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International Business Answers

Q1. What are the various entry methods for International Business?

Export

Exporting is the most traditional way of entering into International Business. Export can be

done in two ways:

1. Direct Export – Products are sold directly to buyers in target markets either through local

sales representatives or distributors. Sales representatives promote their company’s

products and do not take title to the merchandise. Distributors take ownership of the goods

(and the accompanying risk) and usually on-sell through wholesalers and retailers to end-

users.

Advantages of Direct Exports:

A. Give a higher return on your investment than selling through an agent or distributor

B. Allows the exporting company to set lower prices and be more competitive

C. Gives the company a close contact with its customers

Disadvantages of Direct Exports:

A. The company may not have the services of a foreign intermediary, so it may need moretime to become familiar with the market

B. The customers or clients may take longer to get to know the company and its products,

and such familiarity is often important when doing business internationally

2. Indirect Export - Products are sold through intermediaries such as agents and trading

companies. Agents may represent one or more indirect exporters in return for commission

on sales.

Foreign direct Investment

FDI are investments made to acquire a lasting interest by a resident entity in one economy in an

enterprise resident in another economy. FDI has come to play a major role in the

internationalization of business. This has happened due to changes in technologies, improved

trade and investment policies of governments, regulatory environment in terms of liberalization

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and easing of restrictions on foreign investments and acquisitions, and deregulation and

privatization of many industries.

Advantages:

A. It can provide a firm with new markets and marketing channels, cheaper production facilities,

access to new technologies, capital process, products, organizational technologies and

management skills.

B. FDI can provide a strong impetus to economic development of the host country. This is all the

more true when large MNCs enter developing nations through FDI.

C. FDI allows companies to avoid foreign government pressure for local production.

D. It allows making the move from domestic export sales to a locally based national sales office.

E. Capability to increase total production capacity.

Depending on the industry sector and type of business, a foreign direct investment may be an

attractive and viable option. With rapid globalization of many industries and vertical integration

rapidly taking place on a global level, at a minimum a firm needs to keep abreast of global trends

in their industry. From a competitive standpoint, it is important to be aware of whether a

company’s competitors are expanding into a foreign market and how they are doing that. Often,

it becomes imperative to follow the expansion of key clients overseas if an active business

relationship is to be maintained.

New market access is also another major reason to invest in a foreign country. At some stage,

export of product or service reaches a critical mass of amount and cost where foreign production

or location begins to be more cost effective. Any decision on investing is thus a combination of a

number of key factors including:

A. Assessment of internal resources

B. Competitiveness

C. Market Analysis

D. Market expectations

Licensing

Licensing is a legal agreement between the owner of intellectual property such as a copyright,

patent or trademark and someone who wants to use that IP. The licensee pays “rent” to the

licensor for the use of an idea/product/process that is otherwise protected by IP law. Like a lease

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on a building, the license is for a specific period of time. The licensee uses that

idea/product/process to sell products or services and earns money.

Advantages:

A. Licensing appeals to prospective global players because it does not require large capital

investment not detailed involvement with foreign customers. By generating royalty income,

licensing provides an opportunity to exploit research and development already conducted. After

initial costs, the licensor can reap benefits until the end of license contract period.

B. It reduces the risk of expropriation because the licensee is a local company that can provide

leverage against government action.

C. Helps avoid host country regulations that are more prevalent in equity ventures.

D. Provides a way of testing foreign markets without significant resources.

E. Can be used as a preemption major in new market before the entry of competition.

Limitations:

A. Limited form of market entry which does not guarantee a basis for expansion.

B. Licensor may create more competition in exchange of royalty.

Franchising

Franchising involves granting of rights by a parent company to another (franchisee) to do

business in a prescribed manner. This right can take the form of selling the franchiser’sproducts, using its name, production and marketing techniques or using its general business

approach.

It allows provides a network of interdependent business relationships that allows a number of

people to share:

A. Brand identification

B. Successful method of doing business

C. Proven marketing and distribution system

Franchise agreement typically requires the payment of a fee upfront and then a percentage on

sales. In return, the franchiser provides assistance and at times may require the purchase of

goods or supplies to ensure the same quality of goods or services worldwide.

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Franchising is adaptable to international arena and requires minor modification for the local

market. It can be beneficial to both groups. Franchiser has a new stream of income and the

franchisee gets time proven concept/product which can be quickly bought to the market.

Major Forms of Franchising:

- manufacturer-retailer system (e.g. car dealership)

- manufacturer-wholesaler system (e.g. soft-drink companies)

- service firm – retailer system (fast-food, hotel) e,g, McDonald’s, Burger King

Joint Ventures

A joint venture is an agreement involving two or more organizations that arrange to produce a

product or service through a collectively owned enterprise. It has been one of the most popular

way of entering a new market.

Typically, it is a 50-50 joint venture in which each of the party holds 50% ownership stake and

contributes a team of managers to share operating control. At times, this stake can be a majority

one so as to ensure tighter control.

Advantages:

A. Domestic company brings in the knowledge of the domestic market.

B. The risk is divided between joint-venture partners.C. Normally, foreign partner has an option to sell its stake in the venture to another entity.

Limitations:

A. Limited control over business approach for foreign entity.

B. Profits have to be shared.

e.g. Danone-Brittania, Hero Honda, Maruti Suzuki

Wholly Owned SubsidiariesIn a wholly owned subsidiary, the company owns 100% of the equity. Establishing a wholly

owned subsidiary in a foreign market can be done in 2 ways:

1. Set up of new operation

2. Acquisition of established firm.

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WOS allows a foreign firm complete control and freedom to execute its business strategy in the

foreign country. This freedom is accompanied by a greater risk due to lack of knowledge of the

market. Acquisition of an established company can reduce this risk to an extent.

Q2. Influence of PEST Factors on International Business

Any business is affected by its external environment. The major macroeconomic factors in the

external environment that affect the business are political, environmental, social and

technological.

A. Political Environment

The political environment of a country greatly influences the business operating in those

countries or business trading with those countries. The success and growth of international

business depends on the stable, collaborative, conducive and secure political system in the

country.

The following factors affect the political environment in a country.

1. Tax Policy : The tax policy of a country affects the profitability of the business there. The

Corporate Taxation laws affect the profitability directly. The direct taxation laws also

affect the business because it influences consumer spending. The structure of indirect

taxation in a country like its excise duty structure, customs and sales tax greatly affects

the input costs of a business.

For e.g. Countries like UAE have very low direct taxation levels inducing great spending and

hence trading and marketing based business are successful. But due to very high indirecttaxation levels the manufacturing business is not very successful.

2. Government support : One of the most important political factor is the Government

support to international businesses. Business can be successful only if the local

government provides support in terms o infrastructure, license clearing if required,

transparent policy and quick dispute resolution mechanism. Also the nature of the

political system i.e. democracy, communism etc. in the country influences the

Government support.

For e.g. the RBI has provided single window clearance for FDI and hence has greatly increasedthe FDI levels in our country.

3. Labor Laws : the labor laws in a country affect the viability of a business in that country.

The pension laws also play a critical role especially in cross border acquisitions. Many

businesses had to be withdrawn or closed because of the labor unrest in the country.

For e.g.: Withdrawal of Premier Automobiles due to union strikes in our country.

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The problems faced by doctors and nurses in UK due to the restrictive laws in that country.

4. Environmental policy : The countries environmental policy (under the Kyoto Protocol or

otherwise) affects many business like chemicals, refineries and heavy engineering.

5. Tariffs and duty structure : The level of duties and tariffs that are imposed by the country

influence its imports and exports greatly. Some countries follow a protectionist policy to

the domestic industry by raising import barriers For e.g. India in the pre liberalization

era, Russia.

6. Political stability and political milieu : Political stability greatly affects the longevity of the

businesses in a country. Political risk assessment should be done to determine the

country risk on the basis of following parameters :

a. Confiscation: the nationalization of businesses without compensation. For e.g. India

during the nationalist wave during Indira Gandhi’s tenure.

b. Nationalization : Resource nationalization is a major risk for businesses involving

local resources like oil, minerals etc. For e.g. the resource nationalization in

Columbia.

c. Instability risk : The possibility of military takeovers or huge government changes.

For e.g. the coups in Thailand or in Fiji has affected the profits of businesses there by

as much as 60% due to work stoppage and property destruction.

d. Domestication : The global company relinquishing control in favor of domestic

investors. For e.g. Barclays bank in South Africa

B. Economic factors

The economic factors in a country greatly influence the business in that country. The following

factors are important in the macroeconomic environment.

1. Economic system : the economic system in a country i.e. capitalism/ communism/ mixed

economy (India) is important for deciding the nature of the businesses. The nature of the

system decides the allocation of resources. Due to globalization there is a gradual shift

toward market forces to allocate resources even in the communist countries like China.

2. Interest rates : The interest rates in the country affect the cost of capital (if raised locally)

and the operational costs. Interest rates also determine the confidence of the

Government in the economy and consumer spending.

3. Exchange rates : The exchange rates affect international trade and capital inflows in the

country.

4. Income levels and spending pattern : Though it is more of a demographic parameter has

is very important bearing on the sell side of all international businesses. For e.g. In a

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country like India, with rising aspirer population there is a market opportunity for

products like IPod (considered luxury items till now)

C. Social factors

Businesses are driven by people both as human capital and as consumers. It is necessary for an

international businessman to understand the social and cultural aspects of the country they

operate in. The following are the important social factors.

1. Age distribution : the age distribution of the population is important to consider the

consumption patterns in the markets. Age distribution also determines the mindset of

the market and helps segmentation of the market accordingly. It also has a bearing on

the employee quality. A young population also determines a workforce.

2. Family system : the family system has a bearing on the decision makers in consumption.

For e.g. in Islamic countries women have a less say in making consumption decisions. In

emerging economies like India children are gaining important role in consumption. This

helps in positioning of products.

3. Cultural aspects : The cultural aspects influence the way the business is conducted in

countries. In Japan there is a different way in which contracts are signed and executed.

In Russia being a communist oriented mindset the business is conducted in a closed

manner. Italians have a seemingly lazy way of doing business and hence it is very

difficult to conduct business in the pacy US way.

4. Career attitudes : the career attitude of the workforce is important social aspect.

D. Technological Factors

Technology has a very important role to play in determining the success of international

businesses because technology has made international business possible. The following are the

technological factors that influence the business.

1. R&D : the support that the Government gives to R&D encourages setting up R&D business

levels. Also the ease of a qualified local workforce influence business. For e.g. the

semiconductor industry in Taiwan

2. Technology transfer : The ease of technology transfer influences the business climate. The

environment where the technology transfer is not viable gradually loses out on business

from emerging countries that seek technology transfers. For e.g. in the early 40s countries

like Czechoslovakia (the Czech Republic) was a very technologically advanced country but

had very low business interest due to the less chances of technology transfers. For e.g. GE

withdrew operations from a JV as there as they could not access local expertise)

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Q3. Trade Theories

1. Classical Country-Based Theories

1.1. Mercantilism (pre-16th century)

•

This theory takes an “us-versus-them” view of trade; other country’s gain is our country’sloss.

• Neo-mercantilism views persist today.

• A nation’s wealth depends on accumulated treasure.

• Theory says you should have a trade surplus.

• Maximize exports through subsidies.

• Minimize imports through tariffs and quotas.

• Flaw: “Zero-sum game”.

Mercantilism- Zero-Sum Game

• In 1752, David Hume pointed out that:

• Increased exports lead to inflation and higher prices

• Increased imports lead to lower prices

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• Result: Country A sells less because of high prices and Country B sells

more because of lower prices

• In the long run, no one can keep a trade surplus

1.2. Free Trade supporting theories

This theory shows that specialization of production and free flow of goods grow all trading

partners’ economies

1.2.1. Absolute Advantage (Adam Smith, The Wealth of Nations, 1776)

• Mercantilism weakens a country in the long run and enriches only a few segments; it

robs individuals of the ability to trade freely.

• Adam Smith claimed market forces, not government controls, should

determine the direction, volume and composition of international trade.

• Under free (unregulated) trade each nation should specialize in producing those goods it

could produce most efficiently.

• This theory states that a country is capable of producing more of a good with the same

input than another country . Hence, a country should specialize in and export products

for which it has absolute advantage; import others.

• A country has absolute advantage - either natural or acquired when it is more

productive than another country in producing a particular product.

• Trade between countries is, therefore, beneficial.

Assume that there are just two countries in the world, the India and Japan. Pretend also that

they produce only two goods, shoes and shirts. The resources of both countries can be used to

produce either shoes or shirts. Both countries make both products, spending half of their

working hours on each. But India makes more shoes than shirts, and Japan makes more shirts

than shoes.

TABLE A

Shoes Shirts

India 100 75Japan 80 100

Total 180 175 What will happen when each country specializes and spends all its working hours making one

product? It will make twice as much of that product and none of the other, as shown in Table B.

TABLE B

Shoes ShirtsIndia 200 0Japan 0 200

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Total 200 200The world now has both more shoes and more shirts. India can trade 100 units of shoes for 100

units of shirts, and both countries will benefit.

In this example, India could make more shoes than Japan with the same resources. It has an

absolute advantage at shoemaking. Japan, on the other hand, had an absolute advantage atshirt making.

Assumptions:

• Perfect competition and no transportation costs in a world of two countries and two

products

• One unit of input (combination of land, labor, and capital)

• Each nation has two input units it can use to produce either rice or automobiles

• Each country uses one unit of input to produce each product

1.2.2. Comparative Advantage (David Ricardo, Principals of Political

Economy, 1817) – Also known as Opportunity Cost Theory

• David Ricardo, in his theory of comparative costs, suggested that countries will specialize

and trade in goods and services in which they have a comparative advantage.

• A country has a comparative advantage in the production of a good or service that it

produces at a lower opportunity cost than its trading partners.

• The theory of comparative costs argues that, put simply, it is better for a country that is

inefficient at producing a good to specialize in the production of that good it is least

inefficient at, compared with producing other goods.

Now suppose one country has an absolute advantage in both products. Table C shows what

production might be like if India had an absolute advantage at making both shoes and shirts.

TABLE C

Shoes ShirtsIndia 100 80China 80 75Total 180 155

In this case, the India can produce more of each good with the same set of resources than China

can. The India could produce either 200 units of shoes or 160 units of shirts. China could

produce either 160 units of shoes or 150 units of shirts. If the India produces only shoes, it gives

up 80 units of shirts to gain 100 units of shoes. If China produces only shoes, it gives up 75 units

of shirts to gain 80 units of shoes. For India, the opportunity cost of producing shirts is higher

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and the opportunity cost of producing shoes is lower; vice-versa for China. Hence, India has a

comparative advantage in shoemaking and China has a comparative advantage in shirt

making.

Table D shows what happens when each country specializes in the product in which it has a

comparative advantage.

TABLE D


By specializing in this way, the India and China have increased the production of shoes by

twenty units over what they produced before, from 180 to 200. But the world has lost five unitsof shirts, going from 155 to 150.

Production in the India could be adjusted to make up the difference. For example, if the India

gave up 10 units of shoes, it could produce 8 units of shirts. Table E shows the results of such a

tradeoff.

TABLE E


In this way, the total production of both goods could be increased.

For India, the opportunity cost of choosing to produce 80 units of shirts was the 100 units of

shoes that could have been produced with the same resources. In the like manner, China's

opportunity cost of producing 80 units of shoes was 75 units of shirts.

In the terms of trade each reduce each country's opportunity cost of acquiring the good traded

for, trade will take place. In this example, China will not accept fewer than 80 units of shoes for

75 units of shirts and the India will not pay more than 100 units of shoes for 80 units of shirts.

Both countries must benefit for trade to occur.

The real world is much more complex than this two-country, two-product mode. Trade involves

many different countries and products. And it is not always clear where a country's comparative

advantage lies.

Summary

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• Country should specialize in the production of those goods in which it is relatively more

productive, even if it has absolute advantage in all goods it produces.

• This extends free trade argument.

• Efficiency of resource utilization leads to more productivity.

1.3. Free Trade refined

1.3.1. Factor-proportions (Heckscher-Ohlin, 1919)

• Eli Heckscher and Bertil Ohlin developed the theory of relative factor endowments,

now often referred to as the Heckscher-Ohlin theory. The theory states that the pattern

of international trade depends on differences in factor endowments not on differences in

productivity.

• Relative endowments of the factors of production (land, labour, and capital) determine a

country's comparative advantage.

• Countries have comparative advantage in those goods for which the required factors of

production are relatively abundant. This is because the prices of goods are ultimately

determined by the prices of their inputs.

• Goods that require inputs that are locally abundant will be cheaper to produce than

those goods that require inputs that are locally scarce.

For example, a country where capital and land are abundant but labour is scarce will havecomparative advantage in goods that require lots of capital and land, but little labour - grains,

for example.

Since capital and land are abundant, their prices will be low. Those low prices will ensure that

the price of the grain that they are used to produce will also be low - and thus attractive for both

local consumption and export.

Labor intensive goods on the other hand will be very expensive to produce since labor is scarce

and its price is high. Therefore, the country is better off importing those goods.

Summary

• Factor endowments vary among countries

• Products differ according to the types of factors that they need as inputs

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• A country has a comparative advantage in producing products that intensively use

factors of production (resources) it has in abundance

Assumptions

• A given technology was universally available.

• Relative factor endowments are different in each country

• Tastes and preferences are identical in both countries

• A given product was either labor- or capital-intensive

• The theory ignored transportation costs.

1.3.2. Product Life Cycle (Ray Vernon, 1966)

• As products mature, both location of sales and optimal production changes

• Affects the direction and flow of imports and exports

• Globalization and integration of the economy makes this theory less valid

Classic Theory Limitations:

All the classical theories are based on the following assumptions that no longer hold true –

• Simple world (two countries, two products)

• No transportation costs

• No price differences in resources

• Resources immobile across countries

• Constant returns to scale

• Each country has a fixed stock of resources & no efficiency gains in resource use from

trade

• Full employment

2. Modern Trade Theory

In industries with high fixed costs:

• Specialization increases output, and the ability to enhance economies of scale increases

• Learning effects are high.

• These are cost savings that come from “learning by doing”

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New Trade Theory-Applications

• Typically, requires industries with high, fixed costs

o World demand will support few competitors

o Competitors may emerge because of “ First-mover advantage”

• Economies of scale may preclude new entrants

o Role of the government becomes significant

• Some argue that it generates government intervention and strategic trade policy

Theory of National Competitive Advantage

• The theory attempts to analyze the reasons for a nation’s success in a particular industry

• Porter studied 100 industries in 10 nations

- Postulated determinants of competitive advantage of a nation were based on four

major attributes

Factor endowments

Demand conditions

Related and supporting industries

Firm strategy, structure and rivalry

Factor endowments: A nation’s position in factors of production such as skilled labor or

infrastructure necessary to compete in a given industry

• Basic factor endowments

• Advanced factor endowments

Basic Factor Endowments

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• Basic factors: Factors present in a country

- Natural resources

- Climate

- Geographic location

- Demographics

• While basic factors can provide an initial advantage they must be supported by

advanced factors to maintain success

Advanced Factor Endowments

• Advanced factors: The result of investment by people, companies, and

government are more likely to lead to competitive advantage

• If a country has no basic factors, it must invest in advanced factors

- Communications

- Skilled labor

- Research

- Technology

- Education

Porter’s Theory-Predictions

• Porter’s theory should predict the pattern of international trade that we observe in the

real world.

• Countries should be exporting products from those industries where all four components

of the diamond are favorable, while importing in those areas where the components are

not favorable

3. Other Theories:

3.1. The productivity theory by H. Myind

• It is criticized that the comparative cost theories are not applicable to developing

countries. Hence, H. Myint proposed productivity theory and the vent for surplus theory.

• The productivity theory points toward indirect and direct benefits. This theory

emphasizes that the process of specialization involves adapting and reshaping the

production structure of a trading country to meet the export demands.

• Countries increase productivity in order to utilize the gains of exports. This theory

encourages the developing countries to go for cash crops, increase productivity by

enhancing the efficiency of human resources, adapting latest technology etc.

Limitations:

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• Labor productivity did not increase after certain level

• Increase in working hours

• Increase in proportion of gainfully employed labour in proportion to disguised

unemployed labour

3.2.The vent for surplus theory

• International trade absorbs the output of unemployed factors.

• If the countries produce more than the domestic requirements, they have to export the

surplus to other countries. Otherwise, a part of the productive labour of the country must

cease and the value of its annual Produce diminishes.

• In the absence of foreign trade, they would be surplus productive capacity in the country.

This surplus productive capacity is taken by another country and in turn gives the benefitunder international trade.

Appropriateness of this Theory for Developing Countries:

• According to this theory, the factors of production of developing countries are fully

utilized.

• The unemployed labour of the developing countries is profitably employed when the vent

for surplus is exported.

3.3.Mills’ theory of reciprocal demand

• Comparative cost advantage theories do not explain the ratios at which commodities are

exchanged for one another. J.S. Mill introduced the concept of ‘reciprocal demand’ to

explain the determinations of the equilibrium terms of trade.

• Reciprocal demand indicates a country’s demand for one commodity in terms of the

other commodity; it is prepared to give up in exchange. It determines the terms of trade

and relative share of each country.

Equilibrium:

Quality of a product exported by country A = Quality of another product exported by country B Assumptions:

• Existence of two countries

• Trade in only two goods – both the goods are produced under the law of constant returns

• Absence of transportation Costs.

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• Existence of perfect competition

• Existence of full employment

Q4. Ten reasons why FDI happens

1. Foreign Direct Investments (FDI) as defined in the BOP Manual, are investments made to

acquire a lasting interest by a resident entity in one economy in an enterprise resident in

another economy. The purpose of the investor is to have a significant influence, an effective

voice in the management of the enterprise. The definition of the Organization for Economic

Cooperation and Development (OECD) which considers as direct investment enterprise an

incorporated or unincorporated enterprise in which a direct investor who is resident in

another economy owns ten percent or more of the ordinary shares or voting power (for

incorporated enterprise) or the equivalent (for an unincorporated enterprise).

2. It provides a firm with new markets and marketing channels, cheaper production facilities,

access to new technology, products, skills and financing. For a host country or the foreign

firm which receives the investment, it can provide a source of new technologies, capital,

processes, products, organizational technologies and management skills, and as such can

provide a strong impetus to economic development.

3. FDI inflows are considered as channels of entrepreneurship, technology, management skills,

and of resources that are scarce in developing countries. Hence, they could help their host

countries in their industrialization.

4. For small and medium sized companies, FDI represents an opportunity to become more

actively involved in international business activities. In the past 15 years, the classic

definition of FDI as noted above has changed considerably, over 2/3 of direct foreign

investment is still made in the form of fixtures, machinery, equipment and buildings.

5. FDI is viewed as a basis for going “global”. FDI allows companies to accomplish following

tasks:

• Avoiding foreign government pressure for local production

• Circumventing trade barriers, hidden and otherwise

• Making the move from domestic export sales to a locally-based national sales office

• Capability to increase total production capacity.

• Opportunities for co-production, joint ventures with local partners, joint marketing

arrangements, licensing, etc

6. Foreign direct investment is viewed as a way of increasing the efficiency with which the

world's scarce resources are used. A recent and specific example is the perceived role of FDI

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in efforts to stimulate economic growth in many of the world's poorest countries. Partly this

is because of the expected continued decline in the role of development assistance (on which

these countries have traditionally relied heavily), and the resulting search for alternative

sources of foreign capital.

7. FDI enables the firm owns assets to be profitably exploited on a comparatively large scale,

including intellectual property (such as technology and brand names), organizational and

managerial skills, and marketing networks. And it is more profitable for the production

utilizing these assets to take place in different countries than to produce in and export from

the home country exclusively.

8. FDI may result in a greater diffusion of know-how than other ways of serving the market.

While imports of high-technology products, as well as the purchase or licensing of foreign

technology, are important channels for the international diffusion of technology, FDI

provides more scope for spillovers. For example, the technology and productivity of localfirms may improve as foreign firms enter the market and demonstrate new technologies, and

new modes of organization and distribution, provide technical assistance to their local

suppliers and customers, and train workers and managers who may later be employed by

local firms.

9. FDI increases employment in host country. Inflows of FDI also increase the amount of

capital in the host country. Even with skill levels and technology constant, this will either

raise labor productivity and wages, allow more people to be employed at the same level of

wages, or result in some combination of the two.10. Proponents of foreign investment point out that the exchange of investment flows benefits

both the home country (the country from which the investment originates) and the host

country (the destination of the investment). Opponents of FDI note that multinational

conglomerates are able to wield great power over smaller and weaker economies and can

drive out much local competition. The truth might lie somewhere in between but they surely

become reasons for companies to invest in foreign markets.

Q5. WTO Rounds wrt India

The WTO came into being on January 1, 1995, and is the successor to the General Agreement on

Tariffs and Trade (GATT), which was created in 1948. India was one of the 76 countries that

signed the accession to the WTO and is one of the founder members of the WTO.

Trade implications of signing the WTO for India:

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The implications of signing the WTO agreement for Indian trade have been mixed. India has

benefited in the areas of garment exports, agricultural products exports and in market access to

foreign markets in automobiles and electronics. India has a disadvantage mainly in areas of

TRIPs, drug prices, patents in agriculture, TIS ( trade in services ) and TRIMS especially in

biomedical areas, AoA export subsidies etc.

Benefits:

1. Garment exports: The Multi Fiber Arrangement (MFA) that required Indian garment

exporters to have quotas for exporting to developed countries was phased out in 2005. The

readymade garment exports from India has reached Rs 800 crores in 2007 and expected to

reach Rs 1000 crores in 2008. This is thrice the exports in 2004-05.

2. Market access: as a signatory to the WTO India automatically gets the MFN ( most favored

nation ) status. This gives India access to markets in Europe and US in sectors like

automobiles and engineering. India also benefits from the clauses related to trade without

discrimination and benefit from capital good exports.

3. Anti Dumping measures: India suffered from persistent dumping by Romanian and

Russian steel majors in the areas of steel casings, pipes affecting Indian domestic industry

greatly. Also India suffered from dumping by Chinese steel industry. The anti dumping

provisions and countervailing duties lend security to India’s domestic industries.

4. The Agreement on Agriculture : the AoA stipulates that the developed countries will reduce

tariffs on agriculture imports (up to 35%) thus helping India’s agriculture exports. It also

promises reduction of domestic subsidies in the developed countries helping exports from

India.

5. Competitive advantage: India has competitive advantage in the areas of merchandise trade.

India can utilize its competitive advantage in processing, beverages, gems and jeweler

compared to the traditional centers in Europe like Amsterdam or Manchester etc increasing

its trade with both the Euro region and the US.

Disadvantages:

1. TRIPS: the Indian Patent Act is not compatible with the TRIPS agreement under the WTO.

The Indian Patent Act allows only process patents in areas of foods, chemicals and

medicines. Under the TRIPS the IPA will have to modify to allow product patents also. Also

products developed outside India can claim international patents applicable to India. This

will hurt our agriculture foods. E.g. the Alphanso mango and the Basmati strand

controversy.

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2. Drug prices: the granting of the product patents in India will hurt the Indian generic drugs

industry and benefit the foreign pharma companies that own the formulation patents. This

will lead to increase in drug prices in India. (This resulted in regulatory intervention in the

recent budget in life saving drugs) e.g. the Pfizer controversy

3. Genetics: Indian seed and genetic research organizations are Government funded and will

not be able to compete with the MNCs like Montessanto etc that have economies of scale.

This will increase seed prices for Indian farmers and also lend our genetic resources to the

MNCs

4. Services: the opening up of the banking sector in 2009 will affect Indian banks due to the

foreign banks with huge balance sheets.

5. TRIMS: the Trade Related Investment Measures resulted in problems in trade in investment

issues like transit charges, formalities etc. together called as Singapore issues. Indian

companies would have to lose in the differential charges that are applied. These issues were

dropped in the Chachun ministerial conferences.

6. Anti dumping: the anti dumping rules were imposed on Indian linen in EU. Similarly Indian

textiles faced anti dumping regulations in US. There is no mechanism to resolve anti

dumping duties issues.

India’s stand in the Doha round and the following ministerial conferences:

1. Doha round: The Doha Development Round commenced at Doha, Qatar in November

2001 and is still continuing. Its objective is to lower trade barriers around the world,

permitting free trade between countries of varying prosperity. As of 2008, talks have stalled

over a divide between the developed nations led by the European Union, the United States

and Japan and the major developing countries (represented by the G20 developing nations),

led and represented mainly by India, Brazil, China and South Africa.

Issues: Singapore issues: the issues related to the trade facilitation and differential charges in

investment vehicles affected Indian investment and venture companies. This affected the Indian

services.

Agricultural subsidies: the EU, US and Japan support domestic agriculture by subsides. This

was opposed by countries like India and Brazil.

2. Cancun conference 2003 :

The objective of this conference was to forge the agreement discussed in Doha.

Issues: market access to foreign markets. This agreement on market access for the developing

countries in capital and industrial goods increased strength of G20 countries.

India benefited greatly in the capital goods export.

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The Singapore issues were resolved that resulted in removing the undue advantage for countries

like US and Japan in investment arena. This also benefited the Indian financial sector

internationally.

3. Geneva 2004: In Geneva conference the developed nations reduced subsidiaries on

manufactured goods. This resulted in Indian small manufacturers like steel forging, casting

to export largely and benefit from the construction boom in US.

4. Paris 2005: France reduced subsidies on farm products. However US and Japan did not

relent.

Hong Kong 2006 and Potsdam 2007 talks failed in resolving the farm subsidies. So the recent

rounds are in a stalemate situation from India’s point of view.

Q6. Discuss NAFTA/ EU/ ASEAN/ SAARC/ MERCUSOR

Mercosur

Mercosur is a regional trade agreement among Argentina, Brazil ,Paraguay & Uruguay founded

in 1991 by the Treaty of Asunción, which was later amended and updated by the 1994 Treaty of

Ouro Preto. Its purpose is to promote free trade and the fluid movement of goods, people, and

currency. Bolivia, Chile, Colombia, Ecuador and Peru currently have associate member status.

Venezuela signed a membership agreement on 17 June 2006, but before becoming a full

member its entry has to be ratified by the Paraguayan and the Brazilian parliaments.

The bloc comprises a population of more than 263 million people, and the combined Gross

Domestic Product of the full-member nations is in excess of US$2.78 trillion a year (Purchasingpower parity, PPP) according to International Monetary Fund (IMF) numbers, making

Mercosur the fifth largest economy in the World.

Objectives of MERCOSUR

• Free transit of production goods, services and factors between the member states with inter

alia, the elimination of customs rights and lifting of nontariff restrictions on the transit of

goods or any other measures with similar effects;

• Fixing of a common external tariff (TEC) and adopting of a common trade policy with regard

to nonmember states or groups of states, and the coordination of positions in regional andinternational commercial and economic meetings;

• Coordination of macroeconomic and sectorial policies of member states relating to foreign

trade, agriculture, industry, taxes, monetary system, exchange and capital, services, customs,

transport and communications, and any others they may agree on, in order to ensure free

competition between member states; and

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• The commitment by the member states to make the necessary adjustments to their laws in

pertinent areas to allow for the strengthening of the integration process. The Asuncion

Treaty is based on the doctrine of the reciprocal rights and obligations of the member states.

MERCOSUR initially targeted free-trade zones, then customs unification and, finally, a common

market, where in addition to customs unification the free movement of manpower and capital

across the member nations' international frontiers is possible, and depends on equal rights and

duties being granted to all signatory countries. During the transition period, as a result of the

chronological differences in actual implementation of trade liberalization by the member states,

the rights and obligations of each party will initially be equivalent but not necessarily equal. In

addition to the reciprocity doctrine, the Asuncion Treaty also contains provisions regarding the

most-favored nation concept, according to which the member nations undertake to

automatically extend--after actual formation of the common market--to the other Treaty

signatories any advantage, favor, entitlement, immunity or privilege granted to a productoriginating from or intended for countries that are not party to ALADI.

SAARC

The South Asian Association for Regional Cooperation (SAARC) is an economic and political

organization of eight countries in Southern Asia. It was established on December 8, 1985 by

India, Pakistan, Bangladesh, Sri Lanka, Nepal, Maldives and Bhutan. In April 2007, at the

Association's 14th summit, Afghanistan became its eighth member.Sheelkant Sharma is the

current secretary & Mahinda Rajapaksa is the current chairman of SAARC which is

headquartered at Kathmandu.

Objectives of SAARC:

• to promote the welfare of the peoples of South Asia and to improve their quality of life;

• to accelerate economic growth, social progress and cultural development in the region

and to provide all individuals the opportunity to live in dignity and to realize their full

potential;

• to promote and strengthen collective self-reliance among the countries of South Asia;

• to contribute to mutual trust, understanding and appreciation of one another's

problems;

• to promote active collaboration and mutual assistance in the economic, social, cultural,

technical and scientific fields;

• to strengthen cooperation with other developing countries;

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• to strengthen cooperation among themselves in international forums on matters of

common interest; and

• to cooperate with international and regional organizations with similar aims and

purposes.

Free Trade Agreement

Over the years, the SAARC members have expressed their unwillingness on signing a free trade

agreement. Though India has several trade pacts with Maldives, Nepal, Bhutan and Sri Lanka,

similar trade agreements with Pakistan and Bangladesh have been stalled due to political and

economic concerns on both sides. India has been constructing a barrier across its borders with

Bangladesh and Pakistan. In 1993, SAARC countries signed an agreement to gradually lower

tariffs within the region, in Dhaka. Eleven years later, at the 12th SAARC Summit at Islamabad,

SAARC countries devised the South Asia Free Trade Agreement which created a framework for

the establishment of a free trade area covering 1.4 billion people. This agreement went into forceon January 1, 2006. Under this agreement, SAARC members will bring their duties down to 20

per cent by 2007.

The last summit (15th) was held in Colombo where four major agreements - the SAARC

development fund, the establishment of a SAARC standard organization, the SAARC convention

on mutual legal assistance in criminal matters, and the protocol on Afghanistan's admission to

the South Asia Free Trade Agreement (SAFTA) were adopted with emphasis on region-wide

food security.

NAFTA

The North American Free Trade Agreement (NAFTA) is a trilateral trade bloc in North America

created by the governments of the United States, Canada, and Mexico. In terms of combined

purchasing power parity GDP of its members, as of 2007 the trade bloc is the largest in the

world and second largest by nominal GDP comparison. It also is one of the most powerful, wide-

reaching treaties in the world.

The North American Free Trade Agreement (NAFTA) has two supplements, the North American

Agreement on Environmental Cooperation (NAAEC) and the North American Agreement onLabor Cooperation (NAALC).

Implementation of the North American Free Trade Agreement (NAFTA) began on January 1,

1994. This agreement will remove most barriers to trade and investment among the United

States, Canada, and Mexico.

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Under the NAFTA, all non-tariff barriers to agricultural trade between the United States and

Mexico were eliminated. In addition, many tariffs were eliminated immediately, with others

being phased out over periods of 5 to 15 years. This allowed for an orderly adjustment to free

trade with Mexico, with full implementation beginning January 1, 2008.

The agricultural provisions of the U.S.-Canada Free Trade Agreement, in effect since 1989, were

incorporated into the NAFTA. Under these provisions, all tariffs affecting agricultural trade

between the United States and Canada, with a few exceptions for items covered by tariff-rate

quotas, were removed by January 1, 1998.

Mexico and Canada reached a separate bilateral NAFTA agreement on market access for

agricultural products. The Mexican-Canadian agreement eliminated most tariffs either

immediately or over 5, 10, or 15 years.

U.S. trade with Mexico and Canada has grown more rapidly than total U.S. trade since 1994. The

automotive, textile, and apparel industries have experienced the most significant changes intrade flows, which may also have affected employment levels in these industries. The five major

U.S. industries that have high volumes of trade with Mexico and Canada are automotive

industry, chemicals and allied products, computer equipment, textiles and apparel, and

microelectronics.

The effects of NAFTA, both positive and negative, have been quantified by several economists.

Some argue that NAFTA has been positive for Mexico, which has seen its poverty rates fall and

real income rise (in the form of lower prices, especially food), even after accounting for the

1994–1995 economic crisis. Others argue that NAFTA has been beneficial to business ownersand elites in all three countries, but has had negative impacts on farmers in Mexico who saw

food prices fall based on cheap imports from U.S. agribusiness, and negative impacts on U.S.

workers in manufacturing and assembly industries who lost jobs. Critics also argue that NAFTA

has contributed to the rising levels of inequality in both the U.S. and Mexico.

EU

The European Union (EU) is a political and economic union of 27 member states, located

primarily in Europe. The EU generates an estimated 30% share of the world's nominal grossdomestic product (US$16.8 trillion in 2007). Thus EU presents an enormous export and

investor market that is both mature and sophisticated.

The EU has developed a single market through a standardised system of laws which apply in all

member states, guaranteeing the freedom of movement of people, goods, services and capital. It

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maintains a common trade policy. Fifteen member states have adopted a common currency, the

euro.

Objectives of the EU: Its principal goal is to promote and expand cooperation among

members’ states in economics, trade, social issues, foreign policies, security, defense, and

judicial matters. Another major goal of the EU is to implement the Economic and Monetary

Union, which introduced a single currency, the Euro for the EU members.

The single market refers to the creation of a fully integrated market within the EU, which allows

for free movement of goods, services and factors of production. The EU, in conjunction with

Member States, has a number of policies designed to assist the functioning of the market. Some

of the policies are given below:

Competition Policy: The main competition lied in energy and transport sector. The union

designed this strategy to prevent price fixing, collusion (secret agreement), and abuse of

monopoly.Free movement of goods: A custom union covering all trade in goods was established and a

common customs tariff was adopted with respect to countries outside the union.

Services: Any member nation has a right to provide services in other Member States.

Free movement of persons: Any citizen of EU member state can live work in any other EU

member state

Capital: There are no restrictions on the movement of capital and on payments with the EU and

between member states and third countries.

Trade between the European Union and IndiaIndia was one of the first Asian nations to accord recognition to the European Community in

1962. The EU is India’s largest trading partner and biggest source of FDI. It is a major

contributor of developmental aid and an important source of technology. Over the years, EU –

India trade has grown from 4.4 bn to 28.4 bn US$.

Top items of trade between India and EUIndia’s exports to EU % India’s Imports from EU %Textile and clothing 35 Gemstones and jewellery 31Leather and leather products 25 Power generating equipment 28Gemstones and jewelery 12 Chemical products 15

Agriculture products 10 Office machinery 10Chemical products 9 Transport equipment 6

• India is EU’s 17th largest supplier and 20th largest destination for exports.

• Tariff and non-tariffs have been reduced, but compared to International standards they are

still high.

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• Under the Bilateral trade between India and EU, it accounts for 26% of India’s exports and

25% of its imports.

• The European Union (EU) and India agreed on September 29,2008 at the EU-India summit

in Marseille, France's largest commercial port, to expand their cooperation in the fields of

nuclear energy and environmental protection and deepen their strategic partnership.

• Trade between India and the 27-nation EU has more than doubled from 25.6 billion euros

($36.7 billion) in 2000 to 55.6 billion euros last year, with further expansion to be seen.

ASEAN

The Association of Southeast Asian Nations or ASEAN was established on 8 August 1967 in

Bangkok by the five original Member Countries, namely, Indonesia, Malaysia, Philippines,

Singapore, and Thailand. Brunei Darussalam joined on 8 January 1984, Vietnam on 28 July

1995, Laos and Myanmar on 23 July 1997, and Cambodia on 30 April 1999.

OBJECTIVES

The ASEAN Declaration states that the aims and purposes of the Association are:

(i) To accelerate the economic growth, social progress and cultural development in the

region through joint endeavors.

(ii) To promote regional peace and stability through abiding respect for justice and the rule

of law in the relationship among countries in the region and adherence to the principles

of the United Nations Charter.

(iii) To maintain close cooperation with the existing international and regional organizations

with similar aims.

WORKING OF ASEAN

The member countries of ASEAN have Preferential Trading Arrangements (PTA), which reduces

tariffs on products traded among member countries. In 1992, ASEAN developed a Common

Effective Preferential Tariffs (CEPT) plan to reduce tariffs systematically for manufactured and

processed products.

The members have also established a series of co-operative efforts to encourage joint

participation in industrial, agricultural and technical development projects and to increase

foreign investments in their economies. These efforts include an ASEAN finance corporation,

the ASEAN Industrial Joint Ventures Programme (AJIV) etc. ASEAN nations have introduced

some programmes for greater diversification in their economies.

India and ASEAN

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India is interested in maintaining close economic relations with the members of ASEAN, as

these countries are closer to India. The ASEAN countries are offering co-operation to India in

the field of trade, investment, science and technology and training of personnel. Also, India’s

trade with ASEAN countries is satisfactory in recent years.

Q7. Effect of Current Economic Meltdown on International Business

1. Slower global growth: Global growth stood at 5 percent in 2007, but the IMF expects world

growth to slow to 3 percent in 2009 - 0.9 percentage points lower than forecasted in July

2008.

2. Economic contraction in some countries: In G7 countries except for the United States and

Canada, GDP growth was slower in Q2 of 2008 compared to Q1. Three major European

economies (Italy, France and Germany) experienced negative GDP growth in Q2, and

forecasts are for a continued decline in Q3. The IMF forecasts around 0 percent growth for

advanced economies in 2009.

3. Depth of slowdown: It is observed that economic slowdowns, preceded by financial stress

tend to be more severe. Although employment has contracted in several countries in recent

months, it has not been as severe as that during 1990-91.

4. Financing challenges for governments: State and local governments may be faced with

financial crisis. Even administrative costs may be difficult to come by. The governments

would be hard pressed for funds for guarantees and development work. For e.g. In the case

of Iceland the banking sector has assets of around 300% of GDP, something no government

could ever guarantee, at least not on a short-term basis.

5. Rising unemployment : According to IMF, unemployment in the advanced economies will

rise from 5.7 percent in 2008 to 6.5 percent in 2009.

6. Large employment losses in sectors: Some sectors like construction, real estate services will

experience disproportionate employment declines. In addition there will be significant job

losses in the financial sector.

7. Reduced world trade volume: According to the IMF, the world trade will grow only at the

rate of 1.9% as against the earlier estimate of 4.1% for 2009. A drop in exports, as well as

capital inflow, may trigger a falloff in investments.

8. Rising income insecurity and disproportionate impact on low-income groups: As stock

markets around the world have eroded trillions of dollars in wealth and rolled back some of

the investment gains of the past 5 years, the investment and retirement savings of many

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individuals have lost significant value. There is a risk that low-income countries and lower-

income groups within countries will bear the brunt of challenges, as “the most poor are the

most defenseless,” says World Bank President Robert Zoellick.

9. Return to Tariff and Non-Tariff Barriers: Developed economies in order to ward off

unemployment and financial crisis may erect barriers to free trade. This might start a local

business environment. For e.g. President-elect Barrack Obama has already announced his

intention to reduce outsourcing from US by 30%.

10. Surplus Production Capacities: In line with demand destruction, many branded products

may face surplus capacities. For e.g. Car, Steel & Aircrafts manufacturers are already staring

at excess capacity.

11. Increase in Government Controls: In order to bail out sinking Corporates the governments,

would buy out or control the operations of large companies. For e.g. AIG and Citibank

12. Impact on India:

a. BPO Operations: India is likely to face a severe crunch on the IT and ITes services,

rendered by Indian BPO Companies.

b. Increase in Trade Deficit: Already in the last quarter, India’s trade deficit has grown

where exports are not meeting the set targets while imports continue to grow.

c. Falling Currency: as the demand for dollars increases the Indian rupee is likely to

weaken. The rupee has already depreciated to Rs. 50 a dollar.

d. Pressure on Services Sector: As the demand for services is destroyed, these sunshine

industries such as BPOs, Airlines, and Telecommunication etc. will face salary and

employment cutbacks.

Q8. Organizational Structures in International Business

Douglas Wind and Pelmutter advocated four approaches of international business. They are:

1. Echnocentric Approach

The domestic companies normally formulate their strategies, their product design and their

operations towards the national markets, customers and competitors. But, the excessive

production more than the demand for the product, either due to competition or due to

changes in customer preferences push the company to export the excessive production to

foreign countries. The domestic company continues the exports to the foreign countries and

views the foreign markets as an extension to the domestic markets just like a new region.

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The executives at the head office of the company make the decisions relating to exports and,

the marketing personnel of the domestic company monitor the export operations with the

help of an export department. The company exports the same product designed for domestic

markets to foreign countries under this approach. Thus, maintenance of domestic approach

towards international business is called ethnocentric approach.

2. Polycentric Approach

The domestic companies, which are exporting to foreign countries using the ethnocentric

approach, find at the latter stage that the foreign markets need an altogether different

approach. Then, the company establishes a foreign subsidiary company and decentralists all

the operations and delegate decision making and policy-making authority to its executives.

In fact, the company appoints executives and personnel including a chief executive who

reports directly to the Managing Director of the company. Company appoints the key

personnel from the home country and the people of the host country fill all other vacancies.

3. Regiocentric Approach

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The company after operating successfully in a foreign country thinks of exporting to the

neighboring countries of the host country. At this stage, the foreign subsidiary considers the

regions environment (for example, Asian environment like laws, culture, policies etc.) for

formulating policies and strategies. However, it markets more or less the same product designed

under polycentric approach in other countries of the region, but with different market strategies.

4. Geocentric approach

Under this approach, the entire world is just like a single country for the company. They

select the employees from the entire globe and operate with a number of subsidiaries. The

headquarters coordinate the activities of the subsidiaries. Each subsidiary functions like an

independent and autonomous company in formulating policies, strategies, product design,

human resource policies, operations etc.

Q9. Discuss Swaps, Options, Futures

Swaps

a) A swap is a derivative in which two counterparties agree to exchange one stream of cash

flows against another stream. These streams are called the legs of the swap.

b) The cash flows are calculated over a notional principal amount, which is usually not

exchanged between counterparties. Consequently, swaps can be used to create unfunded

exposures to an underlying asset, since counterparties can earn the profit or loss frommovements in price without having to post the notional amount in cash or collateral.

c) Swaps can be used to hedge certain risks such as interest rate risk, or to speculate on

changes in the underlying prices.

d) Most swaps are traded over-the-counter (OTC), "tailor-made" for the counterparties. Some

types of swaps are also exchanged on futures markets such as the Chicago Mercantile

Exchange Holdings Inc., the largest U.S. futures market, the Chicago Board Options

Exchange and Frankfurt-based Eurex AG.

e) The five generic types of swaps, in order of their quantitative importance, are: interest rate

swaps, currency swaps, credit swaps, commodity swaps and equity swaps.

Futures

a) A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a

standardized quantity of a specified commodity of standardized quality at a certain date in

the future, at a price determined by the instantaneous equilibrium between the forces of

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supply and demand among competing buy and sell orders on the exchange at the time of the

purchase or sale of the contract.

b) The future date is called the delivery date or final settlement date. The official price of

the futures contract at the end of a day's trading session on the exchange is called the

settlement price for that day of business on the exchange.

c) A futures contract gives the holder the obligation to make or take delivery under the terms

of the contract,

d) Both parties of a "futures contract" must fulfill the contract on the settlement date. The

seller delivers the underlying asset to the buyer, or, if it is a cash-settled futures contract,

then cash is transferred from the futures trader who sustained a loss to the one who made a

profit. To exit the commitment prior to the settlement date, the holder of a futures position

has to offset his/her position by either selling a long position or buying back (covering) a

short position, effectively closing out the futures position and its contract obligations.

e) Futures contracts, or simply futures, are exchange traded derivatives. The exchange's

clearinghouse acts as counterparty on all contracts, sets margin requirements, and crucially

also provides a mechanism for settlement.

Options

a) An option is a contract written by a seller that conveys to the buyer the right — but not the

obligation — to buy (in the case of a call option) or to sell (in the case of a put option) a

particular asset, such as a piece of property, or shares of stock or some other underlying

security, such as, among others, a futures contract. In return for granting the option, the

seller collects a payment (the premium) from the buyer.

b) For example, buying a call option provides the right to buy a specified quantity of a security

at a set strike price at some time on or before expiration, while buying a put option provides

the right to sell. Upon the option holder's choice to exercise the option, the party who sold,

or wrote, the option must fulfill the terms of the contract.

c) The theoretical value of an option can be evaluated according to several models. These

models, which are developed by quantitative analysts, attempt to predict how the value of

the option will change in response to changing conditions. Hence, the risks associated withgranting, owning, or trading options may be quantified and managed with a greater degree

of precision, perhaps, than with some other investments.

d) Exchange-traded options form an important class of options which have standardized

contract features and trade on public exchanges, facilitating trading among independent

parties. Over-the-counter options are traded between private parties, often well-capitalized

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institutions that have negotiated separate trading and clearing arrangements with each

other.

e) Another important class of options, particularly in the U.S., are employee stock options,

which are awarded by a company to their employees as a form of incentive compensation

f) Other types of options exist in many financial contracts, for example real estate options are

often used to assemble large parcels of land, and prepayment options are usually included in

mortgage loans.

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