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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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  • February 15, 2024
  • 41
  • 2022/2023
  • Summary
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Finance SMV
HC 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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