Lecture 1: Intro to International Finance Flashcards
What is Finance?
The study of how individuals, businesses and institutions raise funds to implemennt investment strategies, and how they allocate these funds to a variety of investment opportunnities.
Unique traits of International Finance?
How individuals, businesses and other innstitutions raise funds and allocate funnds to investment opportunities in an international context (i.e. multi-currency, multi-national)
Home Currency
It is the currency that is used domestically (i.e. it is used by us in our home country).
Foreign Currency
Currency used in other domestic economies (i.e. used in other countries to the HC)
What is the approximate % of trades that each currency is involved in?
USD: 80% of trades as one of the currency pairs
EURO: 40% of trades as one of the currency pairs
YEN: 20% of trades as one of the currency pairs
GBP: 10% of trades as one of the currency pairs
AUD: ~5% of trades as one of the currency pairs
USD is the world’s main ‘reserve’ Currency.
What are the implications of this?
Nearly all currencies are quoted against the USD, this results in countires that don’t quote their currencies against one another to generate cross-rates thus simulating a cross rate.
Approx. 60% of all FC reserves held by banks are in USD.
Typically 1 year of import payments are held as reserve by governments to maintain trade liquidity.
What are the risks associated with a multi-national corporation?
Exchange rate risk
Country risk
Political risk/Sovereign risk
What are the four main types of exchange rate systems?
Hard peg (‘fixed’ FX rate)
Soft peg (‘fixed’ FX rate)
Floating Regimes
- Floating or Managed Float
- Free Floating or Independent Float
Residual (other managed arranngements)
What is a fixed exchange rate system?
exchange rate is essenntially determined by the gov/central bank and varies little over time (fluctuates around a target set earlier).
What is a hard peg? What are the two major forms of hard peg?
A currency peg is a country or government’s exchange-rate policy of pegging the central bank’s rate of exchange to another country’s currency.
No seperate legal tender: country forgoes their ownn currency in preference of another.
Currency board arrangement: country has such a high level of FX reserves compared with currency issued that the FX rate can be fixed with a narrow variatio.
What is a soft peg? What are the differenct types of soft peg?
The FX rate varies from day-to-day but within pre-specified limits over time.
Conventional peg: maintain a given FX rate (± 1%)
Stabilised arrangement: Spot rate fluctuates within ±2% for 6 months +
Crawling peg: FX adjusted inn small amounts at fixed rate or in response to changes in selcted quantitative elements.
Crawl-like arrangement: Spot rate fluctuates ±2% relative to statistically identified trend of 6 months +
Pegged w/horizontal bounds: Central rate and width of bannd are publically announced (min ±1%).
What is a floating currency regime?
What are the types of floating currency?
A floating regime is where no predetermined FX rate is set.
Managed Float: market determined, no predictabe FX rate path, authorities may innterviene to moderate fluctuations.
Free Floating: Entirely market detemined, intervention may occur but is extremerly rare.
What are terms of trade?
The comparison of what a nation recieves for its exports to what it has to pay for what it imports in terms of relative prices.
What is the current account balance?
The sum of the balance of trade (goods and services exports less imports), net income from abroad and net current transfers.
A positive current account balance indicates that the country is a net lender rather then a net borrower.
What effects do interest rates have in international finance?
Two different divergent effects:
- Increasing the real interest rate short-term will attract capital into the country (+ capital, +HC).
- Increasing nominal rates may be due to increasign inflation rates, not high real interest rates (real = nominal + inflation). Therefore reduced capital investment (+ inflation, -capital, -HC)
