Prof - Shikha Atri: International Finance Economics & Foreign Exchange

International Finance Economics
&
Foreign Exchange
Prof.Shikha Atri
Introduction
To
International Finance
Course Objective
• Learning Objective of Session :1

– To provide a framework for making corporate
financial decisions in an international context.
Course Overview
Foreign Sourcing
Exchange Capital in
Markets Global Markets
International
Financial Synthesis
Management
Managing Foreign
FOREX Investment
Exposure Decisions
4
What is money?
• Barter economy
– Search frictions
– Indivisibilities
– Transferability
• Commodity money
– Beaver pelts
– Dried corn
– Metals
• Fiat money
– Faith in government…
5
6
7
Why International Finance is Essential
Why International Finance is Essential
 In previous finance courses you have been taught
about general finance concepts that apply to domestic
or local settings, BUT we live in an international world.
 Companies (and individuals) can raise funds, invest

money, buy inputs, produce goods and sell products
and services overseas.
 With these increased opportunities comes additional
risks. We need to know how to identify these risks and
then how to control or remove them.
International Finance Economics
• .
• International finance is the branch of economics that studies the dynamics of
exchange rates, foreign investment, and how these affect international trade.
It also studies international projects, international investments and capital
flows, and trade deficits. It includes the study of futures, options and currency
swaps. International finance is a branch of international economics.
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12
What is different?
What is different?
Foreign Exchange Risk
Multinational Enterprises
 A multinational enterprise (MNE) is defined as one
that has operating subsidiaries, branches or affiliates
located in foreign countries.
 While international finance focuses on MNEs, purely
domestic firms can also face significant international
exposures:
 Import & export of products, components and services
 Licensing of foreign firms to conduct their foreign
business
 Exposure to foreign competition in the domestic market
 Indirect exposure to international risks through
relationships with customers and suppliers
Types of Multinational
PlayersEnterprises
 Raw Material Seekers
 First type of MNEs
 Exploit raw materials found overseas
 Trading, mining and oil companies
 Market Seekers
 Post-WWII MNEs
 Expand production and sales into foreign markets
 Big name companies – IBM, McDonalds etc.
 Cost Minimisers
 More recent MNEs
 Seek out lowest production cost countries
 Manufacturing and service companies
Bullet points to be understand
• Exchange Rates
• Foreign investment
• International trade
• International economics
Exchange Rates
• Exchange Rates
• In finance, the exchange rates (also known as the foreign-exchange rate, forex rate or FX rate)
between two currencies specifies how much one currency is worth in terms of the other. It is the
value of a foreign nation’s currency in terms of the home nation’s currency.[1] For example an
exchange rate of 91 Japanese yen (JPY, ¥) to the United States dollar (USD, $) means that JPY 91 is
worth the same as USD 1.
Foreign direct investment (FDI)
• Foreign direct investment (FDI) refers to long term participation by country A into country B.
It usually involves participation in management, joint-venture, transfer of technology and
expertise. There are three types of FDI: inward foreign direct investment and outward foreign
direct investment, resulting in a net FDI inflow (positive or negative) and "stock of foreign
direct investment", which is the cumulative number for a given period. Direct investment
excludes investment through purchase of shares.
International economics
• International economics is concerned with the effects upon economic activity of
international differences in productive resources and consumer preferences and the
institutions that affect them. It seeks to explain the patterns and consequences of
transactions and interactions between the inhabitants of different countries, including trade,
investment and migration
International trade
• International trade is exchange of capital, goods, and services across

international borders or territories
• The Panama Canal is important for international sea trade between the Atlantic Ocean and the Pacific Ocean..[1].
International Monetary System
 The International Monetary System is a set of rules that

governs international payments (exchange of money).
 Historical overview of exchange rate regimes:
 Classical Gold Standard: Pre - 1914
 Bretton Woods System: 1944 - 1973
 Floating Exchange Rates: 1973 -
 European Monetary Union
 How is this relevant today? We know what does and doesn’t

work!
The Gold Standard (Pre - 1914)
 Gold has been a medium of exchange since 3,000 BC.

 “Rules of the game” were simple, each country set
the rate at which its currency unit could be converted
to a weight of gold.
 Currency exchange rates were in effect “fixed”.
 Expansionary monetary policy was limited to a
government’s supply of gold.
 Was in effect until the outbreak of WWI as the free
movement of gold was interrupted.
Inter-war years
(1915- 1944)
The Inter-War Years & WWII
During this period, currencies were allowed to

fluctuate over a fairly wide range in terms of gold
and each other.
Increasing fluctuations in currency values became
realized as speculators sold short weak currencies.
The US adopted a modified gold standard in 1934.
During WWII and its chaotic aftermath the US dollar
was the only major trading currency that continued
to be convertible.
Bretton Woods (1944)
As WWII drew to a close, the Allied Powers met

at Bretton Woods, New Hampshire to create a
post-war international monetary system.
The Bretton Woods Agreement established a
US dollar based international monetary system
and created two new institutions the
International Monetary Fund (IMF) and the
World Bank.
Theories of International Trade
• New Trade Theory
• Gravity model
• Ricardian theory of international trade
(modern development)
• Contemporary theories
• Neo-Ricardian trade theory
• Traded intermediate goods
• Ricardo-Sraffa trade theory
New Trade Theory
• These include the fact that most trade is

between countries with similar factor
endowment and productivity levels, and the
large amount of multinational
production(i.e.foreign direct investment)
which exists.

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International Finance Economics

• Learning Objective of Session :1

 Companies (and individuals) can raise funds, invest

• International trade is exchange of capital, goods, and services across

 The International Monetary System is a set of rules that

 How is this relevant today? We know what does and doesn’t

 Gold has been a medium of exchange since 3,000 BC.

During this period, currencies were allowed to

As WWII drew to a close, the Allied Powers met

• These include the fact that most trade is

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