Foreign Direct Investment, Trade & Geography - International Business - Practice Exam

Questions part 1

Multiple choice questions

Question 1

Which of the following statements regarding multinational activity is correct?

1. Multinational firms are more likely to choose franchising as an entry mode if the risk of dissemination is high.

2. Firms are more likely to export than engage in horizontal multinational activity if transport costs are high.

3. Multinational firms are more likely to engage in vertical multinational activity if transport costs are low.

4. Multinational firms are more likely to choose full acquisitions over joint ventures if the desire for a high degree of control is low.

Question 2

Which of the following statements regarding Porter’s Diamond Model and Dunning’s OLI model is true?

1. Porter’s model describes the sources of firm-specific advantages and Dunning’s model the role of firm-specific advantages for the success of multinationals.

2. Porter emphasizes the importance of firm-specific factors for the success of multinationals and Dunning the role of governmental subsidies.

3. Dunning emphasizes the importance of resources available in the home country and Porter emphasizes the importance of resources available in the host country.

4. Porter emphasizes the role of supporting industries and Dunning emphasizes the importance of how firms organize the foreign activity.

Table 1: Information on Balance of Payments in country X

Question 3

Based on table 1, the current account balance is:

1. +400

2. +300

3. -300

4. ‐400

Question 4

Based on table 1, the financial (or capital) account balance is:

1. +400

2. +300

3. -300

4. ‐400

Question 5

Which of the following statements regarding Foreign Direct Investment (FDI) statistics is

correct?

1. FDI flow data show the level of multinational activity.

2. All multinational activity is reflected in FDI data.

3. Vertical multinational activity is not recorded in FDI statistics.

4. Funds that multinationals raise in the host country do not show up in FDI data.

Question 6

If a country’s equilibrium price for wheat under autarky is below the world price for wheat,opening up to trade will:

1. Make the country a net importer of wheat.

2. Lower the price of wheat in the country.

3. Increase the consumer surplus in the rest of the world.

4. Decrease the producer surplus in the country.

Question 7

The gravity model of trade:

1. Links the level of foreign direct investment to the distance between countries.

2. Predicts that the level of trade between two countries depends positively on high uncertainty avoidance.

3. Predicts that the level of trade between two countries depends negatively on their GDP levels.

4. Predicts that trade flows between two countries depend negatively on tariffs.

Question 8

If the FOB price of wine is $150,000 for 500 barrels of wine and the importing firm pays $330 per barrel at the port of entry, what is the value of the unit transportation cost rate?

1. 9%.

2. 10%.

3. $30.

4. $15,000.

Question 9

What is the impact of improved capital mobility on the supply of investment funds faced by firms?

1. The funds supply curve becomes steeper.

2. The interest rate wedge increases.

3. The funds supply curve shifts to the right.

4. Both (a) and (c) are correct.

Vraag 10

Empirical research regarding financial crises has shown that:

1. Currency crises typically precede banking crises.

2. Financial crises are typically preceded by a period of low inflation.

3. Fast growing exports are a major signal for an upcoming financial crisis.

4. Financial crises are typically preceded by strong overvaluation of the currency.

Question 11

If the spot exchange rate of the Dollar is 0.9 Euro per Dollar and the 30-day forward rate is 1.00 Euro per Dollar, and you believe that the spot rate in 30 days will be 0.95 Euro per Dollar, then you can make a profit by:

1. Selling Dollars in the current spot market and buying Dollars in 30 days at the future spot rate.

2. Selling Dollars in the current spot market and buying Dollars in the forward market.

3. Selling Dollars in 30 days at the forward rate and buying Dollars in the future spot market.

4. Buying Euros in 30 days in the future spot market and selling Euros at the forward rate.

Question 12

Please fill in the gap: “Without ____ a currency crisis cannot occur at all”.

1. capital mobility

2. bad macroeconomic fundamentals

3. low interest rates

4. increases in moral hazard and adverse selection problems

Vraag 13

If a currency crisis is contagious, this …

1. indicates that macroeconomic fundamentals in the entire region have deteriorated.

2. indicates that the countries involved are offering better investment opportunities.

3. implies that central banks in the countries involved have to lower the interest rates.

4. implies that neighboring countries will experience an outflow of foreign capital.

Question 14

In the second generation model of currency crises:

1. A crisis is caused by ‘bad fundamentals’ and investors determine the timing of the crisis.

2. A crisis is inevitable, because of ‘herd behavior’ of investors.

3. A crisis is caused by a monetary financed expansionary fiscal policy.

4. A crisis is not the only possible outcome.

Vraag 15

What does it mean that resources that generate a firm-specific advantage should be ‘non-substitutable’?

1. There are no other resources that would create a similar firm-specific advantage.

2. Multinational firms should be able to transfer their resources across borders.

3. Competitors of the firm should not be able to easily copy the firm’s resources.

4. The resources of the firm create more value than the resources of the competitors.

Vraag 16

For an investor who starts with Euros and wants to end up with Euros in the future, which of the following choices is an example of an uncovered international investment?

1. Invest in Euro-denominated financial instruments and sign a forward exchange contract to convert foreign currency into Euros.

2. Sell Euros at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy the foreign currency.

3. Sell Euros at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and sign a forward exchange contract to buy Euros.

4. Sell Euros at the spot rate, invest the proceeds in foreign currency-denominated financial instruments, and then buy Euros at the future spot rate.

Question 17

According to the policy trilemma:

1. Countries cannot have independent monetary policy in case of perfect capital mobility and flexible exchange rates.

2. Perfect capital mobility is the only option if a country wants to have independent monetary policy and maintain a fixed exchange rate.

3. Countries with fixed exchange rates and perfect capital mobility must set their interest rates higher than in the rest of the world.

4. Countries must impose capital controls in order to maintain a fixed exchange rate and have monetary policy autonomy.

Question 18

Increased international capital mobility:

1. Allows for better diversification of country-specific risks.

2. Is the main explanation for why many emerging market economies in Asia managed to get out of the Asian currency crisis very quickly.

3. Explains why capital flows primarily between rich countries, but not from rich to poor countries.

4. Has led to a reduction in the frequency of currency crises in the past 30 years.

Question 19

According to the standard macroeconomic model of demand and supply for investment funds:

1. Capital should flow between rich countries.

2. Countries where capital is scarce should experience a net inflow of capital.

3. Countries where capital is abundant should experience a net inflow of capital.

4. Capital should flow between poor countries.

Open question

Currency Crisis

1. A typical currency crisis starts with growing pressure of the existing exchange rate to depreciate. Describe the next three steps that follow and ultimately lead to a currency crisis. (5 points)

   • Step 1: There is growing pressure on the existing exchange rate to depreciate.

   • Step 2: ...

2. Scenario A:

   Country X is a major oil-producing country with fixed exchange rates. Every year its government is running a budget deficit equivalent to 5% of GDP. The oil producing companies sell the oil in international markets and sell the foreign currency receipts to the Central Bank of X. As a result, every year the foreign currency reserves of the Central Bank of Xincrease by an amount equal to 3% of GDP.

   Refer to scenario A. Is it likely that, according to the first-generation model of currency crises, country A will be facing a currency crisis in the near future? Explain how according to the first-generation model a currency crisis would occur and why or why not this will likely happen in country A. (8 points)

3. Refer to scenario A. Assume now that the government of country X has access to international capital markets and is able to borrow from foreign lenders an amount equivalent to 2% of GDP every year. Will this possibility of the government to borrow from international capital markets change your answer to (b)? Explain, based on the first generation currency crisis model, why or why not your answer would change. (7 points)

Answers part 1

Multiple Choice Questions

1. c

2. d

3. d

4. a

5. d

6. c

7. d

8. b

9. c

10. d

11. c

12. a

13. d

14. d

15. a

16. d

17. d

18. a

19. b

Open Question

Currency Crisis

1. The three steps that follow and ultimately lead to a currency crisis are:

• Step 2: Investors start collectively selling their investments in local currency, increasing the depreciation pressure.

• Step 3: Defense of the exchange rate either by raising the interest rate or selling foreign reserve assets.

• Step 4: Authorities give up and let the currency adjust, leading to a large depreciation.

2. The budget deficit is financed by loans from the central bank (printing of money). The annual budget deficit exceeds the annual growth in foreign reserve assets by 0.02. As long as the stock of foreign reserve assets is sufficiently high, the monetary financing of dF=0.05 can be neutralized by equivalent sales of foreign reserve assets (dR=-0.05) so that the money supply M remains unchanged. However, since R only grows at a rate of 3% every year, selling 5% of reserve assets every year will over time reduce the stock of reserve assets. Once reserve assets are depleted, the financing of the government deficit can no longer be neutralized, thus the money supply will grow, which will lead to inflation according to P=m(M). Inflation forces an increase of the peg according to the PPPcondition (P=E*Pfor). Devaluation is the only outcome given the unsustainable fiscal policy and a currency crisis will thus happen for sure.
3. The answer will change. If the government can borrow 2% of GDP from foreign lenders every year, this means that only 3% of the budget deficit has to be financed by issuing more money. This is equal to the annual growth in foreign reserve assets from oil sales. Thus, the central bank can neutralize the financing of 3% of GDP without having to reduce its stock of foreign reserve assets (gross reserve assets grow by 3% annually and every year 3% of the reserve assets are sold to neutralize the financing of the government deficit; thus, the net growth in reserve assets is 0). Therefore, with government access to international capital markets the stock of foreign reserve assets will remain constant. Thus, the money supply and prices will remain constant as well, and there is no risk of a currency crisis.

Questions part 2

Table A: Information Balance of Payments Country X

Question 1

Based on table A, the current account balance is:

1. +100

2. +200

3. 0

4. -100

Question 2

Based on table A, the financial (or capital) account balance is:

1. +100

2. +200

3. 0

4. -100

Question 3

A sensation of compressed time and space as a result of more advanced transportation and communication technologies is an example of:

1. Political globalization

2. Cultural globalization

3. Economic globalization

4. Geographic globalization

Question 4

Credit (+) items in the balance sheet of payments correspond to transactions that:

1. Involve receipts from foreigners

2. Involves payments to foreigners

3. Decrease the domestic money supply

4. Increase the demand for foreign exchange

Question 5

A English fashion company that produces its clothing lines in Vietnam to sell them exclusively in department stores in England is an example of:

1. A vertical multinational firm

2. A horizontal multinational firm

3. An exporting firm

4. A hybrid firm

Question 6

Remember the analysis of multinational behaviour (‘Going global’ model). Firms face a firmspecific cost F and can choose to locate production in two countries. Setting up a plant gives plant-specific fixed costs P, and exporting a unit of good A involves trade costs t. If we distinguish between a horizontal multinational and a national exporting firm, it is more likely that the firm will decide to become a horizontal multinational if:

1. Countries are similar in size, trade costs are relatively low, and marginal costs differ between countries

2. Markets in the two countries differ in size, trade costs are relatively high, and marginal costs differ between countries

3. Markets in the two countries differ in size, trade costs are relatively low, and marginal costs differ between countries

4. Countries are similar in size, trade costs are relatively high, and marginal costs are similar in the two countries

Question 7

If it is more efficient to organize a foreign activity through the market than by internationalizing the activity, a firm should enter the foreign market via:

1. Acquiring shares of a firm that already has experience in the foreign market

2. Establishing a completely new firm in the host country (greenfield)

3. Licensing its trademark

4. Forming a joint-venture with another firm based in the host country

Question 8

Regarding the different entry modes available, the following statement is correct:

1. The risk of dissemination is highest for joint-ventures and lowest for licensing

2. The level of resource commitment is highest for franchising and lowest for full acquisitions

3. The degree of control is highest in greenfield and low in the case of licensing

4. Joint ventures offer a higher degree of control than full acquisitions

Question 9

Empirical research on the gravity model of trade has shown that:

1. Smaller countries trade more than large countries

2. Countries that share a common border trade more with one another

3. Geographic distance increases bilateral trade

4. Landlocked countries trade more than countries with sea access.

Question 10

Which statement about Porter’s Diamond model is NOT correct?

1. The quality of demand in the home country affects the level of competitiveness of an international firm

2. How a firm is structured and organized matters for its international competitiveness

3. By investing in education the government in the home country can influence the competitiveness of its multinational firms

4. Resources available in the host country are crucial for a firm’s competitiveness

Question 11

Which of the following statements is correct?

1. As countries develop, within-country disparities in welfare decreases first and then increase

2. As countries develop, within-country disparities in welfare fall

3. As countries develop, within-country disparities in welfare increase first and then decrease

4. As countries develop, within-country disparities in welfare increase

Question 12

According to Hofstede (1980), steep hierarchies in organization indicate a:

1. Low level of power distance

2. High level of power distance

3. Low level of uncertainty avoidance

4. High level of uncertainty avoidance

Question 13

If the need to customize is low and the pressure for cost reduction is high, a global firm should use the following strategy:

1. Global standardization strategy

2. Transnational strategy

3. International strategy

4. Localization strategy

Question 14

The World Bank (in their 2009 World Development Report) defines “density” as:

1. The level of economic activity per unit of land area

2. The number of people living per one square kilometre

3. The restrictions imposed by governments on the free flow of goods, capital and people

4. The volume of sales of multinational firms

Question 15

Zipf’s law describes:

1. How geographic distance is related to multinational activity

2. The rank-order of economic density within countries

3. The relationship between the thickness of borders and international trade

4. How the availability of transportation infrastructure influences rural-urban migration

Question 16

If a Big-Mac costs SFr 6.50 in Switzerland and Euro 3.50 in the Netherlands and the Euro-Swiss Franc exchange rate is 0.75 Euro/SFr, what is the value of the real exchange rate (assuming that the Euro is the home currency)?

1. 0.40

2. 0.72

3. 1.39

4. 2.48

Question 17

If a Big-Mac costs SFr 6.50 in Switzerland and Euro 3.50 in the Netherlands, what is the value of the PPP-exchange rate?

1. 1.86

2. 1.33

3. 0.75

4. 0.54

Question 18

When the exchange rate is set now for a currency trade that will take place at a specific date in the future this exchange rate is referred to as a:

1. Spot exchange rate

2. Forward exchange rate

3. Expected exchange rate

4. Effective exchange rate

Question 19

If the Yen-US Dollar exchange rate (¥/$) falls:

1. US products will become more expensive for Japanese customers

2. American export firms will gain competitiveness compared to Japanese export firms

3. Japanese products will become more cheaper for American customers

4. Japanese export firms will gain competitiveness compared to American export firms

Question 20

When uncovered interest parity holds, it means that:

1. A currency is expected to appreciate by as much as its interest rate is lower than the interest rate in the other country

2. A currency is expected to appreciate by as much as its interest rate is higher than the interest rate in the other country

3. Exchange rate risk is unusually high

4. The inflation rate in the foreign country equals the interest rate differential

Question 21

When the current $/£ forward rate is below the current spot rate, the pound is at a(n) ___

1. Forward premium

2. Forward discount

3. Covered parity

4. Uncovered parity

Question 22

Assume you are an American importer who must pay 500.000 Euros at the end of the 90 days when you receive 1.000 cases of French wine at your warehouse in New York. Suppose that you have not covered this transaction in the forward market. In which of the following cases will you suffer the largest loss?

1. The Euro spot exchange rate value vis-`a-vis the Dollar does not change

2. The Euro initially appreciates by 2 percent, and then depreciates by 1 percent

3. The Euro initially depreciates by 3 percent, and then appreciates by 2 percent

4. The Euro initially appreciates by 3 percent, and then depreciates by 2.9 percent

Question 23

An investment exposed to exchange rate risk is a(n) _____ international investment

1. Covered

2. Uncovered

3. Hedged

4. Arbitrage

Question 24

Scenario 1: Suppose that the interest rate on 6-months U.S. government bonds is 10% p.a. and that on German 6-months government bonds is 6% p.a. Today’s spot exchange rate of the Dollar is 0.9 Euros per Dollar and the 6-months forwards exchange rate is 0.87 Euros per Dollar.

Refer to scenario 1: What is the return you can earn by investing in U.S. government bonds and covering the exchange rate risk?

1. 1.5 %

2. 5 %

3. 6.6 %

4. 8.6 %

Question 25

Refer to scenario 1: For which level of the forward exchange rate would covered interest parity hold?

1. 1.09 Euro per Dollar

2. 0.92 Euro per Dollar

3. 0.88 Euro per Dollar

4. 0.85 Euro per Dollar

Question 26

A decrease in German residents’ willingness to invest in US dollar-denominated assets will:

1. Decrease the demand for Euros

2. Increase the demand for Euros

3. Decrease the demand for US Dollars

4. Increase the demand for US Dollars

Question 27

How can one profit through arbitrage if the US Dollar per British Pound exchange rate in London is 2 Dollar per Pound while in New York is 1.95 Dollar per Pound?

1. Buy Dollars in New York and sell them in London

2. Buy Pounds in London and sell them in New York

3. Buy Pounds in New York and sell them in London

4. Buy Dollars in London and sell Pounds in New York

Answers part 2

1. b

2. d

3. d

4. a

5. a

6. d

7. c

8. c

9. b

10. d

11. c

12. b

13. a

14. a

15. b

16. c

17. d

18. b

19. b

20. a

21. b

22. b

23. b

24. a

25. c

26. c

27. c