Republic of the Philippines

City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

DETAILED LEARNING MODULE

Title: GLOBAL FINANCE WITH ELECTRONIC BANKING
Module No.

I. Introduction
The global financial system is the worldwide framework of legal agreements,
institutions, and both formal and informal economic actors that together facilitate
international flows of financial capital for purposes of investment and trade
financing. While Electronic banking is a form of banking in which funds are
transferred through an exchange of electronic signals rather than through an
exchange of cash, checks, or other types of paper documents.
II. Learning Objectives
After studying this module, you should be able to:
 To Understand Inflation rate and Exchange rate dynamics
 To Understand The international capital market and gains from trade
 To Understand Banking and financial fragility

III. Topics and Key Concepts.

 Inflation rate and Exchange rate dynamics
 The international capital market and gains from trade
 Banking and financial fragility

IV. Teaching and Learning Materials and Resources

 Internet
 Laptop/ android phones
 Power point presentation
V. Learning Task

 View on line video included on the power point presentation

 Short online quiz
VI. Reference
https://www.investopedia.com/ask/answers/022415/how-does-inflation-affect-
exchange-rate-between-two-nations.asp#:~:text=Inflation%20is%20closely
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

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https://en.wikipedia.org/wiki/Financial_fragility

LECTURE:
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

How Does Inflation Affect the Exchange Rate Between Two Nations?

The rate of inflation in a country can have a major impact on the value of the country's
currency and the rates of foreign exchange it has with the currencies of other nations.
However, inflation is just one factor among many that combine to influence a country's
exchange rate.

Inflation is more likely to have a significant negative effect, rather than a significant
positive effect, on a currency's value and foreign exchange rate. A very low rate of
inflation does not guarantee a favorable exchange rate for a country, but an extremely
high inflation rate is very likely to impact the country's exchange rates with other nations
negatively.

Inflation and Interest Rates

Inflation is closely related to interest rates, which can influence exchange rates. Countries
attempt to balance interest rates and inflation, but the interrelationship between the two
is complex and often difficult to manage. Low interest rates spur consumer
spending and economic growth, and generally positive influences on currency value. If
consumer spending increases to the point where demand exceeds supply, inflation may
ensue, which is not necessarily a bad outcome. But low interest rates do not commonly
attract foreign investment. Higher interest rates tend to attract foreign investment,
which is likely to increase the demand for a country's currency. (See also, The Mundell-
Fleming Trilemma.)

The ultimate determination of the value and exchange rate of a nation's currency is the
perceived desirability of holding that nation's currency. That perception is influenced by a
host of economic factors, such as the stability of a nation's government and economy.
Investors' first consideration in regard to currency, before whatever profits they may
realize, is the safety of holding cash assets in the currency. If a country is perceived as
politically or economically unstable, or if there is any significant possibility of a
sudden devaluation or other change in the value of the country's currency, investors tend
to shy away from the currency and are reluctant to hold it for significant periods or in
large amounts.

Other Factors Affecting Exchange Rate

Beyond the essential perceived safety of a nation's currency, numerous other factors
besides inflation can impact the exchange rate for the currency. Such factors as a
country's rate of economic growth, its balance of trade (which reflects the level of
demand for the country's goods and services), interest rates and the country's debt level
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

are all factors that influence the value of a given currency. Investors monitor a country's
leading economic indicators to help determine exchange rates. Which one of many
possible influences on exchange rates predominates is variable and subject to change. At
one point in time, a country's interest rates may be the overriding factor in determining
the demand for a currency. At another point in time, inflation or economic growth can be
a primary factor.

Exchange rates are relative, especially in the modern world of fiat currencies where
virtually no currencies have any intrinsic value, say, as defined in terms of gold, for which
the currency could be exchanged. The only value any country's currency has is
its perceived value relative to the currency of other countries or its domestic purchasing
power. This situation can influence the effect that inputs—such as inflation—has on a
country's exchange rate. For example, a country may have an inflation rate that is
generally considered high by economists, but if it is still lower than that of another
country, the relative value of its currency can be higher than that of the other country's
currency.

You may want to read further on the macro fundamentals that affect the economy.

KEY TAKEAWAYS

 Inflation is closely related to interest rates, which can influence exchange rates.
 Other factors, such as economic growth, the balance of trade (which reflects the
level of demand for the country's goods and services), interest rates, and the
country's debt level all influence the value of a given currency.
 The most powerful determiner of value and the exchange rate of a nation's
currency is the perceived desirability of that currency.

The international capital market and gains from trade

International capital markets are a group of markets (in London, Tokyo, New York,
Singapore, and other financial centers) that trade different types of financial and
physical capital (assets), including:
♦ stocks ♦ bonds (government and corporate) ♦ bank deposits denominated in
different currencies ♦ commodities (like petroleum, wheat, bauxite, gold) ♦ forward
contracts, futures contracts, swaps, options contracts ♦ real estate and land ♦
factories and equipment

Gains from Trade • How have international capital markets increased the gains from
trade?

• When a buyer and a seller engage in a voluntary transaction, both receive

 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

something that they want and both can be made better off.

• A buyer and seller can trade

♦ goods or services for other goods or services
♦ goods or services for assets
♦ assets for assets

• Theories of international trade describe the gains from trade of goods and services for
other goods and services:
♦ with a finite amount of resources and time, use those resources and time to produce
what you are most productive at (compared to alternatives), then trade those products
for goods and services that you want.
♦ be a specialist in production, while enjoying many goods and services as a consumer
through trade.

• The theory of inter-temporal trade describes the gains from trade of goods and services
for assets, of goods and services today for claims to goods and services in the future
(today’s assets). ♦ Savers want to buy assets (future goods and services) and borrowers
want to use assets (wealth) to consume or invest in more goods and services than they
can buy with current income. ♦ Savers earn a rate of return on their assets, while
borrowers are able to use goods and services when they want to use them: they both can
be made better off.

• The theory of portfolio diversification describes the gains from trade of assets for
assets, of assets with one type of risk with assets of another type of risk.

♦ Usually (though not in Las Vegas) people want to avoid risk: they would rather have a
sure gain of wealth than invest in risky assets.
♦ Economists say that investors often display risk aversion: they are averse to risk.
♦ Diversifying or “mixing up” a portfolio of assets is a way for investors to avoid or reduce
risk.

Classification of Assets Claims on assets (“instruments”) are classified as either

1. Debt instruments
♦ Examples include bonds and bank deposits ♦ They specify that the issuer of the
instrument must repay a fixed value regardless of economic circumstances.

2. Equity instruments ♦ Examples include stocks or a title to real estate ♦ They

specify ownership (equity = ownership) of variable profits or returns, which vary
according to economic conditions.
International Capital Markets The participants:

1. Commercial banks and other depository institutions: ♦ accept deposits ♦ lend to

 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

governments, corporations, other banks, and/or individuals ♦ buy and sell bonds
and other assets ♦ Some commercial banks underwrite stocks and bonds by
agreeing to find buyers for those assets at a specified price.
2. Non bank financial institutions: pension funds, insurance companies, mutual
funds, investment banks ♦ Pension funds accept funds from workers and invest
them until the workers retire. ♦ Insurance companies accept premiums from
policy holders and invest them until an accident or another unexpected event
occurs. ♦ Mutual funds accept funds from investors and invest them in a
diversified portfolio of stocks or other instruments. ♦ Investment banks specialize
in underwriting stocks and bonds and perform various types of investments.
3. Private firms: ♦ Corporations may issue stock, may issue bonds or may borrow
from commercial banks or other lenders to acquire funds for investment
purposes. ♦ Other private firms may issue bonds or borrow from commercial
banks.
4. Central banks and government agencies: ♦ Central banks sometimes intervene in
foreign exchange markets. ♦ Government agencies issue bonds to acquire funds,
and may borrow from commercial or investment banks.

Because of international capital markets, policy makers generally have a choice of 2 of

the following 3 policies:
1. A fixed exchange rate
2. Monetary policy aimed at achieving domestic economic goals
3. Free international flows of financial capital

 A fixed exchange rate and an independent monetary policy can exist if restrictions
on flows of financial capital prevent speculation and capital flight.
• Independent monetary policy and free flows of financial capital can exist when
the exchange rate fluctuates.
• A fixed exchange rate and free flows of financial capital can exist if the central
bank gives up its domestic goals and maintains the fixed exchange rate.

Banking and financial fragility

Financial fragility is the vulnerability of a financial system to a financial crisis. Franklin

Allen and Douglas Gale define financial fragility as the degree to which "...small shocks
have disproportionately large effects. Roger Lagunoff and Stacey Schreft write, "In
macroeconomics, the term "financial fragility" is used...to refer to a financial system's
susceptibility to large-scale financial crises caused by small, routine economic shocks."

Sources of financial fragility

Why does the financial system exhibit fragility in the first place? Why do banks choose to
take on a capital structure that makes them vulnerable to financial crises? There are two
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

views of financial fragility which correspond to two views on the origins of financial
crises. According to the fundamental equilibrium or business cycle view, financial crises
arise from the poor fundamentals of the economy, which make it vulnerable during a
time of duress such as a recession. According to the self-fulfilling or sunspot
equilibrium view, the economy may always be vulnerable to a financial crisis whose onset
may be triggered by some random external event, or simply be the result of herd
mentality.

Reducing financial fragility

The natural financial fragility of banking systems is seen by many economists as an
important justification for financial regulation designed to reduce financial fragility.
Circuit breakers
Some economists including Joseph Stiglitz have argued for the use of capital controls to
act as circuit breakers to prevent crises from spreading from one country to another, a
process called financial contagion. Under one proposed system, countries would be
divided into groups that would have free capital flows among the group's members, but
not between the groups. A system would be put in place such that in the event of a crisis,
capital flows out of the affected countries could be cut off automatically in order to
isolate the crisis. This system is partly modeled on electrical networks such as power
grids, which are typically well-integrated in order to prevent shortages due to unusually
high demand for electricity in one part of the network, but that have circuit breakers in
place to prevent damage to the network in one part of the grid from causing
a blackout throughout all houses connected through the network. 
Taxing liabilities
As described above, many economists believe that financial fragility arises when financial
agents such as banks take on too many or too illiquid liabilities relative to the liquidity of
their assets. Note that asset liquidity is also a function of the degree of stable funding
available to market participants. As a result, the reliance on cheap short term funding
creates a negative risk externality (Perotti and Suarez, 2011). Some economists propose
that the government tax or limit such liabilities to reduce such excessive risk-taking.
Perotti and Suarez (2009) proposed prudential Pigouvian charges on unstable short term
funding, while Shin (2010) targets unstable foreign flows. Others have supported this
approach.

Capital requirements
Another form of financial regulation designed to reduce financial fragility is to regulate
bank's balance sheets directly via capital requirements.
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314