Question

Define two (2) of the following terms and, briefly, indicate their relevance in international finance: a) The Marshall-Lerner conditions; b) Absorption; c) Dollarization; d) Expenditure switching policy; e) A managed float; f) IMF conditionality; g) The Eurodollar (xenocurrency) market. h) External balance i) Direct controls j) Country risk

Answer 1

a. The Marshall-Lerner condition: "The condition is that an exchange rate devaluation will only results in a balance of trade if the absolute sum of long term export and import demand elasticities is greater than unity." Why does this happen? If a currency depreciates, the import prices will increase and the export prices will decrease. Therefore, if the demand for imports and exports is more price elastic, the fall in demand for imports will be greater as will the increase in demand for exports. Thus, there will be an improvement in trade.

j. Country risk: We define risk as the possibility that the borrower will default on their loans - thus a country risk is the risk that a government will default on its loans or other financial commitments. Unlikely as it sounds, governments often end up defaulting owing to socio-economic conditions of the time. Political and economic unrest in a country increases the country risk of doing business with that particular country and the political atmosphere is often used as a metric by risk analysts.

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