Comprehension

4.4.1 Answer the questions using the active vocabulary.

1. How can you define the basic economic process?

2. What do you think facilitated the development of international trade?

3. W hat are the reasons for international trade?

4. What are the benefits of specialization and trade?

5. How can you define the concept of ‘comparative cost advantage’?

6. What is Free Trade? Describe the main features of it.

7. Does Free Trade really exist? Why or why not?

8. What was the mission of GATT? What organization succeeded to it?

9. How can you define the concept of ‘protectionism’?

10. What are the reasons for governments’ seeking to protect domestic industries?

11. What is dumping? Do you think it is legal to use dumping in free trade?

12. Could you give your own examples of protectionism in different countries?

13. What are the most widely used forms of protectionism?

14. Protectionism is ‘a mixed blessing’, isn’t it? Sum up the advantages and disadvantages of it.

15. What is a country’s Balance of Payments?

16. What is the difference between the Current Account and the Capital Account?

17. Does the balance of payments surplus mean that there is a net inflow of money into the economy?

18. How can a balance of payments deficit be eliminated?

19. What measures can governments take to remove the balance of payments deficit after the reserves have been exhausted?

20. What currencies can be used to make payments in international trade?

21. What is an exchange rate? Why is it of great importance to all businesses?

 

4.4.2 Mark these statements T(true) or F(false) according to the information in the text. If they are false say why.

1. All nations have sufficient amounts of resources to satisfy their wants and needs.(F)

2. Exploitation of resources on a global scale is impossible without international trade.)T)

3. The more the country is involved in international trade the less advanced it is. (F)

4. International trade is impossible without specialization. (T)

5. Different economies specialize in what they can do best and cheapest. Thus they derive a comparative cost advantage and benefit from it. (T)

6. International trade has the effect of enabling countries to import some expensive goods and services rather than export them cheaply.(F)

7. Since 1945, as a result of the work of the General Agreement on Tariffs and Trade (GATT) and successively the World Trade Organization (WTO), completely free conditions have existed, resulting in the growth of trade and of world GDP.(F)

8. Governments with a cost advantage seek to protect key industries from competition by imports from other countries.)F)

9. Dumping is an example of protectionism.(F)

10. Dumping is an example of ‘unfair’ competition.(T)

11. Third world countries may seek to induce growth by protecting their ‘infant’ industries.(T)

12. European textile industries have been protected by governments for strategic reasons.(T)

13. Tariffs and quotas have been largely covered by the WTO agreements.(T)

14. Direct government subsidies to industries, government procurement policies favoring domestic suppliers and other ‘covert’ measures have replaced tariffs on imports and quotas.(T)

15. The Current Account is a summary of all transactions in assets, real or financial.(F)

16. A balance of payments deficit is an imbalance in a nation's balance of payments in which payments made by the country exceed payments received by the country.(T)

17. A balance of payments proficit is considered unfavorable because more currency is flowing out of the country than is flowing in. (F)

18. Deflation, devaluation or depreciation are used to fight against a persistent balance of payments deficit.(T)

19. Governments also try to make it more difficult for capital to leave the country or encourage exports by generous credit facilities to fight against a persistent balance of payments deficit.(T)

20. An exchange rate is the price of one currency expressed in another currency.(T)

21. Movements in the exchange rate facilitate international trade.(F)

Language practice

4.5.1 Match the English terms in the left-hand column with the definition in the right-hand column.

 

	An exchange rate(F)	A	It refers to a globally traded currency that can serve as a reliable and stable store of value.
	A cost advantage(L)	B	An accounting record of all monetary transactions between a country and the rest of the world.
	A forward market(N)	C	An imbalance in a nation's balance of payments in which payments made by the country exceed payments received by the country.
	A real asset(J)	D	A type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market.
	A hard currency (A)	E	A decrease in the value of a particular currency relative to other currencies.
	A financial asset(M)	F	Price for which the currency of a country can be exchanged for another country’s currency.
	A comparative cost advantage(O)	G	A reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged.
	Deflation(K)	H	The pricing of a product below its cost of production.
	A balance of payments deficit (C)	I	A system of trade policy that allows traders to act and or transact without interference from government.
	A floating exchage rate (D)	J	Physical or identifiable assets such as gold, land, equipment, patents, etc.
	Depreciation(E)	K	A decrease in the general price level of goods and services.
	Free trade(I)	L	Superiority achieved through factors such as access to cheaper inputs, efficient processes, favorable location, skilled workforce, superior technology, and / or waste reduction.
	A Balance of Payments (B)	M	An asset that derives value because of a contractual claim e.g. stocks, bonds, bank deposits, and the like.
	Dumping(H)	N	The over-the-counter financial market in contracts for future delivery, so called forward contracts.
	Devaluation(G)	O	The ability of an individual, country, region, or group to produce a good or service at a lower opportunity cost than that of a competing group/individual.

 

4.5.2 Complete the following text using suitable words or phrases from the box below.

 

A	supply of money (4)	F	currency (3)
B	balance of payments (10)	G	deficit (2)
C	inflation (6)	H	source (9)
D	imbalance (1)	I	economy (7)
E	trade (8)	J	exchange rate (5)

 

Fixed and Floating Rates

For 25 years after World War II, the levels of most major currencies определялись правительствами. They were fixed against the US dollar, and the dollar was fixed against gold. One dollar was worth one thirty-fifth of an ounce of gold, and the US Federal Reserve гарантировалa that they could обменять an ounce of gold for $35. Эта система была известна as gold convertability. Fixing against the dollar ended in 1971, because following инфляция in the USA, the Federal Reserve did not have enough золота to guarantee the американскую валюту.

Since the early 1970s, there has been система плавающихвалютных курсов in most western countries. This means that валютные курсы определяются by people покупающими ипродающимивалюту in the foreign exchange markets. A freely плавающий валютный курс means one which is determined by рыночными силами: the level of спроса и предложения. If there are more покупателей of a currency than продавцов, its price поднимется; if there are more sellers, it упадет.

 

4.5.4 Text for discussion .

a. Look up the dictionary for the meaning and pronunciation of the following words and word-combinations and use them to discuss the problems outlined in the text.

Assessment, currency fluctuations, relative inflation rates, currency supply, to pursue policies, gradual reduction in the value of the currency, to be retarded, capital investments, to be deterred, speculators, to guess wrongly, to guess correctly, adjustment of a balance of payments, volatility of currencies, capital movements.

b. Briefly scan the text and outline the list of major points.

c. Read the text more carefully and comment on the following items:

-The major benefits of floating exchange rates.

-The major problems of floating exchange rates.

-The process of balance of payments adjustment under floating exchange rates.

Unit 4 Glossary

ALLOCATION: The process of distributing resources for the production of goods and services, and of distributing goods and services for consumption by households. This process of allocation is essential to an economy's effort to address the problem of scarcity. An allocation is efficient if the resources, goods, and services are distributed according to the economy's highest valued uses.

ASSET: Something that you own. For a person, assets can be financial, like money, stocks, bonds, bank accounts, and government securities, or they can be physical things, like cars, boats, houses, clothes, food, and land. The important assets for our economy are the output we have produced and the resources, capital, and natural resources used to produce that output.

Foreign currencies deposited in banks outside the home country.

BOND RATING: A measure of the ability of a firm to meet its debt obligations or credit worthiness. Basically, a bond rating summarizes the assessment of a firm's net worth, cash flow and viability of projects so that investors can assign the size of the default-risk premium to the bond. These measurements are so important that investors frequently pay professional analysts to collect, monitor and process information about firms.

BUY-SELL SPREAD: (also known as bid/ask or bid/offer spread) for securities (such as stocks, futures contracts, options, or currency pairs) is the difference between the prices quoted (either by a single market maker or in a limit order book) for an immediate sale (ask) and an immediate purchase (bid). The size of the bid-offer spread in a security is one measure of the liquidity of the market and of the size of the transaction cost.

CAPITAL ACCOUNT: One of two parts of a nation's balance of payments. The capital account is a record of all purchases of physical and financial assets between a nation and the rest of the world in a given period, usually one year. On one side of the balance of payments ledger account are all of the foreign assets purchase by our domestic economy. On the other side of the ledger are all of our domestic assets purchased by foreign countries. The capital account is said to have a surplus if a nation's investments abroad are greater than foreign investments at home. In other words, if the good old U. S. of A. is buying up more assets in Mexico, Brazil, and Hungry, than Japanese, Germany, and Canada investors are buying up of good old U. S. assets, then we have a surplus. A deficit is the reverse.

CAPITAL ACCOUNT DEFICIT: An imbalance in a nation's balance of payments capital account in which payments made by the country for purchasing foreign assets exceed payments received by the country for selling domestic assets. In other words, investment by the domestic economy in foreign assets is less than foreign investment in domestic assets. This is generally not a desirable situation for a domestic economy. However, in the wacky world of international economics, a capital account deficit is often balanced by a current account surplus, which is generally considered a desirable situation. If, however, the current account does not balance out the capital account, then a capital account deficit contributes to a balance of payments deficit.

CAPITAL ACCOUNT SURPLUS: An imbalance in a nation's balance of payments capital account in which payments received by the country for selling domestic assets exceed payments made by the country for purchasing foreign assets. In other words, investment by the domestic economy in foreign assets is greater than foreign investment in domestic assets. This is generally a desirable situation for a domestic economy. However, in the wacky world of international economics, a capital account surplus is often balanced by a current account deficit, which is not generally considered a desirable situation. If, however, the current account does not balance out the capital account, then a capital account surplus contributes to a balance of payments surplus.

COMPETITION: In general, the actions of two or more rivals in pursuit of the same objective. In the context of markets, the specific objective is either selling goods to buyers or alternatively buying goods from sellers. Competition tends to come in two varieties -- competition among the few, which is market with a small number of sellers (or buyers), such that each seller (or buyer) has some degree of market control, and competition among the many, which is a market with so many buyers and sellers that none is able to influence the market price or quantity exchanged.

COST: Best referred to as opportunity cost, this is the highest valued alternative foregone in the pursuit of an activity. This is a hallmark of anything dealing with economics -- or life for that matter -- because any action that you take prevents you from doing something else. The value expressed in terms of satisfaction of the foregone activity is your opportunity cost. Because there are usually several alternatives that aren't pursued, opportunity cost is the highest-valued one. An opportunity cost is sometimes compensated with some form of payment, like a wage. However, the existence of an opportunity cost is independent of any actual cash outlay.

CURRENCY: Paper usually issued by the national government that are used as money. Metal coins are also frequently included under the generic heading of currency. Currency in the U.S. economy is issued by the Federal Reserve System (paper) and the U.S. Treasury (coins). This constitutes about 30 to 40 percent of the M1 money supply.

CURRENT ACCOUNT: One of two parts of a nation's balance of payments (the other is capital account). It is a record of all trade, exports and imports, between a nation and the rest of the world. The current account is separated into merchandise, services, and what's called unilateral transfers. The merchandise part is nothing other than the well-known balance of trade. There's also a lesser known balance of services -- the difference between services imported and exported.

CURRENT ACCOUNT DEFICIT: An imbalance in a nation's balance of payments current account in which payments received by the country for selling domestic exports are less than payments made by the country for purchasing imports. In other words, imports (of goods and services) by the domestic economy are greater than exports (of goods and services). This is generally a not desirable situation for a domestic economy. However, in the wacky world of international economics, a current account deficit is often balanced by a capital account surplus, which is generally considered a desirable situation. If, however, the capital account does not balance out the current account, then a current account deficit contributes to a balance of payments deficit.

CURRENT ACCOUNT SURPLUS: An imbalance in a nation's balance of payments current account in which payments received by the country for selling domestic exports are greater than payments made by the country for purchasing imports. In other words, imports (of goods and services) by the domestic economy are less than exports (of goods and services). This is generally a desirable situation for a domestic economy. However, in the wacky world of international economics, a current account surplus is often balanced by a capital account deficit, which is generally considered an undesirable situation. If, however, the capital account does not balance out the current account, then a current account surplus contributes to a balance of payments surplus.

DEFLATION: An extended decline in the average level of prices. This is the exact opposite of inflation--in which prices are rising over an extended period, and it should be contrasted with disinflation--which is a decline in the inflation rate. Like inflation, deflation occurs when the AVERAGE price level decreases over time. While some prices might decrease, other prices could increase or remain unchanged, so long as the AVERAGE follows a downward trend. Deflation is a rare bird indeed in our economy and typically happens only when we're in a prolonged period of stagnation. We might see some deflation during a fairly lengthy recession, but more than likely deflation saves itself for the occasional depression that dots our economic landscape.

DEPRECIATION: A more or less permanent decrease in value or price. "More or less permanent" doesn't include temporary, short-term drops in price that are common in many markets. It's only those price declines that reflect a reduction in consumer satisfaction. While all sorts of stuff can depreciate in value, some of the more common ones are capital, real estate, corporate stock, and money. The depreciation of capital results from the rigors of production and affects our economy's ability to produce stuff. A sizable portion of our annual investment is thus needed to replace depreciated capital. The depreciation of a nation's money is seen as an increase in the exchange rate. This process is described in detail in the entry on the J curve.

DEVALUATION: It is a reduction in the value of a currency with respect to those goods, services or other monetary units with which that currency can be exchanged. In common modern usage, it specifically implies an official lowering of the value of a country's currency within a fixed exchange rate system, by which the monetary authority formally sets a new fixed rate with respect to a foreign reference currency. In contrast, depreciation is used for the unofficial decrease in the exchange rate in a floating exchange rate system. The opposite of devaluation is called revaluation.

EXCHANGE RATE: The price of one nation's currency in terms of another nation's currency. This is often called the foreign exchange rate in that it is the price determined in the foreign exchange market when people buy and sell foreign exchange. The exchange rate is specified as the amount of one currency that can be traded per unit of another.

EXCHANGE: The process of trading one item for another. Exchange is fundamental to the study of economics, markets, and market-oriented economies. Most exchanges in a modern, complex market-oriented economy involve a commodity on one side and a monetary payment (that is, price) on the other. In essence, a buyer gives up money and gets a good, while a seller gives up a good and gets money.

EXPORT: The sale of goods to a foreign country. The United States, for example, sells a lot of the stuff produced within our boundaries to other countries, including wheat, beef, cars, furniture, and, well, almost every variety of product you care to name. In general, domestic producers (and their workers) are elated with the prospect of selling their goods to foreign countries--leading to more buyers, a higher price, and more profit. The higher price, however, is bad for domestic consumers. In that domestic consumers tend to have far less political clout than producers, very few criticisms of exports can be heard. On the positive side, though, exports do tend to add to the multiplicative, cumulatively reinforcing expansion of production and income (that is, the multiplier).

EXPORTS: The sale of goods to a foreign country. The United States, for example, sells a lot of the stuff produced within our boundaries to other countries, including wheat, beef, cars, furniture, and, well, almost every variety of product you care to name. In general, domestic producers (and their workers) are elated with the prospect of selling their goods to foreign countries--leading to more buyers, a higher price, and more profit. The higher price, however, is bad for domestic consumers. In that domestic consumers tend to have far less political clout than producers, very few criticisms of exports can be heard. On the positive side, though, exports do tend to add to the multiplicative, cumulatively reinforcing expansion of production and income (that is, the multiplier).

FAVOURABLE BALANCE OF PAYMENTS: An imbalance in a nation's balance of payments in which payments made by the country are less than payments received by the country. This is also termed a balance of payments surplus. It's considered favorable because more currency is flowing into the country than is flowing out. Such an unequal flow of currency will expand the supply of money in the nation and subsequently cause a decrease in the exchange rate relative to the currencies of other nations. This then has implications for inflation, unemployment, production, and other facets of the domestic economy. A balance of trade surplus is often the source of a balance of payments surplus, but other payments can turn a balance of trade surplus into a balance of payments deficit.

FEDERAL RESERVE SYSTEM (also known as the Federal Reserve, and informally as The Fed ): It is the central banking system of the United States. It was created in 1913 with the enactment of the Federal Reserve Act, largely in response to a series of financial panics, particularly a severe panic in 1907. Over time, the roles and responsibilities of the Federal Reserve System have expanded and its structure has evolved. Events such as the Great Depression were major factors leading to changes in the system. Its duties today, according to official Federal Reserve documentation, are to conduct the nation's monetary policy, supervise and regulate banking institutions, maintain the stability of the financial system and provide financial services todepository institutions, the US government, and foreign official institutions.

FINANCIAL ASSETS: These are assets that derive value because of a contractual claim. Stocks, bonds, bank deposits, and the like are all examples of financial assets. Unlike land and property--which are tangible, physical assets--financial assets do not necessarily have physical worth.

FIXED EXCHANGE RATE: A country's exchange rate regime under which the government or central bank ties the official exchange rate to another country's currency (or the price of gold). The purpose of a fixed exchange rate system is to maintain a country's currency value within a very narrow band. Also known as pegged exchange rate.

 

FLOATING EXCHANGE RATE: A country's exchange rate regime where its currency is set by the foreign-exchange market through supply and demand for that particular currency relative to other currencies. Thus, floating exchange rates change freely and are determined by trading in the forex market. This is in contrast to a "fixed exchange rate" regime.

FOREIGN EXCHANGE MARKET (forex, FX, or currency market): It is a worldwide decentralized over-the-counter financial market for the trading of currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.

FORWARD MARKET: It is the over-the-counter financial market in contracts for future delivery, so called forward contracts. Forward contracts are personalized between parties (i.e., delivery time and amount are determined between seller and customer). The forward market is a general term used to describe the informal market by which these contracts are entered into. Standardized forward contracts are called futures contracts and traded on a futures exchange.

FREE TRADE: The absence of trade barriers, or restrictions on foreign trade. Based on the notion of comparative advantage, unrestricted trade is generally beneficial to a trading country. However, while consumers benefit through a greater selection of products and lower prices, producers in a country are on the receiving end of lower prices and stiffer competition. In that producers tend to have more political clout than consumers, completely, unhindered free trade is seldom seen in the real world. Numerous trade restrictions such as tariffs, nontariff barriers, and quotas are usually the rule of the day (also the rule of the week, year, decade and century).

FREE-TRADE AREA: An agreement among two or more nations to eliminate trade barriers with each other. There is no attempt, however, to adopt a common trade policy with other nations, to allow free movement of resources among the countries, or to adopt common monetary or fiscal policies. This is considered the first of four levels of integration among nations. See common market, customs union, economic union for the other levels.

GATT: The abbreviation for the General Agreement on Tariffs and Trade. A treaty, signed in 1947 by 23 countries including the United States that was designed to reduce trade barriers. It now carries the signatures of about 100 countries and over the years has been pretty darn effective in reducing tariffs, eliminating some import quotas, and promoting commerce.

GOLD CONVERTABILITY: It is the ease with which a country's currency can be converted into gold or another currency. Convertibility is extremely important for international commerce. When a currency in inconvertible, it poses a risk and barrier to trade with foreigners who have no need for the domestic currency.

 

IMPORT: Goods and services produced by the foreign sector and purchased by the domestic economy. In other words, imports are goods purchased from other countries. The United States, for example, buys a lot of the stuff produced within the boundaries of other countries, including bananas, coffee, cars, chocolate, computers, and, well, a lot of other products. Imports, together with exports, are the essence of foreign trade--goods and services that are traded among the citizens of different nations. Imports and exports are frequently combined into a single term, net exports (exports minus imports).

IMPORTS: Goods and services produced by the foreign sector and purchased by the domestic economy. In other words, imports are goods purchased from other countries. The United States, for example, buys a lot of the stuff produced within the boundaries of other countries, including bananas, coffee, cars, chocolate, computers, and, well, a lot of other products. Imports, together with exports, are the essence of foreign trade--goods and services that are traded among the citizens of different nations. Imports and exports are frequently combined into a single term, net exports (exports minus imports).

INDUSTRY: A group of firms producing goods or services that are close substitutes-in-consumption. The similarity of the products makes it possible to analyze the production in a market framework. An industry can be broadly defined, such as the manufacturing industry, or narrowly specified, such as the root beer industry. For most economic analysis the term industry is used interchangeably with the term market.

INFLATION: A persistent increase in the average price level in the economy. Inflation occurs when the AVERAGE price level (that is, prices IN GENERAL) increases over time. This does NOT mean that ALL prices increase the same, nor that ALL prices necessarily increase. Some prices might increase a lot, others a little, and still other prices decrease or remain unchanged. Inflation results when the AVERAGE of these assorted prices follows an upward trend. Inflation is the most common phenomenon associated with the price level.

PURCHASING POWER PARITY (PPP): It is a theory of long-term equilibrium exchange rates based on relative price levels of two countries. The idea originated in the 16th century and was developed in its modern form by Gustav Cassel in 1918. The concept is founded on the law of one price; the idea that in absence of transaction costs, identical goods will have the same price in different markets. In its "absolute" version, the purchasing power of different currencies is equalized for a given basket of goods.

QUOTA: A limit on the quantity of some sort of activity. Two of the more noted quotas are for employment and imports. Employment quotas have been used as a means of providing increased opportunities to blacks, hispanics, women, and other groups that have been historically subject to discrimination. Such quotas, however, tend to anger other groups, especially white males, who don't get favorable treatment. While employment or similar anti-discrimination quota systems might help address historical problems, they are not without cost. In particular, our economy's efficiency is likely to suffer if a less qualified member of an ethnic group is selected over someone who is more qualified. Import quotas have similar problems. They are one form of trade barriers that's usually intended to reduce the competition faced by a domestic producer.

REAL ASSETS: These are physical or identifiable assets such as gold, land, equipment, patents, etc. They are the opposite of a financial asset. Real assets tend to be most desirable during periods of high inflation.

RESOURCE ALLOCATION: The process of dividing up and distributing available, limited resources to competing, alternative uses that satisfy unlimited wants and needs. Given that world is rampant with scarcity (unlimited wants and needs, but limited resources), every want and need cannot be satisfied with available resources. Choices have to be made. Some wants and needs are satisfied, some are not. These choices, these decisions are the resource allocation process. An efficient resource allocation exists if society has achieved the highest possible level of satisfaction of wants and needs from the available resources and resources cannot be allocated differently to achieve any greater satisfaction.

SPECIALIZATION: The condition in which resources are primarily devoted to specific tasks. This is one of THE most important and most fundamental notions in the study of economics. Civilized human beings have long recognized that limited resources can be more effectively used in the production the goods and services that satisfy unlimited wants and needs if those resources specialize. For example, three ice cream parlor workers, can be, in total, more productive if one runs the cash register, another scoops the ice cream, and a third adds the hot fudge topping. By devoting their energies to learning how to do their respective tasks really, really well, these three workers can produce more hot fudge sundaes than if each performed all required tasks.

SPECULATION: Buying an asset with the intent of reselling it later at a higher price. The purpose of speculation is simply to buy low today and sell high tomorrow. Those who engage in speculation have no reason for buying the asset, other than resale at a later time. Such speculation is quite common in most financial markets (futures markets are a particular favorite), but it's also a motive for those who have "investments" in fine art, baseball cards, coins, and real estate.

STABILITY: Limiting macroeconomic fluctuations in prices, employment, and production. This is one of the five economic goals, specifically one of the three macro goals (the other two are economic growth and full employment). One primary focus of this stability goal is to keep inflation in check. High or unpredictable inflation rates can cause uncertainty and haphazardly redistribute income and wealth.

SUBSIDY: A payment from government to individuals or businesses without any expectations of production. The best way of thinking about a subsidy is as a negative tax. Government extends subsidies for many different reasons. They go to students, unemployed workers, the poor, farmers, wealthy friends of political leaders, businesses trying to fend off foreign competitors, and the list could go on. Subsidies are frequently used to redirect resources from one good to another. Sometimes this is justified on efficiency grounds and other times it's just the result of political power.

TARIFF: A tax that's usually on imports, but occasionally (very rarely) on exports. This is one form of trade barrier that's intended to restrict imports into a country. Unlike nontariff barriers and quotas which increase prices and thus revenue received by domestic producers, a tariff generates revenue for the government. Most pointy-headed economists who spend their waking hours pondering the plight of foreign trade contend that the best way to restrict trade, if that's what you want to do, is through a tariff.

THIRD-WORLD COUNTRY: A country with a relatively low standard of living and which lacks the economic development of more advanced industrialized nations like the United States. Most third-world countries are in Africa, Asia, and South America and often rise to newsworthy prominence when they have a famine, are overthrown by a military dictator, or are invaded by a more developed country. They tend to have high rates of population growth and limited success in doing what's necessary to achieve economic growth.

UNFAIR COMPETITION: A wide assortment of business practices that are deceptive and dishonest, and usually hamper competition. Examples of unfair competition include false or misleading advertising, price discrimination, bribery, and even industrial espionage. These practices and many, many more are illegal according to antitrust law, specifically the Federal Trade Commission Act (1914).

UNFAVOURABLE BALANCE OF PAYMENTS: An imbalance in a nation's balance of payments in which payments made by the country exceed payments received by the country. This is also termed a balance of payments deficit. It's considered unfavorable because more currency is flowing out of the country than is flowing in. Such an unequal flow of currency will reduce the supply of money in the nation and subsequently cause an increase in the exchange rate relative to the currencies of other nations. This then has implications for inflation, unemployment, production, and other facets of the domestic economy. A balance of trade deficit is often the source of a balance of payments deficit, but other payments can turn a balance of trade deficit into a balance of payments surplus.

URUGUAY ROUND: The eighth and final round of General Agreement on Tariffs and Trade (GATT) negotiations that is most noted for establishing the World Trade Organization (WTO) to replace GATT. The Uruguay round began in 1986 and was concluded in 1994. In addition to establishing the WTO, the Uruguay round also sought to reduce tariffs and trade restrictions among member countries.

VOLATILITY: In finance, volatility most frequently refers to the standard deviation of the continuously compounded returns of a financial instrument within a specific time horizon. It is common for discussions to talk about the volatility of a security's price, even while it is the returns' volatility that is being measured. It is used to quantify the risk of the financial instrument over the specified time period. Volatility is normally expressed in annualized terms, and it may either be an absolute number ($5) or a fraction of the mean (5%).

WTO: The abbreviation for World Trade Organization, which is an international organization that oversees multilateral trade among nations. The WTO was established in 1995 by the Uruguay round of trade negotiations to replace the General Agreement on Tariffs and Trade (GATT) that had been in place for the preceding five decades. The WTO administers multilateral trade agreements, provides a forum for trade negotiations, handles trade disputes, monitors national trade policies, and provides technical assistance and training for developing countries. The WTO has about 150 member countries.

Reading

Comprehension

5.4.1 Answer the questions using the active vocabulary.

1. What is the essential economic function of financial markets?

2. What are the principal lender-savers and borrower-spenders on financial markets?

3. What are the two major routes of funds in the financial system?

4. What is a financial instrument?

5. What are the main reasons for which financial markets are very important?

6. How can financial markets be classified?

7. What is the difference between debt markets and equity markets?

8. What is the difference between primary markets and secondary markets?

9. How can secondary markets be categorized?

10. Why are the over-the-counter markets very competitive and not very different from a market with an organized exchange?

11. What is the difference between money markets and capital markets?

12. Why is the indirect financial route considered the primary route for moving funds from lenders to borrowers?

13. How does a financial intermediary function?

14. What is financial intermediation?

15. What are the advantages of getting funds from a financial intermediary rather than from a financial market?

16. What is asymmetric information? How can it affect the efficiency of financial operations?

17. What are the main categories of financial intermediaries?

 

5.4.2 Mark these statements T(true) or F(false) according to the information in the text. If they are false say why.

1. Financial markets channel funds from households, firms, and governments that have a shortage of funds because they wish to spend more than their income to those that have saved surplus funds by spending less than their income. (F)

2. Those who have saved and are lending funds, are the lender-savers.T

3. Those who must borrow funds to finance their spending, are the lender-spenders. F

4. Households, business enterprises and the government, as well as foreigners and their governments can be both lender-savers and borrower-spenders in different occasions on financial markets. T

5. Common stocks, which are claims to share in the net income and the assets of the business, often make periodic payments (interest plus principal) to their holders. F

6. Debt instruments periodically make payments (dividends) to their holders. F

7. Bonds, stocks, and mortgages are both securities and debt instruments. F

8. Exchanges and over-the-counter markets have very much in common. T

9. There is no difference between exchanges and OTCs. F

10. Equity instruments are traded on the money markets. F

11. Financial intermediation involves financial intermediaries. T

12. Banks, exchanges, insurance companies and pension funds are financial intermediaries. F

13. Money markets are the same as money market mutual funds. F

14. Life Insurance Companies and Fire and Casualty Insurance Companies, Pension Funds and Government Retirement Funds are the contractual savings institutions. T

15. Savings and Loan Associations, Mutual Savings Banks, and Credit Unions are thrift institutions (thrifts). T

 

Language practice

5.5.1 Match the English terms in the left-hand column with the definition in the right-hand column.

 

	Asymmetric information(I)	A	The process of indirect finance whereby financial intermediaries link lender-savers and borrower-spenders.
	Bond (L)	B	Funds that accumulate investment dollars from a large group of people and then invest in short-term securities such as Treasury bills and commercial paper.
	Common stock (O)	C	Foreign currencies deposited in banks outside the home country.
	Credit union (R)	D	A financial market in which longer-term debt (maturity of periods greater than one year) and equity instruments are traded.
	Exchanges (N)	E	A financial institution that provides services such as accepting deposits and giving business loans.
	Money market (Q)	F	Markets in which funds are transferred from people who have a surplus of available funds to people who have a shortage of available funds.
	Mutual bank (K)	G	A long-term loan secured by real estate.
	Commercial bank (E)	H	All resources owned by an individual, including all assets.
	Financial intermediation(A)	I	The inequality of knowledge that each party to a transaction has about the party.
	Eurocurrencies (C)	J	A secondary market in which dealers at different locations who have an inventory of securities stand ready to buy and sell securities to anyone who comes to them and is willing to accept their prices.
	Transaction costs (M)	K	A bank owned by depositors.
	Mortgage (G)	L	A debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate.
	Security (P)	M	The time and money spent trying to exchange financial assets, goods, or services.
	Wealth (H)	N	Secondary markets in which buyers and sellers of securities (or their agents or brokers) meet in one central location to conduct trades.
	Financial markets (F)	O	A security that gives the holder an ownership interest in the issuing firm. This ownership interest includes the right to any residual cash flows and the right to vote on major corporate issues.
	A capital market (D)	P	A claim on the borrower’s future income that is sold by the borrower to the lender. Also called a financial instrument.
	Over-the-counter market (J)	Q	A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded.
	Money market mutual funds (B)	R	Member-owned financial co-operatives that are created and operated by its members and profits are shared amongst the owners.

 

5.5.2 Complete the following text using suitable words or phrases from the box below.

A	investment opportunities(5)	E	deregulation (3)
B	pool of savings (2)	F	foreign corporations (6)
C	important investors (8)	G	financial markets (1)
D	to expand (4)	H	funds (7)

Financial Regulation

Not surprisingly, given the similarity of the economic system in the USA and in Japan, Canada, and the nations of western Europe, financial regulation in these countries is similar to financial regulation in the United States. The provision of information is improved by requiring corporations issuing securities to report details about assets and liabilities, earnings, and sales of stock, and by prohibiting insider trading. The soundness of intermediaries is ensured by licensing, periodic inspection of financial intermediaries’ books, and the provision of deposit insurance.

The major differences between financial regulation in the United States and abroad relate to bank regulation. In the past, the United States was the only industrialized country to subject banks to restrictions on branching, which limited banks’ size and restricted them to certain geographic regions. (These restrictions were abolished by legislation in 1994.) US banks are also the most restricted in the range of assets they may hold. Banks abroad frequently hold shares in commercial firms; in Japan and Germany, those stakes can be sizable.

 

Unit 5 Glossary

ASYMMETRIC INFORMATION: The inequality of knowledge that each party to a transaction has about the other party. This often happens in transactions where the seller knows more than the buyer, although the reverse can happen as well. Potentially, this could be a harmful situation because one party can take advantage of the other party’s lack of knowledge. With increased advancements in technology, asymmetric information has been on the decline as a result of more and more people being able to easily access all types of information.

 

BANKS: Financial institutions that accept deposits and make loans (such as commercial banks, savings and loan associations, and credit unions).

 

BOND: A debt security that promises to make payments periodically for a specified period of time. Bonds are used by companies, municipalities, states and U.S. and foreign governments to finance a variety of projects and activities. Bonds are commonly referred to asfixed-income securities and are one of the three main asset classes, along with stocks and cash equivalents. The indebted entity (issuer) issues a bond that states the interest rate (coupon) that will be paid and when the loaned funds (bond principal) are to be returned (maturity date). Interest on bonds is usually paid every six months (semi-annually). The main categories of bonds are corporate bonds, municipal bonds, and U.S. Treasury bonds, notes and bills, which are collectively referred to as simply "Treasuries".
Two features of a bond - credit quality and duration - are the principal determinants of a bond's interest rate. Bond maturities range from a 90-day Treasury bill to a 30-year government bond. Corporate and municipals are typically in the three to 10-year range.

 

BRANCHES: Additional offices of banks that conduct banking operations.

CAPITAL MARKET: A financial market in which longer-term debt (maturity of greater than one year) and equity instruments are traded. Individuals and institutions in the public and private sectors often sell securities on the capital markets in order to raise funds. Thus, this type of market is composed of both the primary and secondary markets.

 

COMMERCIAL BANK: A financial institution that provides services such as a accepting deposits and giving business loans. Commercial banking activities are different than those of investment banking, which include underwriting, acting as an intermediary between an issuer of securities and the investing public, facilitating mergers and other corporate reorganizations, and also acting as a broker for institutional clients.

COMMERCIAL PAPER: An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Maturities on commercial paper rarely range any longer than 270 days. The debt is usually issued at a discount, reflecting prevailing market interest rates. The maturity length of commercial paper is less than a year, often 30, 60 or 90 days. The corporations who issue commercial paper are usually the largest, most stable, and most profitable businesses in the country.

COMMODITIES EXCHANGE: A commodities exchange is an exchange where various commodities and derivatives products are traded. Most commodity markets across the world trade in agricultural products and other raw materials (like wheat, barley, sugar, maize, cotton, cocoa, coffee, milk products, pork bellies, oil, metals, etc.) and contracts based on them. These contracts can include spot prices, forwards, futures and options on futures. Other sophisticated products may include interest rates, environmental instruments, swaps, or ocean freight contracts. The two biggest commodity exchanges in good old U. S. of A. are the Chicago Board of Trade and the Chicago Mercantile Exchange. Unlike, let's say a grocery store where commodities physically trade hands, commodity exchanges trade only legal ownership. This is much like a stock market, which trades the ownership of a corporation, but leaves the factory at home. Commodity markets offer two basic sorts of trading -- spot (immediate delivery of a commodity) and futures (delivery of a commodity at a future date).

COMMON STOCK: A security that gives the holder an ownership interest in the issuing firm. This ownership interest includes the right to any residual cash flows and the right to vote on major corporate issues.

CREDIT UNION: A financial institution that focuses on servicing the banking and lending needs of its members, who must be linked by a common bond. These are member-owned financial co-operatives. These institutions are created and operated by its members and profits are shared amongst the owners. As soon as you deposit funds into a credit union account, you become a partial owner and participate in the union's profitability. Credit unions are formed by large corporations and organizations for their employees and members.

DEPOSIT INSURANCE: A program of guaranteeing, or insuring, customers' deposits at a bank or similar institution. Since the 1930s bank deposits have been insured by the Federal Deposit Insurance Corporation (FDIC). Other programs have insured deposits at credit unions and savings and loan associations. The FDIC works like this -- If a bank is unable to pay back all or part of its customers' deposits because it has done something like go out of business, then the FDIC steps in to make up the difference--up to a pretty hefty limit.

DIVIDEND: The portion of a corporation's after-tax accounting profit that's paid to shareholders or owners. Corporate managers usually try to pay the shareholders some minimum dividend that's comparable to returns from other financial markets--such as the interest on government securities or corporate bonds--to keep the owners from selling off the company's stock. That portion of after-tax accounting profit that's not paid out as dividends is typically invested in capital.

EFFICIENCY: Obtaining the most possible satisfaction from a given amount of resources. Efficiency for our economy is achieved when we cannot increase our satisfaction of wants and needs by producing more of one good and less of another. This is one of the five economic goals, specifically one of the two micro goals (the other being equity).

EQUITY: This has two, not totally unrelated, uses in our wonderful world of economics. The first is as one of the two micro goals (the other being efficiency) of a mixed economy. This use relates to the "fairness" of our income or wealth distributions. The second use of the term equity means ownership, especially the ownership of a business or corporation.

 

EUROBONDS: Bonds denominated in a currency other than that of the country in which they are sold.

 

EUROCURRENCIES: Foreign currencies deposited in banks outside the home country.

 

EURODOLLARS: U.S. dollars that are deposited in foreign banks outside of the United States or in foreign branches of U.S. banks.

 

EXCHANGES: Secondary markets in which buyers and sellers of securities (or their agents or brokers) meet in one central location to conduct trades. An exchange is a marketplace in which securities, commodities, derivatives and other financial instruments are traded. The core function of an exchange - such as a stock exchange - is to ensure fair and orderly trading, as well as efficient dissemination of price information for any securities trading on that exchange. Exchanges give companies, governments and other groups a platform to sell securities to the investing public.
An exchange may be a physical location where traders meet to conduct business or an electronic platform.

 

ECONOMIC EXPOSURE: An exposure to fluctuating exchange rates, which affects a company's earnings, cash flow and foreign investments. The extent to which a company is affected by economic exposure depends on the specific characteristics of the company and its industry.

 

FINANCIAL INTERMEDIARIES: Institutions (such as banks, insurance companies, mutual funds, pension funds, and finance companies) that borrow funds from people who have saved and then make loans to others.

 

FINANCIAL INTERMEDIATION: The process of indirect finance whereby financial intermediaries link lender-savers and borrower-spenders.

 

FINANCIAL MARKETS: Markets in which funds are transferred from people who have a surplus of available funds to people who have a shortage of available funds.

 

INSIDER TRADING: Itis the trading of a corporation's stock or other securities (e.g. bonds or stock options) by individuals with potential access to non-public information about the company. In most countries, trading by corporate insiders such as officers, key employees, directors, and large shareholders may be legal, if this trading is done in a way that does not take advantage of non-public information. However, the term is frequently used to refer to a practice in which an insider or a related party trades based on material non-public information obtained during the performance of the insider's duties at the corporation, or otherwise in breach of a fiduciary or other relationship of trust and confidence or where the non-public information was misappropriated from the company.

INSURANCE: Transferring risk to others. The need for insurance occurs because people tend to be risk averse in many circumstances. As such, most of us are willing to pay for certainty. Those who satisfy this need for insurance, insurance companies for example, do so because they can pool risk. If insurance companies know the chance of some loss (an accident, illness, or whatever) and its cost, then they can divide this cost among a large group of risk averse types. The insurance company agrees to pay the cost of the loss and each of the risk averse types pay a risk premium, but get the peace of mind that goes with certainty.

 

INVESTMENT BANKS: Firms that assist in the initial sale of securities in the primary market (underwriting). Financial intermediaries that perform a variety of services. This includes underwriting, acting as an intermediary between an issuer of securities and the investing public, facilitating mergers and other corporate reorganizations, and also acting as a broker for institutional clients. The role of the investment bank begins with pre-underwriting counseling and continues after the distribution of securities in the form of advice.

 

MONEY MARKET: A financial market in which only short-term debt instruments (maturity of less than one year) are traded. A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. The money market is used by participants as a means for borrowing and lending in the short term, from several days to just under a year. Money market securities consist of negotiable certificates of deposit (CDs), bankers acceptances, U.S. Treasury bills, commercial paper, municipal notes, federal funds and repurchase agreements (repos).The money market is used by a wide array of participants, from a company raising money by selling commercial paper into the market to an investor purchasing CDs as a safe place to park money in the short term.

 

MONEY MARKET MUTUAL FUNDS: Funds that accumulate investment dollars from a large group of people and then invest in short-term securities such as Treasury bills and commercial paper.

 

MORTGAGE: A long-term loan secured by real estate.

 

MUTUAL BANK: A bank owned by depositors.

 

MUTUAL SAVINGS BANK: A type of thrift institution, originally designed to serve low-income individuals that historically invested in long-term, fixed-rate assets such as mortgages. Initiated in 1816, the first mutual savings banks (MSBs) were the Philadelphia Saving Society and Boston's Provident Institution for Saving. Most MSBs were located in the Mid-Atlantic and industrial Northeast regions of the United States. By 1910, there were 637 of these institutions. MSBs were generally very successful until the 1970s. During the 1980s, regulations governing what they could invest in and what rate of interest they could pay to customers combined with rising interest rates to cause massive losses for MSBs. Consequently, many MSBs failed in the 1980s; others merged, became commercial banks or converted to stock form.

NEW YORK STOCK EXCHANGE: The largest stock market in the United States, located on the famous Wall Street in New York City. This is the big daddy of all stock markets in the country, often referred to as the "big board." It was begun in the 1790s to help fledgling corporations in our fledgling country raise the funds needed for capital investment. All stock transactions (millions each day) are conducted by its members, making membership a very valuable commodity. It currently has slightly over a 1,000 members or "seats," with the only way to get a seat on the exchange from a retiring or deceased member.

 

OVER-THE-COUNTER MARKET: A secondary market in which dealers at different locations who have an inventory of securities stand ready to buy and sell securities to anyone who comes to them and is willing to accept their prices. A decentralized market of securities not listed on an exchange where market participants trade over the telephone, facsimile or electronic network instead of a physical trading floor. There is no central exchange or meeting place for this market. Also referred to as the "OTC market". In the OTC market, trading occurs via a network of middlemen, called dealers, who carry inventories of securities to facilitate the buy and sell orders of investors, rather than providing the order matchmaking service seen in specialist exchanges such as