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Summary - International Finance (320122-M-6)
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A summary of the course International Finance (320122-M-6) including lecture slides.
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Finance SMVHC 1
Key aspects of International Finance
Broader set of business opportunities (not only your own country, also abroad)
Foreign exchange risk because of different currencies.
Political risk
Market imperfections
Key reason for managers to pursue business internationally:
Access to a larger pool of customers.
More efficient production abroad.
Higher economies of scale.
Raising capital at a lower cost bijv. borrow money in another country is
cheaper.
Political risk
Sovereign countries (= highest in rang) decide on rules of doing business
major consequences for firms!
Examples: sudden changes in taxes & policies that limit certain investments.
Risk especially high if:
Weak rule of law
Political instability (like Trump)
Market imperfections
Frictions limit free flow of people, goods, services, and capital.
Examples:
Legal restrictions
Transaction costs
Transportation costs
Discriminatory taxes
Information asymmetries
International trade
Economists in 19th century argue that trade is beneficial to both countries involved.
Smith: due to absolutely advantage
Italy produces wine more efficiently than Belgium Italy produce wine.
Ricardo: due to comparative advantage:
Italy produces wine more efficiently than beer Italy produce wine.
Belgium produces beer more efficiently than wine Belgium beer.
- Don’t compare with other countries but relative to other products.
Global trade liberalization: General Agreement on Tariffs and Trade (GATT) and later
replaced by the WTO, are arrangements between countries to enhance trade.
Regional trade liberalization: EU, NAFTA, Trans-Pacific Partnership & African
Continental Free Trade Agreement less barriers to flow of goods/ capital/ people.
The dark side of free trade
,Economists in 20th century focused almost exclusively on the aggregate (total)
benefits of trade.
But free trade does not benefit everyone in the society.
Bijv. people can be exploded, think about low wages for foreigners (Polen).
For gains to be felt by everyone, they need to be redistributed e.g., taxes,
education.
Bijv. food in Bulgaria was cheap until they joined the EU same prices as in Europe, while
they have lower wages.
Without that, globalization can exacerbate inequality (rich become richer).
Political consequences: free trade may lead to shifts in political preferences.
Bijv. UK areas that have more Polish Immigrants preferred Brexit.
International Monetary System
Institutional framework within which:
International payments are made.
Movements of capital are accommodated.
Exchange rates among currencies are determined.
Evolution of international monetary system
Bimetallism used gold and silver as means of international payment
exchange rate determined by the content of the metals in the coins.
Classical gold standard gold used for international payments exchange
rate determined by each currencies rate to gold.
Interwar period let go of gold standard to print more money to finance war.
Bretton Woods system: nations set up International Monetary Fund for
conducting rules goal: exchange rate stability without gold standard.
Countries peg (= fix) the currency to dollar & dollar is pegged to gold.
Flexible exchange rate regime: gold abandoned as international reserve.
New role of IMF: assistance in keeping currency stable.
Key tension: everyone wants stability of exchange rates to stimulate trade, but this
requires commitment that you don’t produce too much money, that would lead to inflation.
Gold standard exchange rate & arbitrage
1 pound = 10 ounces of gold, 1 dollar = 15 ounces of gold 1 pound = 0.67 dollars
Arbitrage opportunity makes exchange rate self-correcting.
Trade imbalances are self-correcting: high net imports outflow of gold
value of currency increases because there is less currency left in the country price
levels drop local products are cheaper lower net imports.
Bretton Woods System problems
Growing need for reserves (due to economic growth) US cannot hold
enough gold for all the dollars abroad intervention needed SDR created.
Special Drawing Rights = artificial currency composed of a basket of real
currencies.
Ultimately collapsed due to dollar devaluation (US financing Vietnam War).
Types of exchange rate regimes
,Fixed Managed fixed Flexible
Managed fixed = allowed to deviate from fixed a little bit.
Advantages of flexible exchange rates:
Easier external adjustments (no excess supply/ demand for currency)
Autonomy in use of monetary policy
Less prone to abrupt currency crises.
Disadvantages of flexible exchange rates:
Exchange rate uncertainty may hamper international trade and investment.
No safeguards to prevent crises.
Currency crises
= fixed exchange rate countries are not safe from exchange rate risk currency
crises happens when investors don’t believe that the country has sufficient reserves
to maintain a fixed exchange rate.
Pressure from investors to sell the currency.
This would force the country to run out of the reserves if peg was maintained.
So, peg must be given up and the exchange rate allowed to fall.
Consequence: expensive exports inflation debt in foreign currency gets too
expensive leading to defaults.
Solution: Eurozone 1 currency & monetary policy in hands of ECB.
Advantages of Eurozone
Reduced transaction costs (when changing money)
Elimination of exchange rate uncertainty
Enhanced efficiency and competitiveness of the European economy
Conditions conducive to the development of capital markets with large depth
and liquidity
Political cooperation and peace in Europe
Disadvantages of Eurozone
Loss of national monetary and exchange rate policy independence key tool
in times of crisis!
Some worry that the exchange rates at which Euro was formed led to loss of
competitiveness in the South.
Without full integration of financial markets, system is vulnerable.
, May require stronger integration also on fiscal policy.
Money = anything that is generally accepted as payment for goods or services or in
the repayment of debts.
3 functions: medium of exchange, store of value, unit of account.
Digital currencies
= money but not physical cash, typically not issued by governments, not a legal
tender in any country, allow easy transfers across borders. Bijv. Bitcoin.
Assets whose value is determined by supply and demand.
Have no intrinsic value.
Value derives from use in transaction & belief that others find it valuable
‘’bubble-type asset’’.
Are not a liability on individuals or institutions.
Total supply of digital currencies is limited and grows at an increasingly slow
pace, critically: for most of them not in control of governments!
Block-chain based currencies allow transfer without financial intermediaries.
Is this the future of money?
Risky because it is volatile not a great store of value and unit of account.
Aims to keep the value stable by using existing currencies as reserve.
Regulators are still concerned:
Use for money laundering.
Loss of control of monetary policy
Financial instability
WC 0
Math primer
Effective Interest Rate
HC 2
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