INTERNATIONAL FINANCE

 Overview
International finance is the branch of financial economics broadly concerned with monetary and macroeconomic interrelations between two or more countries.[1][2] International finance examines the dynamics of the global financial system, international monetary systems, balance of payments, exchange rates, foreign direct investment, and how these topics relate to international trade.

 Globalisation
Globalization is the process of international integration arising from the interchange of world views, products, ideas, and other aspects of culture. Globalization describes the interplay across cultures of macro-social forces. These forces include religion, politics, and economics “The broadening set of interdependent relationships among people from different parts of a world that happens to be divided into nations.” Globalisation leads to improvements in transportation and communication, international business grew rapidly after the beginning of the 20th century. International business includes all commercial transactions (private sales,

investments, logistics, and transportation) that take place between two or more regions, countries and nations beyond their political boundary. Usually, private companies undertake such transactions for profit. Such business transactions involve economic resources such as capital, natural and human resources used for international production of physical goods and services such as finance, banking, insurance, construction and other productive activities. International business arrangements have led to the formation of multinational enterprises (MNE), companies that have a worldwide approach to markets and production or one with operations in more than one country.

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usually a year.”  Balance of Payment A Balance of payments (BOP) sheet is an accounting record of all monetary transactions between a country and the rest of the world These transactions include payments for the country's exports and imports of goods. practices. The BOP summarizes international transactions for a specific period. It is the record of all purchases and sales of goods and services with respect to the rest of the world. institutions. typically the domestic currency for the country The balance of Payment is divided into the 2 principal divisions: (A) Current account. cross border investment and generally the reallocation of capital between nation states. including deferred payment. 2 . to provide sufficient liquidity for fluctuating levels of trade and to provide means by which global imbalances can be corrected. International Monetary System International monetary systems are sets of internationally agreed rules. It represents the flows of financial assets either bought & sold. “International monetary system refers to the set of policies. They provide means of payment acceptable between buyers and sellers of different nationality. services and financial capital. that facilitate international trade. they need to inspire confidence. The systems can grow organically as the collective result of numerous individual agreements between international economic factors spread over several decades. and mechanisms that determine the rate at which one currency is exchanged for another. as well as financial transfers. and is prepared in a single currency. regulations. To operate successfully. (B) Capital account. conventions and supporting institutions.

the exchange rate must change to adjust to the change in the prices of goods in the two countries.  International Parity Relationship There are the following four international parity relationships: (A) Interest rate parity (IRP) It states that the exchange rate of two countries will be affected by their interest rate differential. facsimile. The Market for Foreign Exchanges The foreign exchange market is the market where the currency of one country is exchanged for the currency of another country. In other words. satellite. Most currency transactions are channeled through the world-wide Interbank market. and speculators. Interbank market is the wholesale market in which major banks trade with each other. and computer communications between the FOREX market participants which include banks. Further. and vice versa. purchasing power parity states that the exchange rate between the currencies of two countries equals the ratio between the prices of goods in these countries. 3 . This implies that the exchange rate (forward and spot) differential will be equal to the interest rate differential between the two countries. In relative terms. purchasing power states that the exchange rate between the currencies of the two countries will adjust to reflect changes in the inflation rates of the two countries. it means that the forward rate and the current rate differential must be equal to the expected spot rate and the current spot rate differential. (B) Purchasing power parity (PPP) In absolute terms. (C) Forward rates and future spot rates parity The expectation theory of forward exchange rates states that the forward rate provides the best and unbiased forecast of the expected future spot rate. foreign exchange dealers. telex. Foreign exchange (Forex) market is a world-wide market of an informal network of telephone. arbitrageurs. the currency of a high-interest-rate-country will be at a forward discount relative to the currency of a low-interest-rate-country. In formal terms.

The forward exchange rate is the rate that is currently paid for the delivery of a currency at some future date. the international Fisher effect states that the nominal interest rate differential must equal to the expected inflation rate differential in two countries  Foreign Exchange Rates A foreign exchange rate is the price of one currency quoted in terms of another currency. They cannot be canceled except by the mutual agreement of both parties involved.02538/INR. and are used to protect the buyer from fluctuations in currency prices. Bidask spread are the difference between the bid and ask rates of a currency. When the rate is quoted as units of domestic currency per unit of the foreign currency.  Forward Exchange Contracts Forward contracts are not traded on exchanges. “Forward contracts are agreements between two parties to exchan ge two designated currencies at a specific time in the future. and standard amounts of currency are not traded in these agreements. These contracts always take place on a date after the date that the spot contract settles. The parties involved in the contract are generally interested in hedging a foreign exchange position or taking a speculative position.(D) International Fisher effect (IFE). When the rate is quoted per unit of the domestic currency. “ 4 . but are quoted against one common currency. The spot exchange rate is the rate at which a currency can be bought or sold for immediate delivery which is within two business days after the day of the trade. A cross rate is an exchange rate between the currencies of two countries that are not quoted against each other. it is referred to as indirect quote. Thus. the US$ and INR exchange rate would be written as US$ 0. it is referred to as direct quote. In formal terms.

the dollar is said to be trading at a premium relative to the Indian rupee. the spot exchange market is much larger than the forward exchange market. The main constituents of the interbank market are   the spot market the forward market The interbank market is unregulated and decentralized. The currencies of most developed countries have floating exchange rates. However. in the U. It is mainly used for trading among bankers. Forward Exchange Rates The forward exchange rate is the rate that is currently paid for the delivery of a currency at some future date. The forward rate may be at a premium or at a discount. It is a wholesale market through which most currency transactions are channeled. values that fluctuate relative to other currencies. There is no specific location or exchange where these currency transactions take place. the Federal Reserve Bank publishes closing spot prices on a daily basis.  Inter Bank Deals The interbank market is the top-level foreign exchange market where banks exchange different currencies. In terms of the volume of currency transactions. foreign currency options are regulated in the United States and trade on the Philadelphia Stock Exchange. 5 .S. Forward rate premium or discount may be shown as an annualized percentage deviation from the spot rate. Further. For example. The interbank market is an important segment of the foreign exchange market. if forward dollars are more expensive than spot dollars. These currencies do not have fixed values but. or through electronic brokering platforms.[1] The banks can either deal with one another directly.. rather.

foreign bonds and global bonds. International Financial Markets & Cash Management International financial markets are international in scope of monetary fund trading activities. A Eurobond. including both the international monetary market. (B) International Bond Market International bonds include Eurobonds. the international capital market International Financial Market International Banking & Money Market International Equity Market LIBOR International Banking & Money Market International Bond Market (A) International Banking & Money Market A Short term market in which currencies can be borrowed and lent and converted into other currencies for short term period is called International Money Market. is a bond issue sold in a currency other than that of the country of issue (C) International Equity Market Foreign firms often issue new shares in foreign markets and list their stock on major stock exchanges. Tokyo. currency. Brady bonds are issued in order to help developing countries better manage their international debt. generalized international financial market includes. which is issued in U. or London.S. A foreign bond is one sold outside the country of the borrower but denominated in the currency of the country of issue. and many mutual funds in the United States hold these bonds. International bonds are also private corporate bonds issued by companies in foreign countries. also called a global bond. A different type of international bond is the Brady bond. International Finance market refers to the international financing and loan transactions. such as those in New York. The purpose of foreign issues and listings is to expand the investor base in the hope of gaining 6 . International financial assets transaction and its supply demand relations.

respectively. LIBOR rates were first used in financial markets in 1986 after test runs were conducted in the previous two years.  EURO: The official currency of the European Union's (EU) member states. A depository receipt represents number of foreign shares that are deposited in a bank in the foreign country. The depository bundles a specified number of shares as a depository receipt and issues them to investors in the USA. A number of foreign countries also list their GDRs on the Luxembourg Stock Exchange. (2) Global Depository Receipts (GDRs) GDRs allow an Indian firm (or any other foreign firm) to raise funds from the UK. An indirect method of raising equity capital from foreign markets is to issue depository receipts. Euro equities are shares listed on stock exchanges in countries other than the home country of the issuing company. ADRs can be listed and traded on the USA stock exchanges. the euro was introduced by the EU in to the financial community in 1999 and physical euro coins and paper notes were introduced in 2002. The LIBOR is fixed on a daily basis by the British Bankers' Association. The depository receives dividends from the issuing Indian firm and then pays it to the depository receipt holders in the USA. in marketable size.access to capital markets in which the demand for shares of equity ownership is strong. Euros are printed and managed by the European System of Central Banks (ESCB). (1) American Depository Receipts (ADRs) A company issues its shares to a reputed international financial institution in the USA that acts as a depository or the transfer agent. from other banks in the London interbank market. The LIBOR is the world's most widely used benchmark for short-term interest rates. 7 . ADRs are denominated in US dollars and ADR investors receive dollar equivalent dividends. (D) London Interbank Offer Rate (LIBOR) An interest rate at which banks can borrow funds. and list and trade GDRs on the London Stock Exchange. The LIBOR is derived from a filtered average of the world's most creditworthy banks' interbank deposit rates for larger loans with maturities between overnight and one full year. Reliance and Grasim were the first companies to issue GDRs in May and November 1992.