1.10 International Economics
Key Takeaways
A stronger U.S. dollar benefits importers and U.S. tourists abroad but hurts exporters and U.S. manufacturers competing globally
American Depositary Receipts (ADRs) are U.S. securities representing foreign company shares, trading on U.S. exchanges and priced in dollars
ADRs have three levels: Level I (OTC only, minimal requirements), Level II (NYSE/NASDAQ, full SEC registration), and Level III (can raise capital in U.S.)
Currency risk can significantly impact international investment returns, where favorable stock performance can be offset by unfavorable exchange rate movements
The balance of trade measures exports minus imports, with the U.S. typically running a trade deficit (importing more than exporting)
Financial markets are global. Understanding exchange rates, trade balances, and how U.S. investors access foreign markets is increasingly important — and tested on the SIE exam.
Why International Economics Matters
| Factor | Impact on U.S. Markets |
|---|---|
| Exchange rates | Affect corporate profits, import/export costs |
| Global growth | Many U.S. companies earn revenue abroad |
| Foreign investment | Capital flows affect U.S. asset prices |
| Trade policy | Tariffs and agreements impact businesses |
Exchange Rates
An exchange rate is the price of one currency expressed in terms of another.
Example
If USD/EUR = 1.10:
- $1.10 USD buys €1.00 EUR
- A stronger dollar means more euros per dollar
- A weaker dollar means fewer euros per dollar
Types of Exchange Rate Systems
| System | Description |
|---|---|
| Floating | Market forces determine rates (most major currencies) |
| Fixed/Pegged | Government maintains rate against another currency |
| Managed Float | Primarily market-driven with occasional intervention |
Strong Dollar vs. Weak Dollar
Exchange rate movements create winners and losers:
Strong Dollar Effects
| Who Benefits | Who Suffers |
|---|---|
| U.S. importers | U.S. exporters |
| U.S. tourists abroad | Foreign tourists in U.S. |
| Buyers of foreign goods | U.S. manufacturers |
Weak Dollar Effects
| Who Benefits | Who Suffers |
|---|---|
| U.S. exporters | U.S. importers |
| Foreign tourists in U.S. | U.S. tourists abroad |
| U.S. manufacturers | Buyers of foreign goods |
Investment Impact
- Strong dollar: U.S. investors' foreign holdings worth less in dollar terms
- Weak dollar: U.S. investors' foreign holdings worth more in dollar terms
Balance of Trade
The balance of trade measures the difference between a country's exports and imports.
| Term | Definition |
|---|---|
| Trade Surplus | Exports > Imports (positive balance) |
| Trade Deficit | Imports > Exports (negative balance) |
U.S. Trade Position
The U.S. typically runs a trade deficit — importing more than it exports. This affects:
- Dollar value (demand for dollars from foreigners)
- Employment in certain industries
- Political discussions about trade policy
Balance of Payments
The balance of payments is a broader measure that includes:
Current Account
- Trade in goods and services
- Income from investments abroad
- Transfers (foreign aid, remittances)
Capital Account
- Foreign direct investment (building factories, buying businesses)
- Portfolio investment (stocks, bonds)
- Central bank reserves
When one account has a deficit, the other typically has a surplus.
Investing in Foreign Securities
U.S. investors can access foreign markets through several methods:
American Depositary Receipts (ADRs)
ADRs are U.S. securities representing shares of foreign companies.
| Feature | Description |
|---|---|
| What they are | Certificates issued by U.S. banks |
| Where they trade | U.S. exchanges (NYSE, NASDAQ) or OTC |
| Currency | Priced and pay dividends in U.S. dollars |
| Convenience | No need for foreign brokerage account |
ADR Levels
| Level | Exchange | SEC Registration |
|---|---|---|
| Level I | OTC only | Minimal requirements |
| Level II | NYSE/NASDAQ | Full SEC registration |
| Level III | NYSE/NASDAQ | Can raise capital in U.S. |
Sponsored vs. Unsponsored ADRs
| Type | Description |
|---|---|
| Sponsored | Foreign company participates, provides information |
| Unsponsored | Bank creates without company involvement |
Currency Risk
Currency risk (or exchange rate risk) is the risk that exchange rate movements will affect investment returns.
Example
You invest $10,000 in a European stock fund:
- Stock rises 10% in euro terms
- But the euro falls 15% against the dollar
- Your dollar return is negative despite stock gains
Managing Currency Risk
- Currency hedging — Using derivatives to offset currency movements
- Diversification — Spreading across multiple currencies
- Dollar-denominated investments — ADRs or U.S. companies with foreign exposure
Global Economic Indicators
International factors that affect U.S. markets:
| Indicator | Why It Matters |
|---|---|
| Foreign GDP growth | Demand for U.S. exports |
| Central bank policies | Interest rate differentials |
| Political stability | Risk assessment, capital flows |
| Trade agreements | Market access, tariffs |
Emerging Markets
Emerging markets are developing economies with faster growth potential but higher risk:
Characteristics
- Higher growth rates than developed markets
- Greater volatility
- Political and regulatory uncertainty
- Currency instability
- Less liquid markets
Examples
- China, India, Brazil, Mexico, South Africa
- "BRICS" nations (Brazil, Russia, India, China, South Africa)
Risk Considerations
| Risk | Description |
|---|---|
| Political risk | Government instability, policy changes |
| Currency risk | More volatile exchange rates |
| Liquidity risk | Harder to buy/sell |
| Regulatory risk | Less investor protection |
Trade Policy
Government trade policies affect markets:
Key Terms
| Term | Definition |
|---|---|
| Tariff | Tax on imported goods |
| Quota | Limit on quantity of imports |
| Embargo | Complete ban on trade with a country |
| Free Trade Agreement | Reduces/eliminates trade barriers between countries |
Market Impact
- Tariffs raise costs for importers and consumers
- Trade tensions create market uncertainty
- Free trade agreements can open new markets
Global Interconnectedness
Today's markets are highly connected:
- 24-hour trading — As one market closes, another opens
- Contagion risk — Problems in one market spread to others
- Supply chains — Disruptions anywhere affect companies globally
- Interest rate differentials — Capital flows to higher-yielding markets
Key Takeaways
- Exchange rates affect corporate profits, trade, and investment returns
- A strong dollar benefits importers but hurts exporters; a weak dollar does the opposite
- ADRs allow U.S. investors to buy foreign stocks on U.S. exchanges
- Currency risk can significantly impact international investment returns
- Emerging markets offer growth potential but carry higher risk
- Trade policy (tariffs, agreements) impacts corporate costs and market access
- Global markets are highly interconnected — events abroad affect U.S. markets
Which of the following would benefit from a stronger U.S. dollar?
U.S. exporters selling products abroad
U.S. importers buying foreign goods
U.S. tourists traveling to Europe
U.S. manufacturers competing with foreign companies
What is an American Depositary Receipt (ADR)?
A U.S. government bond held by foreign investors
A U.S. security representing shares of a foreign company
A receipt for goods imported into the United States
A currency exchange contract
An investor buys shares of a European company. The stock price increases 8% in euros, but the euro falls 10% against the dollar. What is the approximate return in dollar terms?
Positive 18%
Positive 8%
Negative 2%
Negative 10%
Sections you finish are checked off in the contents.