Ch 7: Foreign Direct Investment
CHAPTER 7
FOREIGN DIRECT INVESTMENT
TRUE/FALSE QUESTIONS 1. Many early trade theories were created at a time when most factors of production either could
not be moved or could not be moved easily across national borders.
(True; Moderate; p. 204; LO1) 2. Factors of production include things such as labor, financial capital, capital equipment, and
land or natural resources.
(True; Easy; p. 204; LO1) 3. Today, all factors of production are internationally mobile. (False; Easy; p. 204; LO1) 4. Portfolio investment is the purchase of physical assets or a significant amount of ownership
of a company in another country to gain a degree of management control.
(False; Moderate; p. 204; LO1) 5. Foreign direct investment is the purchase of physical assets or a significant amount of the
ownership (stock) of a company in another country to gain a measure of management control.
(True; Easy; p. 204; LO1) 6. At the core of foreign direct investment are international flows of capital. (True; Moderate; p. 204; LO1) 7. Two main reasons for increasing foreign direct investment flows over the past decade are
globalization and diversity.
(False; Moderate; p. 204; LO1) 8. Forces causing globalization are part of the reason for long-term growth in foreign direct
investment.
(True; Moderate; p. 205; LO1) 9. Increasing globalization is causing a growing number of international companies from
emerging markets to undertake foreign direct investment.
(True; Moderate; p. 205; LO1) 10. Developed countries are the prime destination for foreign direct investment because cross-border mergers and acquisitions are concentrated in developed countries. (True; Moderate; p. 206; LO1) 11. Trade barriers and specialized knowledge are both examples of market imperfections. (True; Easy; p. 208; LO2) 12. Market imperfection that can encourage foreign direct investment is the possibility that a
company will create a future competitor by charging another company for access to its knowledge.
Ch 7: Foreign Direct Investment
(True; Difficult; p. 208; LO2) 13. The eclectic theory states that firms undertake foreign direct investment when the features of
a particular location combine with ownership and internalization advantages to make a location appealing for investment.
(True; Easy; p. 209; LO2) 14. According to the eclectic theory, an internalization advantage is the advantage that arises
from internalizing a business activity rather than leaving it to a relatively inefficient market.
(True; Easy; p. 209; LO2) 15. According to the eclectic theory, an ownership advantage is the advantage of locating a
particular economic activity in a specific location because of the characteristics of that location.
(False; Easy; p. 209; LO2) 16. Vertical integration is the extension of company activities into stages of production that
provide a firm’s inputs (forward integration) or absorbs its outputs (backward integration).
(False; Difficult; p. 209; LO2) 17. If coffee company Maxwell House were to acquire a coffee plantation in Brazil, it might
achieve market power through vertical integration.
(True; Difficult; p. 209; LO2) 18. In foreign direct investment, 100 percent ownership of a company does not guarantee its
complete control.
(True; Moderate; p. 210; LO2) 19. Benefits of investment by multinationals include increased unemployment, increased tax
revenues, workforce training, and the transfer of technology.
(False; Moderate; p. 210; LO3) 20. Governments never intervene in the flow of foreign direct investment since it always
generates jobs.
(False; Easy; p. 214; LO3) 21. Values, attitudes, and beliefs form the basis for much of a government’s position regarding
foreign direct investment.
(True; Moderate; p. 214-215; LO4) 22. A country’s balance of payments is a national accounting system that records all payments to
entities in other countries and all receipts coming into the nation.
(True; Easy; p. 215; LO4) 23. Any nation’s balance of payments consists of two major components: the current account and
the past-due account.
(False; Easy; p. 215; LO4) 24. The merchandise account includes exports and imports of tangible goods. (True; Moderate; p. 216; LO4)
Ch 7: Foreign Direct Investment
25. The income payment account includes income earned on home country assets held abroad. (False; Moderate; p. 216; LO4) 26. A current account deficit occurs when a country exports more goods and services and
receives more income from abroad than it imports and pays abroad.
(False; Moderate; p. 216; LO4) 27. When a country imports more goods and services and pays more abroad than it exports and
receives from abroad, it experiences a current account deficit.
(True; Moderate; p. 216; LO4) 28. The capital account is a national account that records transactions involving the import and
export of goods and services, income receipts on assets abroad, and income payments on foreign assets inside the country.
(False; Difficult; p. 216; LO4) 29. If a U.S. citizen invests in the Brazilian stock market, the transaction would show up on the
capital accounts of both the United States and Brazil.
(True; Difficult; p. 216; LO4) 30. The two main reasons countries intervene in foreign direct investment flows are to control the
balance of payments and to obtain resources and benefits.
(True; Moderate; p. 216; LO4) 31. Because foreign direct investment inflows are recorded as subtractions to the balance of
payments, a nation is negatively affected from an initial foreign direct investment inflow.
(False; Difficult; p. 216; LO4) 32. One reason a home country may discourage foreign direct investment outflows is to protect
its “sunset” industries.
(False; Difficult; p. 218; LO4) 33. One method used by host countries to restrict incoming foreign direct investment is
ownership restrictions.
(True; Easy; p. 219; LO4) 34. Tax incentives and infrastructure improvements are financial incentives used by home
countries to encourage outflows of foreign direct investment.
(False; Moderate; p. 219; LO5) 35. To limit the effects of outbound foreign direct investment on the national economy, home
governments may impose differential tax rates that charge earnings from abroad at a higher rate than domestic earnings.
(True; Moderate; p. 220; LO5)
MULTIPLE CHOICE QUESTIONS 1. Which of the following are main drivers of rising foreign direct investment over the
foreseeable future?
a. Diversity and telecommunications
Ch 7: Foreign Direct Investment
b. Telecommunications and transportation c. Globalization and mergers and acquisitions (M&A) d. Diversity and globalization (c; Moderate; p. 204; LO1) 2. Which of these created renewed determination to further reduce barriers to trade? a. Consumer demand b. Advancements in telecommunications c. Foreign direct investment and portfolio investment trends d. Uruguay Round of trade negotiations (d; Moderate; p. 205; LO1) 3. Companies seek cross-border mergers and acquisitions to ________.
a. get a foothold in new geographic markets b. increase a firm’s global competitiveness c. fill in gaps in companies’ product lines in a global industry d. all of the above
(d; Moderate; p. 205; LO1) 4. Which of the following statements is NOT true?
a. Entrepreneurs and small businesses do not play an important role in expanding
foreign direct investment flows.
b. Increasing globalization is causing a growing number of international companies
from emerging markets to undertake foreign direct investment.
c. The desire to increase a firm’s global competitiveness drives many cross-border
mergers and acquisitions.
d. Companies may pursue mergers and acquisitions to fill gaps in their product lines. (a; Moderate; p. 205-206; LO1) 5. When companies realized they could produce in the most efficient and productive locations in
the world and simply export to markets worldwide, a new surge of foreign direct investment flowed into ________. a. low-cost newly industrialized nations and emerging markets
b. highly developed economies c. the automobile and computer industries d. totalitarian and theocratic nations only (a; Moderate; p. 205; LO1) 6. Which of the following is NOT one of the four main theories that attempts to explain why
companies engage in foreign direct investment?
a. International product life cycle theory b. Market imperfections theory c. Eclectic theory d. Mercantilism (d; Moderate; p. 207; LO2) 7. Which of these refers to the theory that a company will begin by exporting its products and
later undertake foreign direct investment as a product moves through its life cycle?
a. Eclectic life cycle b. Market imperfections life cycle c. International product life cycle
Ch 7: Foreign Direct Investment
d. Market power life cycle (c; Easy; p. 208; LO2) 8. According to the international product life cycle, in which of the following stages is a good
produced in the home country because of uncertain domestic demand and to keep production close to the research department?
a. Standardized product stage b. Maturing product stage c. Declining product stage d. New product stage (d; Moderate; p. 208; LO2) 9. According to the international product life cycle, in which stage of a product’s life does a
company directly invest in production facilities in countries where demand is great enough to warrant production facilities?
a. New product stage b. Maturing product stage c. Standardized product stage d. Declining product stage (b; Moderate; p. 208; LO2) 10. The ________ theory states that a firm tries to establish a dominant market presence in an
industry by undertaking foreign direct investment.
a. market power b. eclectic c. market imperfections d. trade barriers (a; Easy; p. 209; LO2) 11. Which of the following is the extension of company activities into stages of production that
provide a firm’s inputs or absorb its outputs?
a. Horizontal integration b. Vertical integration c. Market penetration d. Collaborative diversification (b; Moderate; p. 209; LO2) 12. A company that integrates backward or forward can achieve market power through ________. a. ownership advantages b. horizontal integration c. vertical integration d. internalization (c; Moderate; p. 209; LO2) 13. Complete ownership of a business in another country ________. a. guarantees profits b. does not count as foreign direct investment c. does not guarantee control d. guarantees government support (c; Moderate; p. 209-210; LO3)
Ch 7: Foreign Direct Investment 14.
Investment by multinational companies benefits developing and newly industrialized countries in all the following ways EXCEPT ________.
a. transfer of technology b. decreased tax revenues c. decreased unemployment d. training to create a more highly skilled workforce (b; Moderate; p. 210; LO3) 15. Building a subsidiary abroad from the ground up is called a(n) ________. a. portfolio investment b. vertical integration investment c. acquisition d. greenfield investment (d; Easy; p. 211; LO3) 16. A greenfield investment is ________.
a. an investment in Southeast Asia’s former agricultural region b. the building of a subsidiary abroad from the ground up c. an investment in the United States by a non-U.S. company d. the purchase of an existing business that is still in its infancy
(b; Moderate; p. 211; LO3) 17. Which of the following factors reduces the appeal of purchasing existing facilities? a. Obsolete equipment b. Unsuitable location c. Poor relations with workers d. All of the above (d; Easy; p. 211; LO3) 18. All of the following are benefits of acquisitions EXCEPT the ________.
a. acquisition of goodwill the company has built up over the years b. acquisition of the brand recognition of the existing company c. ability to use alternate methods to finance the purchase of the company d. acquisition of an obsolete plant
(d; Moderate; p. 211; LO3) 19. Factors that affect the cost of production in any national market include all of the following
EXCEPT ________.
a. labor regulations b. employee benefits packages c. worker training programs d. tax rates that were assumed to be constant in the local market (d; Moderate; p. 211; LO3) 20. The ________ account records transactions involving the import and export of goods and
services, income receipts on assets abroad, and income payments on foreign assets inside the country.
a. income receipts account b. capital account c. income payments account d. current account
Ch 7: Foreign Direct Investment
(d; Moderate; p. 216; LO4) 21. When a U.S. company buys 40 percent of the publicly traded stock of a French company on
France’s stock market, the U.S. balance of payments records the transaction as an ________. a. inflow of capital recorded with a plus sign b. inflow of capital recorded with a minus sign c. outflow of capital recorded with a plus sign d. outflow of capital recorded with a minus sign
(d; Difficult; p. 216; LO4) 22. Exports and imports of tourism and business consulting are included in which of these? a. Services within the current account b. Capital account c. Merchandise account within the current account d. Corporate account (a; Moderate; p. 216; LO4) 23. Exports and imports of tangible goods are included in the ________ account within the
current account.
a. exports b. capital c. merchandise d. corporate (c; Moderate; p. 216; LO4) 24. Exports and imports of computer software, electronic components, and apparel would be
reflected in the ________ account within the current account. a. services
b. capital c. merchandise d. corporate (c; Moderate; p. 216; LO4) 25. Which of these occurs when a country exports more goods and services and receives more
income from abroad than it imports?
a. Current account deficit b. Capital account surplus c. Current account surplus d. Capital account deficit (c; Easy; p. 216; LO4) 26. Which of the following is a national account that records transactions involving the purchase
or sale of assets?
a. Current account b. Merchandise account
c. Service account
d. Capital account (d; Moderate; p. 216; LO4)
Ch 7: Foreign Direct Investment 27.
If a Japanese citizen invests in the Australian stock market, the transaction would show up on the capital account of ________.
a. Japan b. Australia c. neither Japan nor Australia because it is a current account item d. both Japan and Australia (d; Difficult; p. 216; LO4) 28. When a U.S. subsidiary in another country remits profits back to its parent in the U.S., the
receipt of profits is recorded in the ________. a. income receipts account and given a plus sign b. income receipts account and given a minus sign c. income payments account and given a plus sign d. income payments account and given a minus sign
(a; Difficult; p. 216; LO4) 29. Which of the following is a reason for host country intervention in foreign direct investment
(FDI) flows?
a. FDI sends resources out of the home country b. Outflows of FDI always cause a loss of jobs c. To improve the nation’s balance of payments d. To prevent loss of technology to other countries (c; Moderate; p. 216-217; LO4) 30. Home governments may use which of the following to limit the effects of outbound foreign
direct investment?
a. Insurance b. Differential tax rates c. Low-interest loans d. Infrastructure improvements (b; Moderate; p. 220; LO5) 31. Which of these do home-country governments NOT use to promote outbound foreign direct
investment? a. Offering tax breaks on profits earned abroad. b. Granting loans to firms wishing to increase their investments abroad. c. Establishing ownership restrictions on investments abroad. d. Offering insurance to cover the risks of investments abroad.
(c; Moderate; p. 219-220; LO5)
SHORT-ANSWER QUESTIONS 1. The purchase of physical assets or a significant amount of ownership (stock) of a company in
another country to gain a measure of management control is called ________.
(foreign direct investment (FDI); Easy; p. 204; LO1) 2. The two main drivers of rising foreign direct investment flows for the foreseeable future are ________ and ________.
(globalization, mergers and acquisitions; Moderate; p. 204; LO1)
3.
Ch 7: Foreign Direct Investment
The number of ________ and their exploding value contribute to the growth in foreign direct investment flows.
(mergers and acquisitions; Moderate; p. 205; LO1) 4. The destination of most foreign direct investment inflows is ________ countries. (developed; Moderate; p. 206; LO1) 5. The ________ theory states that a company will begin by exporting its product and later
undertake foreign direct investment as a product moves through its life cycle.
(international product life cycle; Easy; p. 208; LO2) 6. In the ________ stage of the international product life cycle, a good is produced in the home
country because of uncertain domestic demand and to keep production close to the research department that developed the product.
(new product; Moderate; p. 208; LO2) 7. In the ________ stage of the international product life cycle, a company directly invests in
production facilities in countries where demand is great enough to warrant its own production facilities.
(maturing product; Moderate; p. 208; LO2) 8. In the ________ stage of the international product life cycle, increased competition creates
pressures to reduce production costs.
(standardized product; Moderate; p. 208; LO2) 9. ________ theory states that when an imperfection in the market makes a transaction less
efficient than it could be, a company will undertake foreign direct investment to internalize the transaction and thereby remove the imperfection.
(Market imperfections; Easy; p. 208; LO2) 10. A market that operates at peak efficiency and where goods are readily and easily available is
said to be a(n) ________.
(perfect market; Moderate; p. 209; LO2) 11. The ________ theory states that firms undertake foreign direct investment when the features
of a particular location combine with ownership and internalization advantages to make a location appealing for investment.
(eclectic; Moderate; p. 209; LO2) 12. The advantage of locating a particular economic activity in a specific location because of the
characteristics of that location is called a(n) ________.
(location advantage; Moderate; p. 209; LO2) 13. A(n) ________ is the advantage that arises from internalizing a business activity rather than
leaving it to a relatively inefficient market.
(internalization advantage; Easy; p. 209; LO2) 14. A(n) ________ is the advantage that a company has due to its ownership of some special
asset.
(ownership; Easy; p. 209; LO2)
Ch 7: Foreign Direct Investment 15.
The extension of company activities into stages of production that provide a firm’s inputs or absorb its output is called ________.
(vertical integration; Moderate; p. 209; LO2) 16. The ________ theory states that a firm tries to establish a dominant market presence in an
industry by undertaking foreign direct investment.
(market power; Moderate; p. 209; LO2) 17. The benefit of ________ is greater profit because the firm is far better able to dictate the cost
of its inputs and/or the price of its output.
(market power; Moderate; p. 209; LO2) 18. Building a subsidiary abroad from the ground up is called a(n) ________. (greenfield investment; Easy; p. 211; LO3) 19. A system of production in which each of a product’s components is produced in the location
where the cost of producing the component is lowest is called ________.
(rationalized production; Moderate; p. 212; LO3) 20. A country’s ________ is a national accounting system that records all payments to entities in
other countries and all receipts coming into the nation.
(balance of payments; Easy; p. 215; LO4) 21. The ________ is a national account that records transactions involving the import and export
of goods and services, income receipts on assets abroad, and income payments on foreign assets inside the country.
(current account; Moderate; p. 216; LO4) 22. The ________ account within the current account includes exports and imports of tangible
goods.
(merchandise; Easy; p. 216; LO4) 23. The ________ account within the current account includes exports and imports of services. (services; Easy; p. 216; LO4) 24. The ________ account within the current account includes income earned on U.S. assets held
abroad.
(income receipts; Difficult; p. 216; LO4)
ESSAY QUESTIONS 1. What factors have propelled growth in foreign direct investment in recent years? (Moderate; p. 204-206; LO1) 2. Which groups of nations are the main sources and destinations of foreign direct investment? (Moderate; p. 206-207; LO1) 3. Using any two of the four theories that appear in your text, explain why companies engage in foreign direct investment. (Difficult; p. 207-209; LO1)
Ch 7: Foreign Direct Investment
4. Explain the theory of market imperfections and describe the two market imperfections. (Difficult; p. 208; LO2)
165. Distinguish between the different advantages identified by the eclectic theory. (Moderate; p. 209; LO2) 6. Discuss the market power theory and explain how a company can achieve market power. (Moderate; p. 209; LO2) 7. Describe any three management issues involved in foreign direct investment decisions. (Easy; p. 209-214; LO3) 8. Discuss some surprises that may face managers as they invest in new markets. How can
managers minimize the disadvantages of doing business abroad?
(Moderate; p. 212; LO3) 9. Describe how the maquiladora concept works. What are the advantages and disadvantages of
Mexico’s maquiladora?
(Easy; p. 213; LO3) 10. What is meant by the term “following clients?” In which industries would the strategy be
common?
(Easy; p. 213-214; LO3) 11. Discuss the balance of payments using its two major components. (Difficult; p. 215-216; LO4) 12. Identify why a home country might support or discourage outgoing foreign direct investment. (Difficult; p. 217-218; LO4) 13. Why might a host country promote or restrict foreign direct investment? (Difficult; p. 216-217; LO4) 14. Explain the methods of restricting and promoting foreign direct investment that home and
host countries can use.
(Difficult; p. 218-220; LO5)
Ch 7: Foreign Direct Investment
4. Explain the theory of market imperfections and describe the two market imperfections. (Difficult; p. 208; LO2)
165. Distinguish between the different advantages identified by the eclectic theory. (Moderate; p. 209; LO2) 6. Discuss the market power theory and explain how a company can achieve market power. (Moderate; p. 209; LO2) 7. Describe any three management issues involved in foreign direct investment decisions. (Easy; p. 209-214; LO3) 8. Discuss some surprises that may face managers as they invest in new markets. How can
managers minimize the disadvantages of doing business abroad?
(Moderate; p. 212; LO3) 9. Describe how the maquiladora concept works. What are the advantages and disadvantages of
Mexico’s maquiladora?
(Easy; p. 213; LO3) 10. What is meant by the term “following clients?” In which industries would the strategy be
common?
(Easy; p. 213-214; LO3) 11. Discuss the balance of payments using its two major components. (Difficult; p. 215-216; LO4) 12. Identify why a home country might support or discourage outgoing foreign direct investment. (Difficult; p. 217-218; LO4) 13. Why might a host country promote or restrict foreign direct investment? (Difficult; p. 216-217; LO4) 14. Explain the methods of restricting and promoting foreign direct investment that home and
host countries can use.
(Difficult; p. 218-220; LO5)