INTERNATIONAL

TRANSACTIONS AND
PAYMENTS

chapter 6
BMGT26A

Sharon C. Matilla

Instructor
Foreign Exchange Markets

– is the global market for exchanging currencies of different countries.

– key concepts we need to understand the market:
 Foreign exchange is the action of converting one currency into another.
 exchange rate - The rate that is agreed upon by the two parties in the exchange
which may fluctuate widely, creating the foreign exchange risk.
Philippine Foreign exchange Market:
– Black Market - the buying and selling of forex outside the banking system and
that authorized dealers.
– Eurocurrency Market - the buying and selling of foreign currencies deposited as
time deposits in the banks of europe.
Functions Of Foreign
Exchange Markets
A. Transfer of funds or purchasing power from one nation and
currency to another.
1. Demand for foreign currencies
2. Supply of foreign currencies
B. Credit to function.
C. To provide the facilities for hedging and speculation.
 Hedging – refers to the avoidance of a foreign exchange risk , or the
covering of an open position
 Speculation – is the opposite of hedging. Whereas hedger seeks to
cover a foreign exchange risk, a speculator accepts and even seeks out
a foreign exchange risk or an open position.
Speculation can be stabilizing
or destabilizing
Stabilizing speculation – refers to the purchase of foreign
currency when the exchange rates rises or is high, in the
expectation that it will soon fall.
Destabilizing – refers to the sale of a foreign currency when
exchange rate falls or is low, in the expectation that it will fall
even lower in the future.
 Video clips foreign exchange market

https://www.youtube.com/watch
?app=desktop&v=6rX4ZEHQVCM
The exchange rate policy

– refers to the manner in which a country manages its currency in

respect to foreign currencies and the foreign exchange market.
The exchange rate is the rate at which the domestic currency
can be converted into a foreign currency.
– OBJECTIVES:
– The current foreign exchange administration rules are prudential
measures to promote monetary and financial stability conducive to
the sustainable growth of the economy and safeguarding the
balance of payments position as well as safeguarding against
shocks.
Exchange rate policies:

– Foreign exchange rate - This is the price of a foreign money

expressed in terms of a local money.
– Appreciation - The value of the local currency has increased.
– Means that there is an decrease in the domestic currency price of the
foreign currency.
– Depreciation – the value of local currency has decreased in
relation to another currency.
– Means that there is an increase in the domestic currency price of the
foreign currency.
– Devaluation – refers to the increase in price of gold relative to a
currency.
Determinants od exchange
rates
1. Relative income changes
-Income – purchasing power - consumption – importation – demand for dollars

2. Relative price changes

- The higher the price of goods in the country , the more we depend on
cheaper imported goods.

3. Relative Interest rates

- The higher the interest rates in the country, means more or greater
outflows of investments out of our country.

4. Other factors :
1. Persistent Colonial Mentality
2. The stage of our economic development
Cont.
Exchange rate Policies:
• Pegged exchange rate or fixed exchange rate
– The exchange rate is fixed by the CB
• Free- floating exchange rate or flexible exchange rate
the exchange rate is determined by the free interplay between
demand and supply for dollars
• Managed floating exchange rate
- The ER is determined by supply and demand, however the CB interferes
to smooth out disorderly or erratic fluctuations of exchange rates.
a. Clean float
b. Dirty float
Video clips
exchange rate policy
– https://www.youtube.com/watch?v=FVfMLcO6ZUo
Guidelines in choosing
exchange rate policy
1. The degree of openness
2. The size of the economy
3. The relative rate of inflation
4. Commodity diversification
5. The level of international reserves
6. The source of disturbance
7. Trade elasticity
 Cont.

1. Degree of openness - is measured by the actual size of registered

imports and exports within a national economy, also known as the
Impex rate.
2. The size of the economy - is commonly expressed as its gross
domestic product, or GDP, which measures the value of the output of
all goods and services produced within the country in a year.
3. The relative rate of inflation –
countries with similar inflation = fixed ER
Coutries with similar rate of inflation = flexible
Cont.

4. Commodity diversification – a diversifies economy is likely

to experience less problems in their BOP’s = pegged fixed
ER
5. The level of International Reserves- flexible
countries with sufficient International Reserves – fixed
exchange rate
Countries with low International Reserves = flexible
CONT.

6. The source of Disturbance

– If the disturbances come mainly from abroad, the country should
adopt a flexible ER. If the causes of the disturbances are internal,
the country should adopt a fixed ER.
– 7. Trade Elasticities
– For exports is low= fixed
Key terms:

– Nominal exchange rate – refers to the market exchange

rate of a foreign currency.
– Real exchange rate - the purchasing power of the exchange
rate or the number of goods and services it can buy.
– Note” when ER increase , REA decreases; ie. When price increase
purchasing power decreases.
– Appreciation of the real exchange rate can be a disadvantage in
international trade competition. It discourages exports while it
encourages imports.
The international Monetary /
Financial System
– In the fast few centuries , the international monetary system
evolved from a crude payment standard to the gold standard
– Gold standard – was an automatic payments adjusting
mechanism which allowed countries to adjust their domestic
economies with foreign trade.
– Special Drawing Rights SDRs - a composite money , made up
of a basket of widely convertible currencies, like the dollar, yen,
pound , etc.
– This helped relieve the international system only a little, because
the imbalance in payments became chronic among the major
trading countries.
– Smithson Agreement of 1971 – was a fostered later , among
the major countries, to realign currencies. This was one time
when many countries got together and realigned their
exchange rates by negotiations.

– FOREIGN EXCHANGE RATE - the market in which currencies

of different countries are traded, it is here that the foreign
exchange rates are determined depending on the supply and
demand of foreign currency.
– Denotes the price of a foreign country’s currency in terms of
one’s own.
Terminology for exchange rate

– Depreciates– when a country’s foreign exchange rate

declines relative to that of another country which is the
domestic currency.
– Appreciates – foreign currency
– Devaluation – when a country’s official foreign exchange rate
is lowered the currency is devaluation.
– Revaluation –an increase in the official foreign exchange rate.
Cont.

– Freely Floating Exchange-Rate System –

– This one determined purely by supply and demand without any
government intervention.
– Managed Floating Exchange-rate System –
– This is a system in which government interventions and market
forces interact to determine the level of exchange rates.
Thank you!