Cash Flows of Multinational Corporations Assignment

Cash Flows of Multinational Corporations - Assignment Example Forward contracts are very helpful if a party is looking for hedging. A party can also make currency option contracts to protect itself from fluctuating rates. A country has the option to adopt an exchange rate system of its choice. It looks to adopt the system that works best in achieving current account equilibrium. Exchange rates also influence inflation and interest rates of a country which is why the central banks seek some involvement to control the exchange rates. Q2 In the context of international trade, absolute advantage is the ability of a country to use a similar amount of resources as other countries and produce more of a product. On the other hand, comparative advantage is a country’s ability to produce more of a product than other countries at a lower opportunity cost. (Findlay, 1987) Suppose that there are two countries A and B. Country A produces the amount of wheat in 10 hours which is produced by country B in 15 hours. Also, country A produces that much rice in 10 hours which is produced in 15 hours in country B.  Now it is supposed that country B can produce one bushel of wheat in 5 hours and 1kg of rice in 10 hours. On the other hand, country A produces 1 bushel of wheat in 3 hours and 1kg of rice in 1 hour. Once again, country A is more productive than country B. However, for country B, the cost of producing one bushel of wheat is half kg of rice. For country A, the cost of producing one bushel of wheat is 3kg of rice. It means that the opportunity cost of the production of wheat is lower for country B than country A in terms of the kilograms of rice that are to be given up. Therefore, country B has a comparative advantage in producing wheat. Similarly, for country B, the cost of producing 1kg of rice is two bushels of wheat. For country A, the cost of producing 1kg of rice is one-third of a bushel of wheat. Hence, country A has a comparative advantage in the production of rice. Now, if the two countries decide to trade one bushel of wheat with 1kg of rice, country B can specialize in the production of wheat, while trading some with country A, and country A can specialize in the production of rice trading some of it to country B. Now, country B can shift the hours of producing rice to wheat which would result in the production of 2 bushels of wheat which can be exchanged for 2kg of rice. Similarly, country A can reallocate the hours used in the production of wheat to the production of rice hence resulting in the production of 3kg of rice which can be exchanged for 3 bushels of wheat. Therefore, both countries gain from trade where there is a comparative advantage. (Ricardo, 1821)