M3: INTERNATIONA FINANCIAL MANAGEMENT (1)

• International finance, sometimes known as international macroeconomics, is the study of monetary interactions

  between two or more countries, focusing on areas such as foreign direct investment and currency exchange rates (Kagan, International finance, 2020).
• International financial management, also

  known as international finance, is a well-known term in today’s world. It simply means

  financial management in an international business environment. It is different from financial management because of the different factors involved like currency, political situations, imperfect markets, and diversified opportunity sets.
• An exchange rate is the value of one nation's currency versus the currency of another nation or economic zone.

  For example, how many U.S. dollars does it take to buy one euro? As of July 31, 2020, the exchange rate is 1.18, meaning it takes $1.18 to buy €1 (Chen, 2020).
• Exchange rates affect our economy and each of us because:

  1. When the dollar appreciates (strong dollar), the dollar becomes more valuable relative to other currencies.
  2. Foreign products become cheaper to us.
  3. U.S. products become more expensive overseas.
• Currency prices can be determined in two main ways: a floating rate or a fixed rate. A floating rate is determined by the open market through supply and demand on global currency markets. Therefore, if the demand for the currency is high, the value will increase. If demand is low, this will drive that currency price lower.

  Of course, several technical and fundamental factors will determine what people perceive is a fair exchange rate and alter their supply and demand accordingly (Banton, 2021).
• The currencies of most of the world's major economies were allowed to float freely following the collapse of the Bretton Woods system between 1968 and 1973.

  Therefore, most exchange rates are not set but are determined by on-going trading activity in the world's currency markets.
• The Bretton Woods Agreement was negotiated in July 1944 by delegates from 44 countries at the United Nations Monetary and Financial Conference held in Bretton Woods, New Hampshire. Thus, the name “Bretton Woods

  Agreement.

  Under the Bretton Woods System, gold was the basis for the U.S. dollar and other currencies were pegged to the U.S. dollar’s value. The Bretton Woods System effectively came to an end in the early 1970s when President Richard M. Nixon announced that the U.S. would no longer exchange gold for U.S. currency (Chen, Bretton woods agreement and system, 2021).
• Types of Exchange Rates

  * Free Floating

  * Restricted Currencies

  * Currency Peg

  * Onshore vs. Offshore

  * Spot vs. Forward

  * Quotation
• TYPE OF EXCHANGE RATE

  A free-floating exchange rate rises and falls due to

  changes in the foreign exchange market.
• TYPE OF EXCHANGE RATE

  Restricted Currencies

  Some countries have restricted currencies, limiting their exchange to within the countries' borders. Also, a restricted currency can have its value set by the government.
• TYPE OF EXCHANGE RATE

  Currency Peg

  Sometimes a country will peg its currency to that of another nation. For instance, the Hong Kong dollar is pegged to the U.S. dollar in a range of 7.75 to 7.85.2 This means the value of the Hong Kong dollar to the U.S. dollar will remain within this range.
• TYPE OF EXCHANGE RATE

  Onshore Vs. Offshore

  Exchange rates can also be different for the same country. In some cases, there is an onshore rate and an offshore rate. Generally, a more favorable exchange rate can often be found within a country’s border versus outside its borders. China is one major example of a country that has this rate structure.

  Additionally, China's yuan is a currency that is controlled by the government. Every day, the Chinese government sets a midpoint value for the currency, allowing the yuan to trade in a band of 2% from the midpoint.
• TYPE OF EXCHANGE RATES

  Spot vs. Forward

  Exchange rates can have what is called a spot rate, or cash value, which is the current market value.
• TYPE OF EXCHANGE RATES

  Alternatively, an exchange rate may have a forward value, which is based on expectations for the

  currency to rise or fall versus its spot price. Forward rate values may fluctuate due to changes in

  expectations for future interest rates in one country versus another. For example, let's say that traders have the view that the eurozone will ease monetary policy versus the U.S. In this case, traders could buy the dollar versus the euro, resulting in the value of the euro falling.
• TYPES OF EXCHANGE RATES

  Quotation

  Typically, an exchange rate is quoted using an acronym for the national currency it represents.

  For example, the acronym USD represents the U.S. dollar, while EUR represents the euro. To quote the currency pair for the dollar and the euro, it would be EUR/USD. In this case, the quotation is euro to dollar, and translates to 1 euro trading for the equivalent of $1.13 if the exchange rate is 1.13. In the case of the Japanese yen, it's USD/JPY, or dollar to yen. An exchange rate of 100 would mean that 1 dollar

  equals 100 yen.
• Factors that influence currency exchange rates are important for various reasons.

  For countries, these factors can affect how one country trades with another. For individuals, these factors affect how much money one can get when exchanging one currency for another.
• Although it is not always easy to understand, track, or even anticipate these factors, it pays to know them, especially if you are interested in foreign currency.

  It is worth noting that these factors affect currency exchange rates at a macroeconomic level, meaning they affect global currency exchange rates and not local exchange rates.
• FACTORS THAT INFLUENCE EXCHANGE RATES

  1. Inflation

  It is the relative purchasing power of a currency compared to other currencies.

  For example, it might cost one unit of currency to buy an apple in one country but cost a thousand units of a different currency to buy the same apple in a country with higher inflation.

  Such differentials in inflation are the foundation of why different currencies have different purchasing powers and hence different currency rates. As such, countries with low inflation typically have stronger currencies compared to those with higher inflation rates
• FACTORS THAT INFLUENCE EXCHANGE RATES

  2. Interest Rates

  These are tightly tied to inflation and exchange rates. Different country’s central banks use interest rates

  to modulate inflation within the country.

  For example, establishing higher interest rates attracts foreign capital, which bolsters the local currency rates. However, if these rates remain too high for too long, inflation can start to creep up, resulting in a devalued currency. As such, central bankers must consistently adjust interest rates to balance benefits and drawbacks.
• FACTORS THAT AFFECT EXCHANGE RATES

  3. Public Debt

  Most countries finance their budgets using large-scale deficit financing. In other words, they borrow to finance

  economic growth. If this government debt outpaces economic growth, it can drive up inflation by deterring foreign investment from entering the country, two factors that can devalue a currency. In some cases, a government might print money to finance debt, which can also drive-up inflation.
• FACTORS THAT AFFECT EXCHANGE RATES POLITICAL STABILITY

  4. Political Stability

  A politically stable country attracts more foreign investment, which helps prop up the currency rate. The opposite is also true – poor political stability devalues a country’s currency exchange rate. Political stability also affects local economic drivers and financial policies, two things that can have long term effects on a currency’s exchange rate. Invariably, countries with more robust political stability like Switzerland have stronger and higher valued currencies.
• FACTORS THAT AFFECT EXCHANGE RATES

  5. Economic Health

  Economic health or performance is another way exchange rates are determined. For example, a country with low unemployment rates means its citizens have more money to spend, which helps establish a more robust economy. With a stronger economy, the country attracts more foreign investment, which in turn helps lower inflation and drive up the country’s currency exchange rate. It is worth noting here that economic health is more of a catch-all term that encompasses multiple other drivers like interest rates, inflation, and balance of trade.
• FACTORS THAT AFFECT EXCHANGE RATES

  6. Balance of Trade

  Balance of trade, or terms of trade, is the relative difference between a country’s imports and exports.

  For example, if a country has a positive balance of trade, it means that its exports exceed its imports. In such a case, the inflow of foreign currency is higher than the outflow. When this happens, a country’s foreign exchange reserves grow, helping it lower interest rates, which stimulates economic growth and bolsters the local currency exchange rate.
• FACTORS THAT AFFECT EXCHANGE RATES

  7. Current Account Deficit

  The current account deficit is closely related to the balance of trade. In this scenario, a country’s balance of trade is compared to those of its trading partners. If a country’s current account deficit is higher than that of a trading partner, this can weaken its currency relative to that country’s currency. As such, countries that have positive or low current account deficits tend to have stronger currencies than those with high deficits.
• FACTORS THAT AFFECT EXCHANGE RATES

  8. Confidence / Speculation

  Sometimes, currencies are affected by the confidence (or lack thereof) traders have in a currency. Currency changes from speculation tend to be irrational, abrupt, and short-lived. For example, traders may devalue a currency based on an election outcome, especially if the result is perceived as unfavorable for trade or economic growth. In other cases, traders may be bullish on a currency because of economic news, which may buoy the currency, even if the economic news itself did not affect the currency fundamentals.
• FACTORS THAT AFFECT THE EXCHANGE RATES

  9. Government Intervention

  Governments have a collection of tools at their disposal through which they can manipulate their local exchange

  rate. Primarily, central banks are known to adjust interest rates, buy foreign currency, influence local lending

  rates, print money, and use other tools to modulate currency exchange rates. The primary objective of

  manipulating these factors is to ensure favorable conditions for a stable currency exchange rate, cheaper credit,

  more jobs, and high economic growth.