International Finance

Frederick University

2012

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

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

The foreign exchange market

The demand for foreign currency = the supply of domestic currency

Pof $In €

Q of $

The demand for $

P of €In $

Q of €

Ε > 1

A

B

A

BE = 1

C

E < 1

C

The supply of €

HOUSEHOLDSFIRMS

Expenditures on final goods and services

Primary Income

importsМ

taxesТ

savingsS

exportsХ

Government purchasesG

InvestmentІ

LeakagesInjections

Production factors

Final goods and services

The Circular Flow

AE

Macroeconomic Equilibrium

I + G + X =S + T + M

(X - M) = (T - G) + (S - I)

(I – S) =(T – G) + (M - X)

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

The three basic subaccounts of the BOP

the current account, the capital account, and the official settlements account.

The current account balance

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

Merchandise trade balance Goods and services balance Goods, services and income

balance Current account balance

The capital account balance (financial account balance)

Private investment Other nonofficial investment flows

Balance of payments

Current account Capital account The official settlements

account (changes in holdings of official international reserves)