International Finance (IF)

Subject Code: 4549221

MBA SEM-4
CHAPTER 1- International
Finance – Overview
(Module-1)

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 INDEX
• Globalization and Multinational firm,
(Theory)
• International Monetary System
• Balance of payment (Theory)
• Market for Foreign Exchange (Theory)
• International Parity Relationship &
Forecasting Foreign Exchange rate.
(Theory &Numerical)

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Globalization and Multinational firm
• Globalization gives businesses access to markets that
would have been difficult to reach in the past. Because
of the internet, customers from anywhere in the world
can order products from companies anywhere else in the
world, and have those products delivered by airplane in
just a few weeks. This is naturally a tremendous
advantage to businesses, who stand to increase their
potential customer base by millions by reaching out to
foreign buyers.

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 Positive aspects as to become
global
• 1. Access to Labour at Cheaper Prices
• Put multinational corporations and globalization together, and you
get a business that can access labour at cheap prices. Outsourcing
and off-shoring allow businesses to hire employees in foreign
countries.

• 2. Costs Advantage
• Multinational companies have a wider range of options related to the
physical location of facilities and labour than their domestic
competitors, allowing them to locate facilities in countries with the
most favourable tax structures, interest rates and labour costs.

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• 3. Political Advantages
• Multinationals can do more to reduce or eliminate political influences
on their bottom line than international businesses based in a single
country.

• 4. Workforce Innovation
• Employing people from multiple countries provides distinct human
resources advantages. Different cultures produce different
fundamental outlooks on business, management, society and life in
general.

• 5. Company Growth
• All of the advantages mentioned above combine to provide
multinationals with greater prospects for revenue and profit growth.

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 International Monetary System
• International monetary system refers to the system and rules
that govern the use and exchange of money around the world
and between countries.
• Each country has its own currency as money and the
international monetary system governs the rules for valuing and
exchanging these currencies.
• An international monetary system is a set
of internationally agreed rules, conventions and supporting
institutions that facilitate international trade, cross border
investment and generally the reallocation of capital between
nation states.
•

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• It is the global network of the government and financial
institutions that determine the exchange rate of different
currencies for international trade. It is a governing body that
sets rules and regulations by which different nations
exchange currencies with each other.
• With the growing complexity in the international trade and
financial market, the international monetary system is
necessary to assign a standard value of the international
currencies.
• The rules and regulations set by the international monetary
system to regulate and control the exchange value of the
currencies are agreed upon by the respective governments of
the nations. Thus, the government’s stand may affect the
decision making of the international monetary system. For
example, change in the trade policy of a government may
affect the international trade of goods and services.

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 History of the International
Monetary System
• The pre-1914 gold standard: a fixed exchange
system:
• In the pre-1914 era, most of the major trading nations
accepted and participated in an international monetary
system called the GOLD STANDARD. Under this
regime, countries use gold as a medium of exchange
and a store of value. The gold standard had a stable
exchange rate.

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• Monetary disorder: 1914-45: a flexible exchange
system:
• The gold standard collapsed after the First World War
and ended the stability of exchange rates for the major
currencies of the world. The value of currencies
fluctuated very widely.
• The great depression of 1929-32 and the international
financial crisis of 1931, further prevented the restoration
of gold standard. Governments started devaluing their
currencies to support exports.

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• Fixed exchange rates: 1945-73:
• a. The Bretton woods agreement was signed by representatives of
44 countries in 1944 to establish a system of fixed exchange rates.
• b. Under this system, each currency was fixed by government action
within a narrow range of values relative to gold or some currency of
reference. US dollar was used frequently as a reference currency to
establish the relative prices of all other currencies
• c. At this conference, they agreed to establish a new monetary
order, which centered on IMF and IBRD (World Bank).
• d. IMF provides short term balance of payment adjustment loans,
while the world bank makes long term development and
reconstruction loans.
• e. The agreement emphasized the stability of exchange rates by
adopting the concept of fixed but adjustable rates.

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• The post 1973 dirty floating system:
• The exchange rate became much more volatile
during this period due to a number of events
affecting the international monetary order. Oil
crisis of 1973, loss of confidence in US dollar
between 1977 and 1978, second oil crisis in
1978, formation of European monetary system in
1979, end of Marxist revolution in 1990 and
Asian financial crisis in 1997

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 THE INTERNATIONAL
MONETARY FUND (IMF)
• a. An international organization created in 1944 with a
goal to foster global monetary cooperation, secure
financial stability, facilitate international trade, promote
high employment and sustainable economic growth, and
reduce poverty.
• b. Oversees the global financial system by following the
macroeconomic policies of its member countries, in
particular those with an impact on exchange rates and
the balance of payments.

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• c. Offers financial and technical assistance to its
members, making it an international lender of
last resort. Countries contributed to a pool which
could be borrowed from, on a temporary basis,
by countries with payment imbalances.
• d. It is headquartered in Washington, D.C., USA.
• e. The IMF has 190 member countries

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THE EUROPEAN MONETARY
UNION
• A monetary union is a formal arrangement in
which two or more independent countries agree
to fix their exchange rates or employ only one
currency to carry out all transactions.
• Full European monetary union was achieved in
2002, which enabled 15 EU countries to carry
out transactions with one currency through one
central bank under one monetary policy. A single
currency called the EURO was adopted.

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 Balance of payment
• The balance of payments (BOP) is a
statement of all transactions made
between entities in one country and the
rest of the world over a defined period of
time, such as a quarter or a year.

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• The balance of payments (BOP), also
known as balance of international
payments, summarizes all transactions
that a country's individuals, companies
and government bodies complete with
individuals, companies and government
bodies outside the country.
• These transactions consist
of imports and exports of goods, services
and capital, as well as transfer payments,
such as foreign aid and remittances.

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• A country's balance of payments and
its net international investment
position together constitute its international
accounts.

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• The balance of payments include both the
current account and capital account.
• The current account includes a nation's net trade
in goods and services, its net earnings on cross-
border investments, and its net transfer
payments.
• The capital account consists of a nation's
transactions in financial instruments and central
bank reserves.
• The sum of all transactions recorded in the
balance of payments should be zero; however,
exchange rate fluctuations and differences in
accounting practices may hinder this in practice.
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• If a country cannot fund its imports through
exports of capital, it must do so by running down
its reserves. 
• This situation is often referred to as a balance of
payments deficit.
• In reality, however, the broadly defined balance
of payments must add up to zero by definition. In
practice, statistical discrepancies arise due to
the difficulty of accurately counting every
transaction between an economy and the rest of
the world. 

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 Market for Foreign Exchange
• The foreign exchange market (also known as forex, FX
or the currency market) is an over-the-counter (OTC)
global marketplace that determines the exchange rate
for currencies around the world. Participants are able to
buy, sell, exchange and speculate on currencies.
Foreign exchange markets are made up of banks, forex
dealers, commercial companies, central banks,
investment management firms, hedge funds, retail forex
dealers and investors.

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