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amounts of its own currency, driving its value higher, but, given the enormous size of the currency markets, this is not considered an always effective strategy. Since traders analyze each government’s fiscal health and trade standing, among other matters, the government can best affect the value of its currency with sound policies. Short-term interest rates can also have an impact on the value of one currency against others. If one nation’s central bank sets short-term rates at 20% and other nation’s central bank sets rates at 2%, people will flock to the 20% return. Usually, the difference isn’t quite so stark; the point is that the currency speculators analyze what kind of return they will get, as well as government’s fiscal health.
Currency trading is dominated by large players, such as global banks, big hedge funds and institutions. It is not a market that a lot of individual investors play in. But understanding currency rates matters to those travelling abroad as well as to those doing business abroad. Exchange rates affect repatriated profits. If the dollar is weak, U.S. exports can be priced more competitively. If the dollar is strong, a trip to the Bordeaux region of France, for example, is more affordable. Recently, the dollar has been weak. In early 2005, it took $1.30 to buy a euro, the currency of France and eleven other countries. Just a few years ago, about 90 cents would get you a euro.
You have read the text. Check your understanding.
1)What factors determine the market value of money?
2)How do currency markets operate?
3)How can governments affect the value of their own currency?
4)What impact has interest rate on the value of one currency against others?
Bank Accounts
Many of us keep our money in the bank. The bank, of course, doesn’t keep actual dollars and cents in the vault; it keeps an electronic record of that money. The bank does keep some cash on
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hand to satisfy withdrawal demands, but most of our deposits are active elsewhere, usually in the form of loans to people buying homes or cars.
The most basic form of keeping our money in the bank is a savings account. Such an account pays a small amount of interest, and we can deposit and withdraw cash from the account, either at the bank or via an automated teller machine, or ATM.
Many of us have a checking account. This is like a savings account and usually pays some interest on the money deposited. But unlike a savings account, a checking account permits us to write our name on a piece of paper (a check) and give money from our account to a person or company without having to go to the bank physically and get the money. The check is processed electronically, and the money moves from our account to another account, whether our landlord’s or a retailer’s.
Some people also keep their money in certificates of deposit or CDs. These are similar to savings accounts, in the sense that we deposit money in the bank and receive interest in return. But a CD has a fixed period of time during which the depositor can’t withdraw the money without suffering a penalty. Because the depositor had promised not to take the money out for that period of time, the interest paid on the account is higher than on a savings or checking account. CDs are generally short term in nature, ranging from several months to a few years.
Money market deposit accounts are similar to savings and checking accounts, though some money markets accounts place restrictions on the amount of checks that can be written. These accounts pay a small interest rate.
All the above accounts are federally insured by the Federal Deposit Insurance Corporation. The FDIC was created by the government in 1933. The FDIC takes in premiums from banks and savings and loans and monitors the health of banks. In return, in most cases the FDIC guarantees accounts of up to $ 100 000 in the event of bank failure. But similar insurance is not provided for other investments, such as mutual funds, stocks and bonds.
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You have read the text. Check your understanding.
1)In what form does the bank keep deposits?
2)What’s the difference between savings account and checking account?
3)On what condition is money kept in certificates of deposit?
4)How are bank accounts insured?
II. Case Study
Case Study 1
Leipzig, East Germany's second largest city, has attracted attention from office developers as it changes from a planned to a market system. The city has a shortage of office space. Most of its existing space is obsolete compared with Western standards. Also, if Leipzig is to achieve the status of other German cities, it needs to develop another 2 or 3 million sq. ft of office space. Developers are receiving a number of incentives, including grants, favorable tax treatment, EC regional grants and subsidized lending rates. Another attractive feature for developers is the state of rents. Because of the shortages rents have risen sharply and Leipzig is seen as a good investment opportunity by many property speculators.
However, there have been problems as the city copes with the transition.
Pollution from open cast mining in the countryside has disfigured much of Leipzig's building stock.
Inadequate building stock has resulted in housing shortages discouraging skilled workers from moving to the city. Hotel shortages have also restricted the number of visitors to Leipzig.
Poor transport infrastructure.
Many of the young and relatively well educated members of the population have migrated from the city. This has contributed to a population decline from 713,000 to 511,000 over a 50 year period.
Land ownership disputes have resulted in delays and frustration as land and property is transferred from the state to the private sector.
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There has been a flood of goods from West Germany into the city.
You have read the text. Answer the questions:
1)How far are the problems facing Leipzig a result of it being formerly part of a planned economy?
2)How might cities such as Leipzig overcome the problems of changing from a planned to a mixed economy?
Case Study 2
Gurrinder Niijer owns a small business that manufactures carpet slippers.
She is considering expanding her production in the near future by taking on five extra workers. The existing workers are concerned about how much the new employees will be paid. They feel that there need to be pay differentials between themselves and the new workers.
Although Gurrinder has 5000 pounds of her own money to invest, she is likely to require a loan. Her bank has indicated that now is a good time to borrow as interest rates are low. However, it has also warned her that the government could force up rates in future if they needed to control the exchange rate or if inflation started to increase.
Gurrinder feels happy that she can pay back the loan quickly, because although the economy is still in recession, there is a strong local demand for her goods.
You have read the text. Answer the questions:
1)What are the: a) internal
b) external factors that may affect Gurrinder’s decision to expand?
2)How might the business be affected if the “strong local demand” for its products decreases?
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Case Study 3
The Price Responsiveness of Demand
The quantity demanded increases as the price of a good falls. Frequently we need to know by how much it will increase. The Table presents some numbers for the relation between ticket price and quantity demanded, other things equal.
Table 2
|
The demand for football tickets |
|
|
|
|
Price |
|
Quantity of tickets demanded |
($/ticket) |
|
(thousands/ game) |
12.50 |
|
0 |
10.00 |
|
20 |
7.50 |
|
40 |
5.00 |
|
60 |
2.50 |
|
80 |
0 |
|
100 |
We see from the Table 2 that each price cut of $1 leads to 8000 extra ticket sales per game. Suppose, however, that we wish to compare the price responsiveness of football ticket sales with the price responsiveness of the quantity of cars demanded: clearly, $1 is a trivial cut in the price of a car and will have a negligible effect on the quantity of cars demanded. When commodities are measured in different units it is often best to examine the percentage change, which is unit-free. This suggests that we think about the effect of a 1 per cent price cut on the quantity of cars and football tickets demanded. Similarly, it is not the absolute number of cars and tickets we should examine but the percentage change in quantity demanded. Not only does this solve the problem of comparing things measured in different quantity units, it also takes account of the size of the market. Presumably an extra sale of 8000 tickets is more important when ticket sales are 4000 than when they number 40 000.
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Responsiveness of demand to price changes is measured by the price elasticity of demand.
The price elasticity of demand is the percentage change in the quantity of a good demanded divided by the corresponding percentage change in its price.
Although there are other demand elasticities – the cross price elasticity and the income elasticity – the (own) price elasticity is perhaps the most frequently used of the three. Whenever economists speak of the demand elasticity they mean the price elasticity of demand.
If a 1 per cent price increase reduces the quantity demanded by 2 per cent, the demand elasticity is –2. Because the quantity falls 2 per cent, we express this as a change of –2 per cent, then divide by the price change of 1 per cent (a price rise) to obtain – 2. If a price fall of 4 per cent increases the quantity demanded by 2 per cent, the demand elasticity is –½, since the quantity change of 2 per cent is divided by the price change of –4 per cent. Since demand curve slopes down, we are either dividing a positive percentage change in quantity (a quantity rise) by a negative percentage change in price (a price fall), or dividing a negative percentage change in quantity (a quantity fall) by a positive percentage change in price (a price rise).
The price elasticity of demand tells us about movements along a demand curve and the demand elasticity must be a negative number.
You have read the text. Answer the questions:
1)How can we measure the responsiveness of the quantity demanded to the price of the good?
2)What effect does the price cut have on the sales of the good?
3)What method is used when we compare commodities measured in different units?
4)In what way is demand elasticity calculated?
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Case Study 4
The Japanese market had long been one that seemed to work according to its own rules. The difficulty of producing software which used the Japanese language allowed a handful of domestic manufacturers, led by NEC, to carve up the personal computer (PC) market amongst them.
Price wars began in October 1991 when Compaq, a US firm, introduced a machine at half the price of Japanese machines. IBM, also a US company, followed suit. “We brought out low-priced models because it was the main way in which to differentiate between IBM’s and NEC’s machines”, – said Mr. Tsutomu Maruyama, director of Personal Systems Operations at IBM’s Japan General Business Company. IBM and Compaq both reported strong sales. In 1993, Dell, the US firm, announced a low price desktop computer for sale in the Japanese computer market. Shortly afterwards Toshiba announced its first low cost notebook PC.
Total prices after reduction
NEC |
Compaq |
Dell |
218 000 yen |
196 000 yen |
170 000 yen |
You have read the text. Answer the questions:
1)What possible problems of a market system are mentioned in this article?
2)What is the effect of the changes in prices on the allocation of resources in the computer market?
3)What might be the results of these changes for:
a)Japanese businesses;
b)US businesses?
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Case Study 5
In May 1999 TheStreet.com, an online financial news outfit, went public. Its shares were priced at $19. The shares on offer were sold first to a group of investors, a mixture of institutions and individuals lined up by the investment bank, or underwriter. (The investment bank is called an underwriter because technically it acquires the shares from the company and then resells them to the investors it has lined up to buy the shares. This transaction occurs the night before public trading begins.) The next day, the so-called opening trade was at $72. This high price came about because of the overwhelming demand for the shares by investors not involved in the initial pricing of the deal. At the time, individuals couldn’t get enough dot-com shares, so a good number of these told their broker, “Buy me some shares in TheStreet.com at any price.” These investors would’ve been buying at $72 or near there, rather than at $19. But because a lot of people who bought shares at the initial price sold quickly after the first trade, the selling pressure quickly outweighed the buying enthusiasm. Thus, shares in TSCM steadily dropped from the first day, and most first-day buyers were money losers.
Google’s summer 2004 IPO (initial public offering) had a strong first-day pop in price, and its shares raced higher from there. The IPO was priced at $85 a share. It ended its first day of trading at $100.34 on about 22 million shares of trading volume.
You have read the text. Answer the questions:
1)What is the reason of sharp changes in the price of shares?
2)How did the pricing of IPO change in the period from 1999 till 20004? Why?
Case Study 6
Venture funds are pools of money gathered up from institutions and wealthy individuals. They focus on young, small companies. They take great risks on untested or unproven ideas, and
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the thesis is that they will get great rewards when the young companies grow into mature, publicly traded stocks. A number of well-known technology companies received early backing from venture capital funds, notably Apple Computer and Google. The venture capital is most associated with technology investing.
Coe LLC, a venture fund, eyed a promising software startup. The start-up didn’t have a lot of cash, but it had a clever idea and strong management. The founders of Coe needed money to bring their idea to the marketplace. So the venture fund bought a 25% stake in the company. In order to do so, it determined a value for the company. This valuation process is usually done by getting competing VC firms to bid for an investment. Each bid will include a money amount as well as a valuation of the company. The winning VC valued Coe LLC at $10 million. So, for $2.5 million, it got its 25% share. After three years of successful growth, the company decided to go public with an IPO. The investment bankers valued the software company at $100 million. That meant the venture stake had grown tenfold over three years, to $25 million. Of course, a lot of times this 25% becomes zero. About 70% of venture investments fail. It is a high-risk, high-reward game.
You have read the text. Answer the questions:
1)What is the role of venture funds in the development of small companies?
2)How does a successful venture investment work?
Case Study 7
Private equity funds are generally larger than venture funds, and they often use lots of borrowed money to execute transactions. Oftentimes, a private equity fund hunts for assets that are undervalued or fallen on hard times. Or it hunts for divisions that no longer fit the core mission of a particularly far-flung company. Investment bankers love to build up companies, tear them apart and build them up again. Oftentimes in the teardown phase, private
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equity funds are buyers. In 2002, Diageo, a large liquor conglomerate, found itself trying to figure out what to do with its Burger King unit. Not seeing many synergies between burgers and Bacardi, Diageo sold Burger King to Texas Pacific Group, a private equity firm, for $1.5 billion. Similar to a venture fund, the private equity seeks to improve the business and eventually sell it to another large company or take it public with an initial public offering.
You have read the text. Answer the questions:
1)Are private equity funds more or less risky than venture funds?
2)Why do these funds operate in private, not giving much public information?
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