International Finance

Balance of Payments
Foreign Exchange Markets
Foreign Exchange Rates
Spot rates and forward rates
Foreign Exchange Systems
Risk Management in International Business
Other internationally traded financial
instruments
Balance of Payments
The balance of payments is an accounting
listing (tabulation) of the values of
economic (trade and financial) transactions
between the resident of a (home) country
and residents of other countries.
Balance of payments entries are recorded
based on the double-entry bookkeeping
principle.
The balance of payments entries are always
balanced; the entries add up to zero.
Balance of Payments Account Categories
Current Accounts
Merchandise Trade
Service Trade
Services of Capital: Interest Incomes, Dividends
Unilateral Current Transfers
Capital Accounts
US private investments abroad
Foreign private investments in the US
Other investments/capital transactions
Official Accounts
(Changes in) US official reserve assets abraod: gold, SDRs, foreign
currencies
(Changes in) foreign official assets in the US

Double-Entry Principle
Each transaction affects at least two account
Debit entries balance credit entries
Imports are debit entries
The balancing (credit) entry(ies) for an import take(s) place in one
(or more) of the sections of capital the accounts
Exports are credit entries
The balancing (debit) entry(ies) for an export take(s) place in one (or
more) of the sections of the capital accounts
Capital inflows (increases in foreign assents) are credit entries
Capital outflows (increases in US residents-owned assets abroad) are
debit entries
Increases in US claims against residents of other countries are debit
entries
Increases in foreign residents claims against US are credit entries

Balance of Payments Balances
Balance of Merchandise Trade
Balance Merchandise and Services
Current Account Balance

Capital Account Balance
Official Settlement Balance
Statistical errors

Overall Balance = 0
How is the BOP balances?
Debit(-) Credit (+)
Export 100
Import 120
Current Account Balance -20
Reduction in US bank
Deposit claims abroad 10
Official Settlement Balance -10
Reduction in official
reserves 10
Balance of Payments 00

Foreign Exchange Markets
Given that each nation state has its own currency (with
which domestic transactions are carried out), all
international transactions potentially generate either
supply or demand for foreign exchange.
Generally, transactions resulting in debit entries in the
BOP generate demand for FX(e.g., imports,
investments abroad); transaction resulting in credit
entries generate demand(e.g., exports, foreign
investments in the US)
Foreign exchange markets are places, systems, or
mechanisms through which currencies are exchanged
or traded.
Today, most currency exchange rates are largely
determined by the forces of supply and demand
Foreign Exchange Markets
Yen
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Prices and Exchange Rates

Exchange rate quotes:
The value of FX in domestic currency ($)
$1.5/pound $.0089/Y $1.20/Euro
The value domestic currency ($) in terms of a foreign currency
0.666 pound/$ Y112.36/$ E0.8333/$

$ P = e. YP

$ P = .0089 X 20000 = $ 178
Foreign (FX)Exchange Rates and Inflation
Changes in FX rate and domestic prices
Appreciation of a currency
Depreciation of a currency

Nominal FX rate vs. real FX rate

The effect of a currency depreciation (on price)
could be partly of totally off set by inflation in the
prices denominated in that currency

FX Cross Rates and Arbitrage
Suppose
Y/$ rate = Y128/$
Y/E rate = Y150/E

Cross $/E rate = (150/128) = $1.1718
If the market $ spot rate for euro is quoted as
$1.20/E, there is an arbitrage opportunity:
Buy 128 yen with a dollar, convert it to euro at
Y150/E. Youll get 0.8533 euro. Then sell your
euro at $1.20/E. Youll receive $1.024. You have
made $.024 on each dollar.
Foreign Exchange Risk
Transaction Exposure


Accounting/Translation Exposure


Economic Exposure
FX Risk Management
FX Spot Markets
Buying or selling FX for immediate delivery (on the spot)
FX Forward Markets
Buying or selling FX at a predetermined (agreed upon) rate for
future delivery
FX Futures
Buying or selling standardized blocks of FX at (market
determined) preset rates for future delivery
FX Options
Buying or selling options to buy (call) or options to sell (put)
standardized blocks of FX at preset prices in the future for
future delivery
Currency Swaps

A Forward Transaction
An American company is expecting to receive
2.5 million euro from a German company in
the first week of March. Todays euro spot
rate is $1.17/euro.To avoid a loss from
possible depreciation of the euro, through it
bank, the company sells its expected euro
receipt in the forward market at $1.16 per
euro for March delivery. According to this
forward contract on March 3 the company
will receive:
2,500,000 x 1.16 = $2,900,000

A Call Option Transaction
An American auto importer has purchased 1000
automobiles from Japan. On March 3, the
importer is expected to pay for these cars in yen:
1,320,000,000 yen
The importer purchases 105 blocks of yen (call)
options for March settlement at 92.5* cents per
100 yen at 1.25 per 100 yen.
Today the importer pays:
105x(12,500,000/100)x.0125 = $164,062.5
That is equivalent to 108.018 yen per dollar