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Class 2 Int Finance

12:30
National Saving S=National Income Y that is not spent on Consumption C or
government purchases G. So, for an OPEN ECONOMY: S=Y-C-G.
An open economy can save by building up its capital stock or by acquiring foreign
wealth. S=i+CA
Private and gov saving
Private saving is the part of disposable income (Y-T) that is saved rather than
consumed: Sp=Y-T-C=Yd-C
Gov saving js net tax revenue T minus gov purhcases G: Sg=T-G (>0 its rare, <0 most
common)
Sp+Sg=Y
Balance of payments accounts
A countrys balance of paymaents accounts accounts for its payments to and its
receipts from foreigners (all transactions).
An international transaction involves two parties, and each transaction enters the
accounts twice: once as a credit + and once as a debit -.
Its double-entry accounting and the overall balance is supposed to be 0 by
construction.
The bal of payments accounts are separated into 3 broad accounts:
-current account: accounts for flows of goods and services (imports and exports)
-fin. Account: accounts for flows of fin. Assets(financial capital)
-capital account: important for countries sometimes, its flows of special categories of
assets (capital)
Eg: I download an ebook from amazon:
Ebook: CA, France Service Import, -10
Bank deposit: Financial account, France asset sale, +10 Because money is considered
as a store of wealth, but also an asset.
Eg: I buy a Japanese katana. Japanese shop receives payment from your credit card
company.
Katana: CA, france Good Import, -100
Sale of credit card claim (fin. Account, france asset sale), +100
E.g
I buy a share of Samsung, Samsung deposits the money in a Korean bank.
Stock purchase: financial account, france asset purchase, -1000
Bank deposit: fin. Account, france asset sale, +1000
How do the bal of payments balance?
Due to the double entry of each transaction, it balances by this equation: ca+fin.acc.
+cap.account=0
Capital account: flows of special categories of assets (capital). Typically nonmarket,
non-produced, or intangible assets like debt forgiveness, copyrights and trademarks.
Eg
French bank forgive a 50M debt owed by Greek govern through debt restructuring.

French bank who holds the debt thereby reduce the debt by crediting Greece0s bank
accounts.
Debt forgiveness: capital account, France transfer payment, -50M
Reduction in banks claims: financial account, France asset sale, +50M.
We can consider the asset sale as an Export (cazzata).
The three broad accounts are more finely divided:
*CA: imports and exports and NET UNILATERAL TRANSFERS:
-merchandise=goods
-services=payments, shipping services..
-Income receipts=interest and dividend payments, earnings of firms and workers
operating in foreing countries
-gifts (transfers) across countries that dont purchase a good or service nor serve as
income for goods and services produced.
*Capital account: records special transfers of assets
*Financial account has at least 3 subcategories:
-official (international) reserve assets: assets that are held in order to deal with the
exchange rate issues(financial instability). Assets include government bonds, currency,
gold. The ones sold to foreign central banks are a credit + because the domestic
central bank can spend more money to cushion against instability. The negative value
of the official reserve assets is called official settlements balance or balance of
payments; its the sum of the ca, the cap account, the nonreserve portion of the fin
account and the statistical discrepancy. A negative off settlements balance may
indicate that a country is depleting its official international reserve assets, or may be
incurring large debts to foreign central banks so that the domestic central bank can
spend a lot to protect against financial instability.
-all other assets
-statistical discrepancy: data from a transaction may come from different sources THAT
DIFFER in coverage, accuracy, and timing. The balance of payments accounts
therefore seldom balance in practice. The statistical discrepancy is the account added
to or subtracted from the financial account to make it balance with the current account
and the capital account.

Exchange rates and the foreign exchange mkt: an asset approach


Exc rates are quoted as foreign currency per unit of domestic currency or domestic
currency per unit of foreign currency.
Exc rates allow us to denominate the cost or price of a good or service in a common
currency.
Eg on slides.
Depreciation is a decrease in the value of a currency relative to another currency. A
depreciated currency is less valuable (less expensive) and therefore can be exchanged
for (can buy) a smaller amount of foreign currency. If dollar per euro becomes greater
than before, it means that the dollar has depreciated relative to the euro and euro
appreciated relative to the dollar (euro more valuable now, dollar less valuable).
A depreciated currency is less valuable and therefore it can buy fewer foreign
produced goods that are denominated in foreign currency; it also means that imports
are more expensive and domestically produced goods and exports are less expensive;
a depreciated currency lowers the price of exports relative to the price of imports

Foreign exchange markets


The set of markets where foreign currencies and other assets are exchanged for
domestic ones.
The participants:
-commercial banks and other depository institutions: trnasacations involve buying and
selling of deposits in different currencies for investment purposes.
-non-bank financial institutions (mutual funds, hedge funds, securities firms, insurance
companies, pension funds) ,may buy/ sell foreign assets for investment.
-non-financial businesses conduct foreign currency transactions to buy.

Buying and selling in the foreign exc mkt are dominated by commercial and
investment.
Central banks sometimes intervene, but the direct effects of their transactions are
small and transitory in many countries.
Computer and telecommunications technology transmit info rapidly and have
integrated mkts.
The integration of fin mkts implies that there can be no significant differences in exch
rate s across locations.
Arbitrage
Spot rates and forward rates

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