An exchange rate is the price of one currency in terms of another currency. As in the case of any other goods, the price of a currency is affected by supply and demand. As demand for a currency increases (or supply decreases) its price will rise. This is referred as an appreciation. Conversely, as demand for a currency decreases, or supply increases, its value will depreciate. The prospect of large and rapid swings in exchange rates introduces uncertainty into the business environment. A well-functioning international monetary system ensures stability in the exchange rates. The central element of the international monetary system involves the arrangements by which exchange rates are set. The purpose of an exchange-rate system is to facilitate and promote international trade and finance. There have been three major exchange rate regimes from a historical perspective — Fixed Exchange Rates, Floating or Flexible Exchange Rates, and Managed Exchange Continue reading
International Finance
International finance is the branch of economics that studies the dynamics of foreign exchange,foreign direct investment and how these affect international trade. Also studies the international projects, international investment and the international capital flow .International Finance can be broadly defined, as the study of the financial decisions taken by a multinational corporation in the area of international business i.e. global corporate finance. International finance draws much of its background from the preliminary studies in the topics of corporate finance such as capital budgeting, portfolio theory and cost of capital but now viewed in the international dimension.
International Payments Using Drafts
Commonly used in international trade, a draft is an unconditional order in writing – usually signed by the exporter (seller) and addressed to the importer (buyer) or the importer’s agent – ordering the importer to pay on demand, or at a fixed or determinable future date, the amount specified on its face. Such an instrument, also known as a bill of exchange, serves three important functions: To provide written evidence, in clear and simple terms, of financial obligation. To enable both parties to potentially reduce their costs of financing. To provide a negotiable and unconditional instrument (that is, payment must be made to any holder in due course despite any disputes over the underlying commercial transaction.) Using a draft also enables an exporter to employ its bank as a collection agent. The bank forwards the draft or bill of exchange to the foreign buyer (either directly or through a branch Continue reading
Basis Rate Swaps
A fast developing area in the international swap markets is the basis rate swap. The structure of the basis rate swaps is the same as the straight interest rate swaps, with the exception that floating interest calculated on one basis is exchanged for floating interest calculated on a different basis. The forerunner of this type of swap was the US Dollar Prime Rate LIBOR swap. However, an even larger market has developed for the exchange of 1 month US Dollar LIBOR for 6 month US Dollar LIBOR and more recently US Dollar LIBOR for US Dollar commercial paper at much finer rates than those available on the foreign exchange market. The availability of the basis rate swaps market provides an excellent method for entities to arbitrage spreads between different floating rate funding sources. More importantly, it provides a discreet and most efficient method for European entities in particular to stimulate Continue reading
National Competitive Advantage Theory of International Trade – Porters Diamond Model
It is a fact that Porter (1990) never focused primarily on the factors determining the pattern of trade, yet his theory of national competitive advantage does explain why a particular country is more competitive in a particular industry. If, for example, Italy maintains competitive advantage in the production of ceramic tiles and Switzerland possesses the competitive advantage in watches, it can be interpreted that the former will export ceramic tiles and the latter will export watches and both of them will import goods in which their own industry is not competitive. Why is this there a difference? Porter explains that there are four factors responsible for such diversity. He calls those factors the “diamond of national advantage”. The Porters diamond model includes: Factor conditions Demand conditions Related and supporting industries Firm strategy, structure and rivalry These factors have been more or less taken into account by earlier economists. What is Continue reading
Important International Finance Terms
1) Gold Bullion Standard: The basis of money remains a fixed weight of gold but the currency in circulation consist of paper notes with the authorities standing ready to convert unlimited amounts of paper currency in to gold and vice-versa, on demand at a fixed conversion ratio. Thus a pound sterling note can be exchanged for say ‘x’ ounces of gold while a dollar note can be converted into say ‘y’ ounces of gold on demand. 2) Gold Exchange Standard: Gold Exchange Standard was established in order to create additional liquidity in the international markets. Hence the some of the countries committed themselves to convert their currencies into the currency of some other country on the gold standard rather than into gold. The authorities were ready to convert at a fixed rate, the paper currency issued by them into the paper currency of another country, which is operating a gold Continue reading
Impact of Foreign Exchange Rate on Balance of Payments (BOP)
The International Monetary Fund (IMF) defines the Balance of Payments (BOP) as a statistical statement that systematically summarizes, for a specific time period, the economic transactions of an economy with the rest of the world. BOP data measures economic transactions include exports and imports of goods and services, income flows, capital flows, and gifts and similar one-sided transfer payments. The net of all these transactions is matched by a change in the country‘s international monetary reserves. The significance of a deficit or surplus in the BOP has changed since the advent of floating exchange rates. Traditionally, BOP measures were used as evidence of pressure on a country‘s foreign exchange rate. This pressure led to governmental transactions that were compensatory in nature, forced on the government by its need to settle the deficit or face a devaluation. Impact of Foreign Exchange Rate on Balance of Payments (BOP) The relationship between the Continue reading