International Economics
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?
What is an American Depositary Receipt (ADR)?
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?