International Finance - Introduction

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International F

July 2015

Dr. Dhirendra GauPh.D., CA, CMA & CW


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! Introduction

! Course Content

! What is Finance

! International Finance

! Domestic Finance

! Domestic Vs. International Finance

! Why International Finance

Agenda


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Introduction


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Introduction

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Course Content:

! Foreign Exchange

! International Financial Institutions

! Balance of Payments (Structure and Equilibrium)

! Foreign Exchange Markets

! Mechanics of Foreign Exchange Markets! Economic Unions and Trade Agreements

! Indias Foreign Trade Promotion and Control.

International Financial


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SL.No Particulars

1

FOREIGN EXCHANGE RATES

Theories of exchange rates. Purchasing power parity theory. Demand supply and elasticities in foreign exchange rate determination. Balance of Paymen

exchange rate. Gold Standard, Inter-war instability, Bretton Woods, Fixed exchange rates, fluctuating exchange rates.

2Case fo r Fixed or fluctuating exchange rates. The changing nature of world money. The rise of private world money. Eurocurrencies, Eurodollars, Euro

mechanics and impact. International capital - flows and shocks. International debt problem - its origin, history and status. International liquidity and SD

3

Int ernational Financial Institutions - International Monetary Fund, World Bank, International Finance Corporation, Washington D. C., Asian Developm

tradi ng. Foreign exchange dealers. Clearing, hedging, speculation in foreign exchange markets. Forward exchange rate, forward against spot exchange r

fluctuations.

4

BALANCE OF PAYMENTS (Structure and Equilibrium)

Balance o f Payments definition. Component of Balance of Payments. Current Account, Capital Account, Balance of Payments Models, Basic balance. D

Payments. Measures to correct disequilibrium in Balance of Payments.

5

FOREIGN EXCHANGE MARKETS

Operat ions of foreign exchange markets. Modes and mechanism of spot and forward exchange contracts. Exchange trading and position. Syndication. S

Int ernational Money, Capital and Foreign Exchange Markets with reference to New York, London, Tokyo, Hong Kong and Singapore.

6

MECHANICS OF FOREIGN EXCHANGE MARKETS

Con tracts, Credits and Documentation. Sale and Purchase Contracts. Risks in international transactions. Incoterms, their importance and their applicabil

Documentary credits. Types of credits. Important credit clauses. Procedure for establishing credits.

Documents in foreign trade. Financial, Commercial, transport, insurance and other documents. Arbitration and conciliation.

7

ECONOMIC UNIONS AND TRADE AGREEMENTS

Theory of Custom Union. Political economy of trade barriers. Protection in world trade - a historical perspective. InternationalTrade Organization (ITO

Trade (GATT). Kennedy Round. UNCTAD. Generalised System of Preferences (GSP). Tokyo Round. New International Economic Order. Brandt Com

Uruguay Round. North South divide and dialogue. European Economic Community (EEC) and integration 1992. Impact of currency blocks on world tra

8

INDIA'S FOREIGN TRADE PROMOTION AND CONTROL :

Ind ia' s economy in global perspective. India's external debt. Export promotion strategy and policy. Export promotion measures. Commercial Policy. No

Accounts.

The Exp ort-Import Bank of India- its functions, resources, organization, management and current operations.

Export Credit Guarantee Corporation (ECGC) - its function, policy, management and current operations.

Financing of foreign trade. Types of credits, guarantees, bid bonds etc. Mechanism of Operations.

Foreig n exchange controls - Objectives, exchange management and controls in India. FERA/ FEMA and its important provisions. Import Export Policy

9 Case Stu dies and Presentations


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What is

Finance?


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InternationalFinance

I t ti l Fi


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! International Finance is an area of financial economics tha

monetary interactions between two or more countries.

! More Specifically:

! Foreign (Currency) exchange rates,

! International monetary systems,

!

Foreign direct investment,! International financial management including

! Political risk and foreign exchange risk inherent in managingcorporations.

International Finance


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DomesticFinance


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Financial Management


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Financial Management

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Why ?InternationalFinance

Why International Finance


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Domestic Vs.InternationalFinance

Domestic Vs International


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ForeignExchange

Foreign Exchange


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Foreign Exchange! The total turnover in Forex Market apprx. US dollar 1

day. Indian Market USD 1.20 BN per day.

! Round the clock market starting from Sydney and Tokthrough Hong Kong, Singapore, Bahrain, London and

! participants are central banks , commercial banks

funds, corporate, individualsand brokers.

! Over the counter market

Foreign Exchange


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Theories of exchange rates.

! Purchasing power parity theory (PPP)

!Demand supply and elasticity in foreign exchange rate determination.

! Balance of Payments theory.

! Historical perspective on exchange rate.

! Gold Standard,

! Inter-war instability,

! Bretton Woods,! Fixed exchange rates,

! Fluctuating exchange rates.

Foreign Exchange


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Exchange Rate is a rate at which one ccan be exchanged into another currency.words it is value one currency in terms of

say:

US $ 1 = Rs. 65.10

This rate is the conversion rate of every URs. 65.10


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F l l i i Th


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For example, lets assume a currency appreciation The euroUS dollar.

Firstly, the exports of the European Union (E.U) nationsexpensive for the United States of America (USA), which

things means that E.U product will lose in terms of competitiveSecondly, such a currency appreciation will be to the benimports, should those be payable in US dollars. Conversely, aof the euro against the US dollar will cause an opposite impact

On the other hand, the rapid growth of international trade (bot

penetration and the export ratio) during the last decades, whichdue to the increase of the open economies, enhances the signifforeign exchange rates.

Depreciation and Appreciation


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Depreciation and Appreciation

! Depreciation is a decrease in the value of a currency relative to

currency.

" A depreciated currency is less valuable (less expensive) and

can be exchanged for (can buy) a smaller amount of foreign

" $1/!1 "$1.20/!1 means that the dollar has depreciated rel

euro. It now takes $1.20 to buy one euro, so that the dollar

valuable.

" The euro has appreciated relative to the dollar: it is now mo

Depreciation and Appreciation Con


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! A depreciated currency is less valuable, and therefore it cfewer foreign produced goods that are denominated in for

currency." How much does a Honda cost? 3,000,000

" 3,000,000 x $0.0098/1 = $29,400

" 3,000,000 x $0.0100/1 = $30,000

! A depreciated currency means that imports are more expedomestically produced goods and exports are less expens

! A depreciated currency lowers the price of exports relativprice of imports.




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! Appreciation is an increase in the value of a currelative to another currency.

" An appreciated currency is more valuable (more expetherefore can be exchanged for (can buy) a larger amoforeign currency.

" $1/!1 "$0.90/!1 means that the dollar has appreciateto the euro. It now takes only $0.90 to buy one euro, s

dollar is more valuable.

" The euro has depreciated relative to the dollar: it is novaluable.




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FOREIGN EXCHANGE REGIMES! Governments have always paid very serious attention to the exchange rat

currency, utilizing any available means at hand, in order to stabilize

range of rate.

! Historically, there were periods that governments through theintervened in the foreign exchange market in order to affect the flu

exchange rate that otherwise would be determined by market forces.

! There were also periods with no intervention when the exchange rate,j

was determined by supply and demand.

! On 22nd July, 1944, at Bretton Woods in the United States of Americ

agreed that a broad international action was necessary to maintain amonetary system, which would promote foreign trade.

FOREIGN EXCHANGE REGIMES


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FOREIGN EXCHANGE REGIMES! In this respect, it established a worldwide system offixed exchange rates bet

Actually, the tool was gold, with the following quota: one ounce of gold was

dollars 35. After the establishment of the fixed rate of exchange, all other curren

to the US dollar at a fixed exchange rate.

! The End Of the "Fixed" Dollar, by the beginning of the 1960s, the US dolla

ratio was becoming more and more difficult to sustain. Gold demand was rising a

reserves were declining.

! On 15th August, 1971, President Nixon, repudiated the international obligatio

redeem its dollar in gold. By the end of 1974, gold had soared from $35 to $195 an

! Since the collapse of the Bretton Woods agreement (February 1973), the world's cu

"floated" with respect to the US dollar.

! Thus, the foreign exchange rate regime changed from a fixed exchange rate to a

floating exchange rate. A system in which, exchange rates are determined by sup

that is called clean float or where governments through central banks intervene (

currencies) in the markets, which is called dirty float.

VOLATILITYAND RISK (Associated ith Floating E change Rate)


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VOLATILITY AND RISK (Associated with Floating Exchange Rate)! Undoubtedly, dramatic movements in the value of currencies can occur where the

and demand freely determine the price.

! Consequently, such a system increases the exchange rate risk associated with bu

international transactions.! The cross-border financial activity differs from the domestic activity in respect to

to the fact that when investing in a foreign country you have to consider many oth

as:

" Tax system - differences related to the specific countrys system.

" Political risk - a democratic country is preferable to a non-democratic one.

" Government intervention - it is also preferable to deal with a country withou

intervention.

" Business risk - unforeseen changes in the general economic environment.

! In addition, the likely volatility in the exchange rate can drastically affect the cost,

return on investments of international firms, thus, resulting in the following levels

VOLATILITYAND RISK (Associated with Floating Exchange Rate)


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! Additionally the volatility in the exchange rate can drastically affect the cost, pro

investments of international firms, thus, resulting in the following levels of risk:

! Transaction exposure is related to those activities that trade internationally.For example, a EU company imports bicycle components from the United State

credit. Possible US dollar depreciation will be for the benefit of the EU organizati

pay fewer Euros. On the contrary, if the US dollar appreciates, the company will

to the fact that it will pay more Euros. The transaction exposure (the risk of ad

in the exchange rate) can be eliminated using hedging instruments. An example

forward rate contracts.

! Operational exposure. Although a company may not trade globally, due to co

may suffer the exchange rate risk.

For example, a US bicycle producer will have a competitive advantage compared

of a similar type of bicycle if the euro depreciates against the US dollar. The

bicycle if converted into Euros will fall, and consequently will attract EU member



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! Translation exposure

Assuming a company that has a subsidiary outside the EU and expects profits in on

Based on the current exchange rate between foreign and domestic currency, the co

converted the amount of profits in its local currency. If the euro appreciates againscurrency, then the amount of profits when converted into Euros will be less.

DETERMINANTS OF EXCHANGE RATE


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DETERMINANTS OF EXCHANGE RATE

Many theories there have been written in respect to the main determexchange rates. Although the majority of these theories give adequate r

to explain what actually determines the rates between the currencies, wethere are many factors that may cause a currency fluctuation.

Consequently, there is little that can be alleged in respect to the the

answers the question of what finally determines the exchange rates.

Here below, we will refer to the main theories regarding the deterexchange rates.

Supply and Demand


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Supply and Demand

! As stated earlier, the exchange rate, just like commodities, determines its price res

forces of supply and demand.

! Therefore, if for some reason people increase their demand (shift of the curve from

specific currency, then the price will rise from A to B, provided the supply remainscontrary, if the supply is increased (shift of the curve from S to S1), the price will d

C, provided the demand remains stable.

! Any excess supply (above the equilibrium point) or excess demand (below the equ

will increase or decrease temporarily foreign currency reserves accordingly.

! Finally, such disequilibrium situations will be eliminated through the pricing, e.g.

! Therefore, if for some reason people increase their demand (shift of the curve from

specific currency, then the price will rise from A to B, provided the supply remains

! On the contrary, if the supply is increased (shift of the curve from S to S1), the pric

from A to C, provided the demand remains stable

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