International Finance

1. International Finance Frederick University 2012

2. The foreign exchange market • The foreign exchange market – worldwide institutions that exist for the purpose of exchanging the currencies of different countries • Spot markets – the markets in which currencies are traded for immediate delivery • Forward markets – the markets in which foreign exchange deliveries are to be made at some specified future date

3. The foreign exchange market • Arbitrage – the process by which individuals seek to make a profit by taking advantage of discrepancies among prices prevailing simultaneously in different markets • Speculation – a way to make a profit by taking a deliberately risky position • Hedging – a way to avoid foreign exchange risk

4. The foreign exchange market The demand for foreign currency = the supply of domestic currency A P of € In $ Pof $ In € Ε > 1 C B B E = 1 E < 1 C A Q of $ Q of € The supply of € The demand for $

5. Leakages imports М Injections exports Х Government purchases G taxes Т Expenditures on final goods and services AE Investment І Final goods and services savings S Macroeconomic Equilibrium I + G + X = S + T + M (X - M) = (T - G) + (S - I) (I – S) = (T – G) + (M - X) HOUSEHOLDS FIRMS Production factors Primary Income The Circular Flow

6. Balance of payments • BOP – a set of accounts recording all the transactions of the residents of a nation with the residents of all other nations during a particular period of time • Credit transactions – reflect the inflow of foreign currency • Debit transactions – reflect the outflow of currency

7. The three basic subaccounts of the BOP • the current account, • the capital account, and • the official settlements account.

8. Credit Exports of goods Inflows from international travel and transportation Exports of other services Profits from foreign investment Workers remittances and pensions from abroad Inflows of military purposes Inflows for diplomatic purposes Gifts inflows Debit Imports of goods Outflows for international travel and transportation Imports of other services Repatriated profits of foreign investors Outflows of workers remittances and pensions Outflows for military purposes Outflows for diplomatic purposes Gifts outflows The current account balance

9. The current account balance • Merchandise trade balance • Goods and services balance • Goods, services and income balance • Current account balance

10. The capital account balance (financial account balance) • Private investment • Other nonofficial investment flows

11. Balance of payments • Current account • Capital account • The official settlements account (changes in holdings of official international reserves)