IB Exam 2

Free Trade Agreement

An agreement between two or more countries to reduce or eliminate trade barriers such as tariffs and quotas.

Regional Economic Integration

A process in which countries within a region work together to reduce barriers to trade and investment.

Levels of Economic Integration

The stages of integration: Free Trade Area, Customs Union, Common Market, Economic Union, and Political Union.

Free Trade Area

A region where member countries remove trade barriers among themselves but keep their own policies toward non-members.

Customs Union

A group of countries that remove trade barriers among members and adopt a common external trade policy.

Common Market

A market that allows free trade, free movement of labor and capital, and shared policies among member countries.

Economic Union

A deeper integration involving a common market plus harmonized economic policies and a shared currency.

Political Union

A system where countries coordinate government and political systems; the highest form of integration.

European Union (EU)

The world’s largest and most advanced regional economic integration; aims to promote peace, stability, and prosperity in Europe.

Single European Act (1987)

Legislation that created a single market within the EU by removing barriers to trade, labor, and capital.

Benefits of Economic Integration

Increased trade, investment opportunities, job creation, and stronger economic growth among member countries.

Costs of Economic Integration

Loss of national sovereignty and possible harm to specific industries or regions.

Trade Creation

When lower-cost producers within a free trade area replace higher-cost domestic producers.

Trade Diversion

When trade shifts from a more efficient non-member producer to a less efficient member due to preferential agreements.

NAFTA (Now USMCA)

A trade agreement between the U.S., Canada, and Mexico designed to eliminate trade barriers and increase cooperation.

ASEAN (Association of Southeast Asian Nations)

A regional organization promoting economic growth and political stability in Southeast Asia.

Foreign Direct Investment (FDI)

Investment made by a company in facilities to produce or market a product in another country.

Flow of FDI

The amount of FDI undertaken over a specific time period.

Stock of FDI

The total accumulated value of foreign-owned assets at a given time.

Outflows of FDI

The amount of FDI originating from a country.

Inflows of FDI

The amount of FDI received by a country.

Greenfield Investment

Establishing a new operation in a foreign country from the ground up.

Acquisition or Merger

When a company buys or combines with an existing foreign firm.

FDI vs. Exporting

FDI may be chosen over exporting when transportation costs or trade barriers make exporting unattractive.

FDI vs. Licensing

FDI may be preferred to maintain control, protect technology, and gain management or marketing advantages.

Internalization Theory

Explains why firms choose FDI instead of licensing to retain control and reduce risk.

Eclectic Paradigm

Firms choose FDI based on ownership advantages, location advantages, and internalization advantages.

Strategic Behavior

Companies engage in FDI to match or counter the moves of global competitors.

Product Life Cycle Theory

Firms invest abroad at different stages of a product’s life to maintain advantage.

Radical View of FDI

Belief that multinational enterprises exploit host countries for their own gain.

Free Market View of FDI

Belief that FDI should be encouraged as it increases efficiency and global wealth.

Pragmatic Nationalism

View that FDI should be allowed if benefits outweigh costs for the host country.

Benefits of FDI for Host Country

Capital inflows, technology transfer, job creation, and increased competition.

Costs of FDI for Host Country

Profit repatriation, loss of economic independence, and potential harm to local firms.

Benefits of FDI for Home Country

Increased foreign income, skill transfer, and global competitiveness.

Costs of FDI for Home Country

Job loss from outward investment and negative balance of payments effects.

Foreign Exchange Market

The market where one currency is exchanged for another; supports international trade and investment.

Exchange Rate

The price of one currency in terms of another.

Spot Exchange Rate

The current exchange rate for immediate delivery.

Forward Exchange Rate

The agreed-upon rate to exchange currency at a future date; used for hedging.

Foreign Exchange Risk

The risk that currency value changes will affect business profits or costs.

Hedging

Using financial instruments like forward contracts to protect against exchange rate fluctuations.

Currency Swap

Simultaneous purchase and sale of a currency for different value dates, often used by multinational firms.

Arbitrage

Buying currency in one market and selling it in another to profit from price differences.

Law of One Price

Identical products should cost the same in different countries when expressed in the same currency.

Purchasing Power Parity (PPP)

The theory that exchange rates adjust so that identical goods cost the same in different countries.

Big Mac Index

A tool comparing prices of McDonald’s Big Macs across countries to measure currency value differences.

Money Supply and Inflation

When a country increases its money supply faster than output, inflation rises and the currency depreciates.

Bandwagon Effect

A situation where traders move in the same direction as others, causing further exchange rate movement.

Efficient Market Theory

The idea that forward exchange rates reflect all publicly available information about future currency values.

Inefficient Market Theory

The belief that not all information is reflected in exchange rates, allowing potential forecasting opportunities.

Fundamental Analysis

Uses economic data like inflation and interest rates to predict future exchange rate movements.

Technical Analysis

Uses past price patterns and trends to predict future exchange rate changes.

Currency Convertibility

The ability of residents and nonresidents to exchange domestic currency for foreign currency.

Freely Convertible Currency

No government restrictions on currency exchange; allows open trade and investment.

Externally Convertible Currency

Only nonresidents can convert; used to control domestic capital outflow.

Nonconvertible Currency

Government restricts exchange to prevent capital flight and protect reserves.

Capital Flight

The large-scale movement of money out of a country due to fear of instability or devaluation.

Countertrade

Trading goods and services directly when currency is not convertible.

Transaction Exposure

The impact of exchange rate changes on specific individual transactions.

Translation Exposure

The effect of exchange rate changes on financial statements when consolidating foreign operations.

Economic Exposure

The long-term impact of exchange rate changes on a company’s future earnings power.

Lead Strategy

Collect receivables early or pay payables early when expecting certain currency changes.

Lag Strategy

Delay payments or collections based on expected currency appreciation or depreciation.

Centralized Risk Management

Managing all foreign exchange risk through a central system for consistency and efficiency.

Exchange Rate Forecasting

Helps firms plan pricing, investment, and sourcing decisions; must account for uncertainty.

Trade Surplus

Occurs when a country's exports exceed its imports; can result from currency depreciation.

Trade Deficit

Occurs when imports exceed exports; can result from currency appreciation.

Appreciation

An increase in a currency’s value relative to another; makes exports more expensive and imports cheaper.

Depreciation

A decrease in a currency’s value relative to another; makes exports cheaper and imports more expensive.