Running head: WEEK 12-CHAPTER 18 1

International Finance MG760-144

Week12 Chapter 18

Nazifa Antara Prome

Homework Assignment

Monroe College King Graduate School

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International Finance MG760-144

Week 13 Chapter 17 and Chapter 18
Homework Assignment

1. Explain the pricing spill-over effect.

Spillover Effect

Spillover effect refers to the impact that seemingly unrelated events in one nation can have on the

economies of other nations. Although there are positive spillover effects, the term is most commonly

applied to the negative impact a domestic event has on other parts of the world. For example, if consumer

spending in the United States declines, it has spillover effects on the economies that depend on the U.S. as

their largest export market. The larger an economy is, the more spillover effects it is likely to produce

across the global economy.

BREAKING DOWN 'Spillover Effect '

Spillover effects are a type of network effect that has become more common as globalization deepens the

financial connections between economies. The Canada-U.S. trade relationship provides an example of

spillover effects. This is because the U.S. is Canadas main market by a wide margin across nearly every

export-oriented sector. The effects of a minor U.S. slowdown are amplified by the Canadian reliance on

the U.S. market for its own growth.

Since the 2009 China has also emerged as a major source of spillover effects. This is because Chinese

manufacturers have driven much of the global commodity demand growth since 2000. With China

becoming the number two economy in the world after the U.S., the number of countries that experience

spillover effects from a Chinese slowdown is significant. China slowing down has a palpable impact on
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worldwide trade in metals, energy, grains, and many more commodities. This leads to economic pain

through much of the world, although it is most acute in Eastern Europe, the Middle East and Africa as

these areas count on China for a larger percentage of their revenue.

Spillover Effects on Unconnected and Safe Haven Economies

There are some countries that experience very little as far as spillover effects from the global market.

These closed off economies are getting rarer as even North Korea - an economy nearly sealed off from the

world trade - feels spillover effects from the Chinese slowdown. A few developed economies are sway to

economic phenomenon that can overwhelm spillover effects. Japan, the U.S. and the Eurozone, for

example, experience spillover effects from China but this impact is partially counteracted the flight to

safety by investors when global markets get shaky. Similarly, if one of the economies in this safe haven

group is struggling, investment will usually go to one of the remaining safe havens. This effect was seen

with the U.S. investment inflows during the EUs struggles with the Greek debt crisis. When dollars flow

into U.S. Treasuries, the yield goes down and the borrowing cost for American home buyers, borrowers

and businesses. This is an example of a positive spillover effect from the perspective of a U.S. consumer.

2. In what sense do firms with nontradable assets get a free-ride from firms whose securities are

internationally tradable?

Answer:

Due to the spillover effect, firms with nontradable securities can benefit in terms of higher security prices

and lower cost of capital, without in curring any costs associated with making the securities

internationally tradable. This is an example of free ride.

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3. Explain the pricing-to-market phenomenon.

Answer:

The pricing-to-market (PTM) refers to the phenomenon that the same securities are priced differently for

different investors. A well-known example of PTM is provided by Nestle. Up until 1988 November,

foreigners were only allowed to hold Nestle bearer shares; only Swiss residents were allowed to hold

registered shares.

4. Explain how the premium and discount are determined when assets are priced-to-market. When

would the law of one price prevail in international capital markets even if foreign equity

ownership restrictions are imposed?

Answer:

The premium and discount are determined by

(I) the severity of restrictions imposed on foreigners and

(ii) foreigners ability to mitigate the effect of these restrictions using their own domestic securities.

In a special case where foreigners can exactly replicate the securities under restriction, then PTM will

cease to apply.
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References

Spillover Effect Definition | Investopedia http://www.investopedia.com/terms/s/spillover-

effect.asp#ixzz4nhdzdQfV