Sources of International Finance

International Financing
• Management of and trading in International money and monetary
assets
• Monetary assets are claims on
- Foreign currency
- Foreign deposits and investments and/or
- Foreign assets

• Claims are
- Denominated in various foreign currencies purchased and sold.
- Involves exchange between various currencies
Components of International Finance

• All claims based transactions give rise to

(i) Borrowing and lending operations in foreign currencies or trading in financial assets
denominated in foreign currencies - FOREIGN CURRENCY MARKET

(ii)A foreign exchange transaction involving an exchange of one currency for another-
FOREIGN EXCHANGE MARKET

(iii) INTERNATIONAL CAPITAL MARKETS

(iv) BONDS MARKETS

The Foreign Exchange Market
Structure of the Foreign Exchange Market
•The Currency Market:
where money denominated in one currency is bought and sold
with money denominated in another currency

•International Trade and Capital Transactions:

facilitated with the ability to transfer purchasing power between
countries
Organization of the Foreign Exchange Market

• PARTICIPANTS AND TYPES

A. Participants at 2 Levels
I. Wholesale Level (95%) - major banks

2. Retail Level - business customers.

B. Two Types of Currency Markets

1. Spot Market:
- immediate transaction
- recorded by 2nd business day
2. Forward Market:
- transactions take place at a specified future date
Organization of the Foreign Exchange Market

C. Participants by Market
1. Spot Market

a. Commercial banks
b. Brokers
c. Customers of commercial and central banks
2. Forward Market
a. Arbitrageurs
b. Traders
c. Hedgers
• Speculators
Spot Rates
In finance, a Spot contract, spot transaction, or simply "spot," is a contract Of buying or selling a commodity,
security, or currency for settlement (payment and delivery) on the spot date, which is normally two business
days after the trade date. The settlement price (or rate) is called a "spot price" or "spot rate. "
Forward Rates
A spot contract is in contrast with a forward contract where contract terms are agreed now but delivery and
payment will occur at a future date. The settlement price of a forward contract is called a "forward price" or
"forward rate. “Depending on the item being traded, spot prices can indicate market expectations Of future
price movements.
Cross Rates
A cross rate is the currency exchange rate between two currencies, both Of which are not the official
currencies of the country in which the exchange rate quote is given in.
For example, if an exchange rate between the euro and the Japanese yen was quoted in an American
newspaper, this would be considered a cross rate in this context, because neither the euro or the ven is the
standard currency of the U.S. However, if the exchange rate between the euro and the U.S. dollar were
quoted in that same newspaper, it would not be considered a cross rate because the quote involves the
U.S. official currency.
Exchange Rate Determination

•The trade and other economic and commercial transactions

involve receipts and payments as between countries

•These will lead to exchange of one currency for others

•The demand for and supply of each of the currencies against

an alternative currency determines the rate at which two currencies
are exchanged
Devaluation and Depreciation of Currency

Devaluation
A devaluation is when a country makes a conscious decision to lower its
exchange rate in a fixed or semi-fixed exchange rate. Therefore, technically a
devaluation is only possible if a country is a member of some fixed exchange
rate policy

Depreciation
When there is a fall in the value of a currency in a floating exchange rate.
This is not due to a government's decision, but due to supply and demand side
factors.
Reason to Pursue a Policy of Devaluation

1. To Boost Exports

2. To Shrink Trade Deficits

3. To Reduce Sovereign Debt Burdens

Sources of Foreign Exchange

I . International Trade:
The trade of goods and services between countries requires each to purchase
the currency of the other in order to make payments. Therefore, the
international demand for a country's output (exports) directly affects the
demand, and consequently the price, of its currency.

2. Currency:
In addition to global demand for a country's securities and exports, a country's
currency is affected by day-to-day movements in prices driven heavily by
speculative trading activity, such as day trading.
Institutions in Intl Finance

• National banks and domestic financial institutions which deal in foreign

currencies and foreign credits.
• International brokers of repute.

• Regional or multi-national banks or corporations dealing in international

markets and borrowing/ lending in these markets.
• Regional Finance and Development Corporations and banks such as the
Asian Development Bank, Commonwealth Finance Corporation, Latin
American Development Bank, Bank for International Settlements, etc.
• International financial organizations like International Monetary Fund (IMF),
International Bank for Reconstruction and Development (IBRD), International