Topic 1: Introduction to Financial Markets & Brief History

Question 1

Give two definitions of International Finance

Answer 1

• The allocation of real income and consumption over time in an economy that links with world markets
• The analysis of key financial markets & instrments that allocate savings (more micro focussed)

Question 2

According to Groenewold, what is the role of financial markets?

Answer 2

• Faciliate Transactions (like forex)
• Facilitate Transfers of Savings
• Risk Shifting (And insurance - added)

Question 3

According to Groenewold, how can we classify financial markets?

Answer 3

Again,

• Facilitating Transactions
  • Forex Markets
• International Borrowing & Lending
  
  • Money Markets (Short)
  • Capital Markets (Long)
• International risk sharing

Question 4

What was the general state of international finance before 1971?

Answer 4

• Fixed exchange rates
• Extensive capital controls

This meant there was basically no international finance markets.

Question 5

When and why did the US abandon the gold standard?

Answer 5

1971

The US had been running a persistant CAD which was unsustainable. This deficit has persisted due to military spending, subsided with Clinton and then remerged with the George Bush tax cuts. Due to the GFC, the US looks set to have the twin deficit problem for quite some time.

Question 6

Capital Controls

Answer 6

Measures taken by the government to restrict or control the flow of capital in and out of the country.

Question 7

Financial Deregulation

Answer 7

The elimination or reduction of government power and control in financial markets.

Question 8

What is financial contagion?

Answer 8

The spread of financial crisis from one countries economy to another.

Question 9

Portfolio Investment

Answer 9

Investment in financial assest without buying big stakes of companies for the purpose of exerting control. Definined in Australia as a non-equity investment or an equity investment that is < 30% of the companies market capitalization.

Question 10

Foriegn Direct Investment

Answer 10

Opposite of portfolio investment. Investment that leaves the investor/s with significant control of a company, defined in Australia as an equity investment that leaves the investor/s controlling >30% of the companies shares.

Question 11

What indicators of the internationalization of finance does Moosa give?

Answer 11

1. Volume of international bank lending
2. Value of securities tranasactions with foreigners
3. Flows of portfolio investment & FDI
4. Daily turnover in the global forex market
5. Percentage of FOREX trading conducting with cross-border counterparties

Question 12

What have been the broad trends in the Eurodollar market over the last 60 years?

Answer 12

In the post WWII the US dollar settled everything, and was the only convertable currency really.

This has decreased over the last half century, and now the Euro holds a very reasonable portion of transactions - though still smaller then the US dollar.

Question 13

How are oil prices and their fluctuation understood to effect the global economy?

Answer 13

This has been a topic of much research

• Some have found a link between inflation and negative cyclical output effects and higher oil prices for oil importing countries in the short run (Hamilton, Roubini & Sester)
• Moosa found no link in OECD countries
• Oil prices don’t affect us as much anymore - OECD
  
  • smaller share of oil in production
  • more flexible labour markets
  • improvemenets in monetary policy

Question 14

What is securitisation?

Answer 14

A process by which a company loans money by selling bonds in a market, rather then loaning money from a bank.

Question 15

What are some advantages of securitisation?

Answer 15

• Markets can more effectively price assets, and link savers to borrowers. Thus, efficiency (savings are better allocated) and in the long run, economic output is improved.
• Big loans can be made from multiple small investors by selling multiple bonds to each of them.
• In some security devices, risk can be shifted towards those more willing to bear it.
• Spreads and can eliminate risk

Question 16

What are some disadvantages to securitisation?

Answer 16

• Devices can get overly complicated and difficult for investors to understand, and other parties to regulate / rate
• Fragments resonsibility
• Puts the loaner far away from the investor
• Device creators don’t have incentives to make strong long term loans.

Question 17

Explain the Bretton Woods System

Answer 17

Existed from 1944 to 1971

The IMF supervised the maintaince of a series of fixed exchange rates between all 44 participating countries. These rates were adjustable, but countries had to prove the existance of sustained deficits.

All countries were pegged to the US dollar, or gold. The US dollar itself was set to 35 ounces of gold.

Exchange rates were only allowed to vary within 1% (intervention points).

Question 18

What were some problems with the Bretton Woods System?

Answer 18

Because the peg was adjustable there was contant speculation on if the peg would adjust - which would partially cause an adjustment of the peg.

Countries also ran persistant deficits under the system, espicially the US.

Question 19

What is a currency board?

Answer 19

An indendent board with the exclusive ability to print money that maintains a pegged rate. Eg. Hong Kong.

Question 20

What is the history of Australian International Finance?

Answer 20

Pegged to the pound until 1971.

1971-1974: Pegged against the US dollar.

1974-1983: Pegged to a bundle of currencies.

1976-1983: Peg is regularly adjusted.

1983 onwards: Flexible system is adopted, Capital controls abandoned.

Question 21

Define Capital Mobility

Answer 21

The freedom of financial assets to move across borders.

Question 22

Define Market Integration

Answer 22

A country’s financial markets are integrated with the world’s financial markets if:

• Capital is free to move into and out of the country.
• Comestic assets are close substitutes for foreign assets.

Question 23

What is the Equoequity market?