INTERNATIONAL FINANCE

UNIT -1
International Finance
International finance is the study of monetary interactions that transpire between two or more
countries. International finance focuses on areas such as foreign direct investment and currency
exchange rates. Increased globalization has magnified the importance of international finance. In
this video explained:- meaning,nature,scope and importance of international finance.
Scope of international finance

As there are many prospects that come into the picture and there is the scope it books profits and
benefits from each of these prospects accordingly.

• It is important while determining the exchange rates of the country. This can be done against
the commodity or against the common currency.

• It plays a crucial role in investing in foreign debt securities to have a clear idea about the
market.

• The transaction between countries can be significant in assessing the economic conditions of
the other country.

• The arbitrage in tax, risk, and price due to market imperfections can be used to book good
profits while transacting in international trade.

Importance of international finance

International finance plays a critical role in international trade and inter-economy exchange of
goods and services. It is important for a number of reasons, the most notable ones are listed here

• International finance is an important tool to find the exchange rates, compare inflation rates, get
an idea about investing in international debt securities, ascertain the economic status of other
countries and judge the foreign markets.

• Exchange rates are very important in international finance, as they let us determine the relative
values of currencies. International finance helps in calculating these rates.

• Various economic factors help in making international investment decisions. Economic factors
of economies help in determining whether or not investors’ money is safe with foreign debt
securities.

• Utilizing IFRS is an important factor for many stages of international finance. Financial
statements made by the countries that have adopted IFRS are similar. It helps many countries to
follow similar reporting systems.
• IFRS system, which is a part of international finance, also helps in saving money by following
the rules of reporting on a single accounting standard.

• International finance has grown in stature due to globalization. It helps understand the basics of
all international organizations and keeps the balance intact among them.

• An international finance system maintains peace among the nations. Without a solid finance
measure, all nations would work for their self-interest. International finance helps in keeping that
issue at bay.

• International finance organizations, such as IMF, the World Bank, etc., provide a mediators’
role in managing international finance disputes.

The very existence of an international financial system means that there are possibilities of
international financial crises. This is where the study of international finance becomes very
important. To know about the international financial crises, we have to understand the nature of
the international financial system.

Disadvantages of international finance

Political turmoil in one country which is a stakeholder of international trade can affect the other
stakeholder of the same trade-in another country.

• Depending on other country’s exchange rate is always risky given that all the currencies have
significant volatility.

• The credit risk because of international trade should be careful

• As there is more than one culture involved, there will be cultural differences which if not
tackled properly can damage the reputation of the brand.

It requires the financial world to regain trust and confidence from just about any part of society,
as well as a process that will eradicate some of the least acceptable behavior and implement a
risk management culture.

Challenges of International Financ

1. Challenge of Protection of Natural Resources

When there is more international finance, its growth will affect the natural resources. For
example, after increasing the number of banks in India, ACs are used at large scale due to this,
there is increasing the temperature of India. Who is responsible for this. Surely international
banks are responsible who are opening the branches in India.
2. Terrorism
Terrorism is also main challenge of International Finance. If any country will increase the
terrorism in other country, its international finance will affected.
3. Culture

International finance has also challenge of culture of each country. India is veg. country. So,
McDonnell and other non-veg. country should ban to produce the non-veg. in India.

4. Follow the Political Policies and Law of Nation

If business people have to grow international finance in any country, they have to make their
policy according to the law and political policy of same country.

5. International Currencies
International finance also affects from international currencies.You have some foreign currency
if you have to deal with foreign country. At the time of dealing, you know what is the current
market rate of forex. If your own currency is low value, you should wait for business, otherwise,
your own capital will decrease at fast rate.
Forward Rate vs. Spot Rate: An Overview
The precise meanings of the terms "forward rate" and "spot rate" are somewhat different in
different markets. In general, a spot rate refers to the current price or bond yield, while a
forward rate refers to the price or yield for the same product or instrument at some point in the
future.

In commodities futures markets, a spot rate is the price for a commodity being traded
immediately, or "on the spot". A forward rate is the settlement price of a transaction that will
not take place until a predetermined date.

Spot Rate
A spot rate or spot price is the real-time price quoted for the instant settlement of a contract. In
commodities markets, the spot rate represents the current price for the purchase or sale of a
commodity, security, or currency.

A spot rate is associated with the immediate need for a good as the delivery date of the contract
normally occurs within two business days of the trade date. Regardless of price fluctuations that
occur between the settlement date and the delivery date, the contract will be completed at the
agreed-upon spot rate. When contracting with a spot rate, buyers and sellers are mitigating price
fluctuation risk by sacrificing potentially favorable future market conditions.

Forward Rate
What if the restaurant or farmer didn't need to immediately transaction for the goods? Market
participants that are willing to transact in the future rely on the forward rate.
A forward rate is a specified price agreed by all parties involved for the delivery of a good at a
specific date in the future. The use of forward rates can be speculative if a buyer believes the
future price of a good will be greater than the current forward rate. Alternatively, sellers use
forward rates to mitigate the risk that the future price of a good materially decreases.

What Is the Eurocurrency Market?

The eurocurrency market is the money market for currency outside of the country where it
is legal tender. The eurocurrency market is utilized by banks, multinational corporations, mutual
funds, and hedge funds. They wish to circumvent regulatory requirements, tax laws, and interest
rate caps often present in domestic banking, particularly in the United States.

The term eurocurrency is a generalization of eurodollar and should not be confused with the EU
currency, the euro. The eurocurrency market functions in many financial centers around the
world, not just Europe.

Interest rates paid on deposits in the eurocurrency market are typically higher than in the
domestic market. That is because the depositor is not protected by the same national banking
laws and does not have governmental deposit insurance. Rates on eurocurrency loans are
typically lower than those in the domestic market for essentially the same reasons. Eurocurrency
bank accounts are also not subject to the same reserve requirements as domestic accounts.

Advantages and Disadvantages of Eurocurrency Markets

The main benefit of eurocurrency markets is that they are more competitive. They can
simultaneously offer lower interest rates for borrowers and higher interest rates for lenders. That
is mostly because eurocurrency markets are less regulated. On the downside, eurocurrency
markets face higher risks, particularly during a run on the banks.

What is quotation in foreign exchange?

Exchange rate quotations can be quoted in two ways – Direct quotation and Indirect
quotation. Direct quotation is when the one unit of foreign currency is expressed in terms of
domestic currency. Similarly, the indirect quotation is when one unit of domestic currency us
expressed in terms of foreign currency.

International parity conditions refer to the economic theories that link exchange rates, price
levels (inflation), and interest rates. These theories describe the interrelationships that help
determine long-run fluctuations in exchange rates, interest rates, and inflation.

Assumptions of International Parity Conditions

 There are no transaction costs.

 Market participants have access to perfect information.
 Market prices can easily be adjusted.
 Transactions occur in a risk-neutral environment.
1. Covered Interest Rate Parity
This no-arbitrage condition states that an investment in a foreign market that is entirely hedged
against exchange rate risk should give the same return as a similar investment in a domestic
market. Mathematically, it is represented as:

Ff/d=Sf/d⎛⎜⎝1+if[Actual360]1+id[Actual360]⎞⎟⎠(1+[Actual360]1+[Actual360])

Where:

id = The interest rate in the base currency (domestic country).

if = The interest rate in the foreign currency or the quoted currency.

Sf/d = The current spot exchange rate.

Ff/d = The forward foreign exchange rate.

Under the covered interest rate parity, the interest rate differential between any two currencies in
the cash money markets should equal the differential between the forward and spot exchange
rates. In other words, any forward premium or discount exactly offsets differences in interest
rates. As a result, an investor would earn the same return investing in either currency.

For this condition to hold, it is assumed that:

 There is no transaction cost.

 The domestic and foreign market instruments should be identical in terms of liquidity,
time to maturity, and default risk.

4. The Purchasing Power Parity (PPP)

This condition reflects the link between the exchange rates and the difference in countries’
inflation rates. However, there are different versions of this condition, whose foundation is based
on the law of one price. They include:

 Absolute PPP.
 Relative PPP.
 Ex Ante PPP.

The law of one price states that the price of a foreign good x denoted as Pxf must be equal to the
price of a similar good in a domestic country, Pxd, using the spot rate Sf/d. Here, we have used
the (f/d) notation for simplicity. Put mathematically,

Pxf=Sf/d×Pxd
For instance, a product in Canada costs CAD 100. The nominal exchange rate for USD/CAD is
0.76. The same product will, therefore, cost 0.76 × 100 = USD 76 in the U.S.

Now, let’s discuss each version.

Absolute PPP
This version of the PPP amplifies the law of one price to include a broader range of goods and
services and not just good x. The act of one price equation transforms into:

Pf=Sf/d×Pd

Where:

Pf = Price level of the foreign country.

Pd = Price level of the domestic country.

Sf/d = Nominal exchange rate.

Making Sf/dthe subject of the formula, we get:

Sf/d=PfPd

Therefore, the absolute PPP states that the ratio of the national price level of the two countries
determines the equilibrium in the exchange rates. However, if the transaction cost is coupled
mainly with the non-tradeable nature of some goods, this condition might not hold.