7/30/2019 ib abhay

1/34

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

companys 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:o Give a higher return on your investment than selling through an agent or distributor

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

o Gives the company a close contact with its customers

Disadvantages of Direct Exports:

o The company may not have the services of a foreign intermediary, so it may need

more time to become familiar with the market

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

deregulation and privatization of many industries.

7/30/2019 ib abhay

2/34

Advantages:

o 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.

o 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.

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

o It allows making the move from domestic export sales to a locally based national sales

office.

o 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 verticalintegration 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 companys 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:

o Assessment of internal resources

o Competitiveness

o Market Analysis

o 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 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.

7/30/2019 ib abhay

3/34

Advantages:

o 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.

o It reduces the risk of expropriation because the licensee is a local company that can

provide leverage against government action.

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

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

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

Limitations:o Limited form of market entry which does not guarantee a basis for expansion.

o 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 franchisers

products, 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:

o Brand identification

o Successful method of doing business

o 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.

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.

7/30/2019 ib abhay

4/34

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, McDonalds, 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:

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

o The risk is divided between joint-venture partners.

o Normally, foreign partner has an option to sell its stake in the venture to another entity.

Limitations:

o Limited control over business approach for foreign entity.

o Profits have to be shared.

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

Wholly Owned Subsidiaries

In 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.

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.

7/30/2019 ib abhay

5/34

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 ofindirect 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 indirect

taxation 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

increased the 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 ofPremier Automobiles due to union strikes in our country.

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.

7/30/2019 ib abhay

6/34

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

for products like IPod (considered luxury items till now)

C. Social factors

7/30/2019 ib abhay

7/34

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 mindsetof 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 theycould not access local expertise)

7/30/2019 ib abhay

8/34

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 countrys gain is our

countrys loss.

Neo-mercantilism views persist today.

A nations 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

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

more because of lower prices

7/30/2019 ib abhay

9/34

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 100Total 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 200Total 200 200

7/30/2019 ib abhay

10/34

The 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 at shirt 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 Shirts

India 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

7/30/2019 ib abhay

11/34

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 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

Shoes ShirtsIndia 200 0China 0 150Total 200 150

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

units of 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

Shoes ShirtsIndia 190 8China 0 150Total 190 158

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.

7/30/2019 ib abhay

12/34

Summary

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 endowment 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 have

comparative 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

7/30/2019 ib abhay

13/34

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

7/30/2019 ib abhay

14/34

Learning effects are high.

These are cost savings that come from learning by doing

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 nations 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 nations position in factors of production such as skilled labor or

infrastructure necessary to compete in a given industry

Basic factor endowments

Advanced factor endowments

7/30/2019 ib abhay

15/34

Basic Factor Endowments

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

Porters Theory-Predictions

Porters 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.

7/30/2019 ib abhay

16/34

Limitations:

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 benefit under 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 countrys 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

7/30/2019 ib abhay

17/34

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

returns

Absence of transportation Costs.

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 adirect 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.

7/30/2019 ib abhay

18/34

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 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 local firms 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 inbetween but they surely become reasons for companies to invest in foreign markets.

7/30/2019 ib abhay

19/34

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:

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 Indias 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 Indias agriculture

7/30/2019 ib abhay

20/34

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 etcincreasing 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.

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.Indias 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,

7/30/2019 ib abhay

21/34

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. Thisaffected 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.

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 Indias point of view.

7/30/2019 ib abhay

22/34

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 Asuncin, 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, butbefore 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

(Purchasing power 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 and international 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

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.

7/30/2019 ib abhay

23/34

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 bythe 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 product originating 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;

to strengthen cooperation among themselves in international forums on matters of

common interest; and

7/30/2019 ib abhay

24/34

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 force on 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 on Labor 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.

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.

7/30/2019 ib abhay

25/34

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 foragricultural 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 in trade 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 19941995 economic crisis. Others argue that NAFTA has been

beneficial to business owners and 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 gross

domestic 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 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

7/30/2019 ib abhay

26/34

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 functioningof 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 India

India was one of the first Asian nations to accord recognition to the European Community in

1962. The EU is Indias 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 EUIndias exports to EU % Indias Imports from EU %Textile and clothing 35 Gemstones and jewellery 31Leather and leather products 25 Power generating equipment 28Gemstones and jewelery 12 Chemical products 15Agriculture products 10 Office machinery 10Chemical products 9 Transport equipment 6

India is EUs 17th largest supplier and 20th largest destination for exports.

Tariff and non-tariffs have been reduced, but compared to International standards theyare still high.

Under the Bilateral trade between India and EU, it accounts for 26% of Indias 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

7/30/2019 ib abhay

27/34

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 ASEANThe 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

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,

Indias trade with ASEAN countries is satisfactory in recent years.

7/30/2019 ib abhay

28/34

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 countriesin 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 ofIceland 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 insecurityand 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 ofmany 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

7/30/2019 ib abhay

29/34

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, Indias 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.

7/30/2019 ib abhay

30/34

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. 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.

Fig: Organization Structure of an Echnocentric Company

7/30/2019 ib abhay

31/34

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 anddecentralists 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.

Fig: Organization Structure of a Polycentric Company

3. Regiocentric Approach

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.

7/30/2019 ib abhay

32/34

Fig: Organization Structure of a Regiocentric Company

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.

Fig: Organization Structure of a Geocentric Company

7/30/2019 ib abhay

33/34

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 from movements 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 ChicagoMercantile 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 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 futurescontract, 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.

7/30/2019 ib abhay

34/34

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 notthe obligation to buy (in the case of a calloption) 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 (thepremium) 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

with granting, 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 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.