Essay on "International Economics US Direct Investment Into Foreign"

Essay 5 pages (1622 words) Sources: 1

[EXCERPT] . . . .

International Economics

US Direct Investment into Foreign Countries

Foreign Direct Investment or FDI is the process of domestic investment dollars entering into foreign markets. The types of available direct investment options include long-term capital infrastructure, building and land purchase for industrial use, and investment into the developing the revenue behind hard assets like film financing. An example of FDI is the recent decision rendered by the Chinese government that eased FDI into the country for development of private hospital infrastructure. A scenario where a U.S. domiciled private hospital invests into constructing medical buildings within the borders of a foreign land as an affiliated hospital is an example of U.S. Foreign Direct Investment into a Foreign Country.

FDI into the U.S.

The reverse of U.S. FDI is FDI into the U.S. The relative importance of the latter over the former prominently featured recently in financial news reports as foreign countries are actively making direct investments into the U.S. A recent example of FDI into the U.S. is India's private equity businesses engaging Hollywood film studios to finance film development, marketing, and release. FDI in this regard was critical to the continuation of Hollywood film production as Wall Street and other major U.S. based investors bailed out of Tinsel town due to a lack of cash in the wake of the economic crisis. This is a case where FDI contributed to the growth of an industry destined to decline due to insufficient financing streams from domestic investors.

Functions, and descriptions, of the forward, futures and options market

Forward contracts and swaps are financial derivatives used to hedge against investment risk and therefore comprise the forward exchange market. Forward contracts arose early in the 20th century as a means to guarantee a price for a commodity and delivered on a future date. An example, a farmer looking to protect against supply and demand pressures would enter into a forward contract that guaranteed the farmer to receive a fixed price for the harvest regardless of supply in the market. An example of a futures contract is a 6-month forward contract to purchase for wheat at (below market value) for an agreed on price. The price is determined by the forward rate.

The options market is comprised of option contracts that enable an investor to purchase the RIGHT to buy or sell a stock, without taking ownership. For example, it is currently the month of January and an investor is purchasing a February call option (right to purchase) contract on the General Electric Company. The current price for GE stock is $20.00 USD and the option is set to expire in February with a cost of $3.00 per contract to obtain the right to purchase the stock at $25.00. This is the right strategy if you feel the price of the stock will rise "in the money" to a price above $25.00 before the option expiration date, that is the third Friday of the month. If the price rises to $27.00 the investor can exercise the option on each contract and purchase the stock at $25.00 for $3.00 per contract and then sell the stock in the open market. A put strategy is the right to sell a stock at a specified price at a specified date. There are various strategies to options investing including straddles which involve going long or short on a stock and simultaneously buying/selling an call or put.

The relationship between the forward rate and the spot rate

The forward rate refers to a specified price to deliver an asset such as fiat dollars (currency), a commodity (gold or wheat), for delivery at an agreed point in the future. Referring to the forward contract, the forward rate is the price necessary to derive the intrinsic value, or price of the contract. Forward rates also apply to revenue streams associated with interest rate risk and forward rate contracts. The spot rate is the market rate to settle immediately on an asset such as a currency, commodity, or stock and is directly reflective of the expected future value of said asset.

Domestic interest rates and their affect on the balance of payments

Interest rates at U.S. banks, determined by adding 2.5% to the LIBOR average is, the prime rate for investors. Though given recent economic turmoil an investor with substantial cash to invest can borrow at a rate close to LIBOR. The balance of payments is the deficit or surplus of all trade and transactions between a country and its global partners and often refers to the aggregate amount of a nation's exports in comparison to its imports. The balance of payments is not highly accurate measure of financial transactions between nations. For instance, trade and commerce at the port are often not tabulated nor are many private asset management transactions. Receipts are the main measure of determining the balance of trade and that does not complete the entire pie of economic activity. There is a direct linear relationship between rising interest rates and the increase in the amount of a balance of payment deficit. As domestic interest rates increase, the relative value of the outstanding debt increases as well. Higher interest rates domestically means that the cost to service outstanding debt must increase as it is now less attractive to hold U.S. dollars. The higher interest rate is to encourage savings to reduce the float of U.S. dollars outstanding.

Welfare effects of trade creation and trade diversion

The welfare effects of trade are a function in the growth of comparative advantage in a global marketplace. What were once simply agrarian economies has now blossomed into dynamic hi-tech industries that operate without borders. Unfortunately, the markets that opened up to bring about jobs in developing nations created a welfare state throughout the manufacturing belt in the U.S. Factories in Buffalo, NY, Utica, NY, Cleveland, OH, and other manufacturing cities lost numerous jobs to overseas manufacturing companies that are able to produce the same material at a lower cost. Trade diversion is a euphemism for free trade policy that releases tariff restrictions on trade partners. The diversion creates the ability for less-efficient producing nations to engage in trade partnerships with nations due to the lack of a trade tariff. However, this practice produces market inefficiencies as the more efficient nation losses an export partner resulting in the diversion. An example would be if Canada produces good x most efficiently but has a tariff in its export to the U.S. Mexico produces the same good but not as efficiently and has signed a trade agreement with the U.S. To export good x with no tariff. The U.S. will no longer trade for good x with Canada opting instead to trade with Mexico.

Purchasing-power-parity theory; limitations and effect on inflation

Purchasing-power-parity theory states that two currencies are at parity when their currencies have equal purchasing power when exchanged for the other currency to purchase goods in a foreign country. For example, if $1.00 USD is equal to 10 Japanese yen, and it costs $30.00 in the U.S. To purchase good x that costs $240 yen to purchase the same good in Japan, then the buyer will exchange dollars for yen and purchase good x in Japan. However, in practice this will drive the price for good x in the U.S. down and raise its price in Japan. To achieve parity, there can be no advantage. Now if the exchange rate adjusts to $1 USD to 8 yen, then the cost to obtain good x is the same in the U.S. As it is in Japan as $30.00 buys one of good x in the U.S. And $30 buys the same amount in Japan. Inflation rates erode the purchasing power of a currency by indicating that there is too much of a "float" of the currency out… READ MORE

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