International Business

International monetary Fund Emergence of Euro World financial markets Concerns of developing countries Exchange rates International financial intermediaries

Financial institutions

Money is the commodity that is generally accepted as an exchange for goods and services In modern society people, firms, and government need a place to keep there money safe. They also want to borrow money, make investments and exchange the money to the money of other countries to make payments overseas. Business organisations that provide these services are called financial institutions Money market is no different from any other market, it is made up of those people and organisations that want money, and all other people and organisations willing and able to supply money, namely the banking system that creates deposit money and a central bank that issues notes and coins Banks are financial institutions in the money market. They are just like any other business except the product they supply is money, in the form of loans and other financial products Most but not all banks are large, profit-making public limited companies. In fact, banks are some of the biggest and profitable corporations in the world

Financial institutions
Banks earn profit for there shareholders in a number of ways: 1. Making Loans and charging interest on them 2. Fees for various services 3. Investing in shares of other companies

Financial institutions
Types of banks 1. Commercial Banks ( earlier called High-Street banks) 2. Savings Banks ( owned and run by on behalf of small depositors, not for profit) 3. Savings and loan associations ( Building societies for the purpose of homes for low income, not for profit) 4. Credit unions ( co-operative not for profit to provide low cost loans to members) 5. Investment banks ( help large corporations in raising money from various sources like stock market, HNIs etc. they also advice on M&A) 6. Merchant banks ( type of investment bank originally they helped merchants finance the sle and transportationof goods overseas. Now they provide funds to large corporations through the purchase of shares rather then as loans) 7. Islamic banks ( as per Shariaa Law these cannot charge interest they are allowed to charge a fee and depositers will get a share in profit)

Financial institutions

Other money market institutions Finance houses ( Hire purchase companies) Venture capitalists ( risky and new ventures usually in return for some ownership and control of the new business) Pension funds ( EPF, PPF) Insurance companies Investment and unit trusts ( Make investments in shares of companies and make profit for its shareholders)

Role of central bank

The central bank sits in the centre of the banking system in an economy. It is the governments banker and the bankers bank. Its main functions are to maintain the stability of the national currency and the money supply in its country or in its group member states, such as EU It is the sole issuer of notes and coins It is the governments banker It manages the nations gold and foreign exchange reserves It manages national debt It regulates and supervises the banking system It is the lender of last resort It sets the monetary policy through interest rate managementcontrols inflation and exchange rate Some examples of central banks are US federal reserve, Bank of England, RBI, Bank of Mexico, Bank of Japan, Bank of Canada, Reserve Bank of Australia and the European central bank

Foreign exchange

Foreign exchange is money denominated in the currency of another nation or a group of nations The market in which these transactions take place is the foreign exchange market Foreign exchange can be in the form of cash, funds available on credit and debit cards, travelers checks, bank deposits and other short term claims Exchange rate is the price of a currency. It is the number of units of one currency that buys one unit of another currency

Foreign exchange
Players in the foreign exchange markets are: 1. Bank of International settlements ( BIS) a central banking institution in Basel, Switzerland owned and controlled by 55 member central banks 2. Reporting dealers or money centre banks are large banks like HSBC, Deutsche bank etc who are primary members and very large dealers in foreign exchange 3. Other financial institutions are commercial banks excluding money centre banks, hedge funds, pension funds, money market funds, and the like 4. Non- financial customers are governments and companies that participate in the foreign exchange markets

Foreign exchange
The foreign exchange market has two major segments 1. OTC ( over the counter ) market is composed of commercial banks, investment banks and financial institutions 2. Exchange trades market is composed of securities exchanges such as CME group (Chicago mercantile exchange), the Philadelphia stock exchange, and London international financial futures and options exchange (LIFFE), where exchange-traded futures and options are traded

Foreign exchange
Foreign exchange instruments: 1. Spot transactions involve the immediate exchange of currency, which is generally made on the second business day after the date on which the two foreign-exchange dealers agree on the transaction. This rate is called spot rate 2. Outright forward transactions involve the exchange of currency a future date. It is a single purchase or sale of a currency for future delivery. This rate is called the forward rate 3. FX swap: in FX swap one currency is swapped for another on one date and then swapped back on a future date. The first leg is a spot transaction and the second leg is a future transaction. Although a FX swap is a spot and a forward transaction it is accounted for as one 4. In addition to the traditional instruments there are derivatives such as currency swaps, options and futures. Currency swaps are OTC instruments, options are both OTC and traded on exchanges and futures are exchange traded instruments 5. Currency swaps deal with interest-bearing financial instruments (like bonds) and they involve the exchange of principal and interest payments 6. Options are the right but not the obligation to trade foreign exchange in the future 7. A futures contract is an agreement to buy or sell foreign exchange between two parties as specified in the standard contract of the specific exchange

Foreign exchange

Modes of payment in international transaction are: Commercial bill of exchange/ documents through bank. Here the exporter gives all the required documents of the transaction to the buyers bank through their bank along with a bill of exchange or draft asking for payment Letter of credit is an instrument where the buyer specifies the documents he requires, upon receipt of these documents through the sellers bank the buyers bank makes payment to the seller Revocable letter of credit is one where any party can change the terms of L/C Irrevocable L/C is one where changes can be made only if both parties consent Confirmed letter of credit is one where a third bank which is acceptable to both parties confirms the credit worthiness of the buyer

International monetary fund (IMF)

1. 2. 3.

IMF was formed in Dec. 27th 1945 to bring economic stability and growth to the post war world. It started financial operations on March 1st 1947 29 countries initially signed the IMF agreement currently there are about 185 member countries The objectives of IMF are: To promote international monetary co-operation, exchange stability and orderly exchange arrangements To foster economic growth and high levels of employment To provide temporary financial assistance to countries to help ease balance-of-payments adjustment

International monetary fund (IMF)

Bretton Woods and the principle of Par value The bretton Woods agreement established a system of fixed exchange rates under which each IMF member country set a par value for its currency based on gold and the US dollar. Because the value of USD was fixed at $35 per ounce of gold, the value would be the same whether USD or gold was used as the basis This par value became the benchmark by which each countrys currency was valued against other currencies Par values were done away with when IMF moved to greater exchange-rate flexibility

IMF today

The quota system: When a country joins the IMF, it contributes a certain sum of money called quota based on its economic position relative to other countries. The quota is a pool of money that the IMF can draw on to lend to countries and it is the basis of how much a country can borrow from IMF. It is also the basis on which the IMF allocates special drawing rights (SDRs). Quota also determines the voting rights of member countries SDR are IMF currency. It is an international reserve asset created to supplement members existing reserve assets with the IMF. SDR is the unit in which IMF keeps its records Assistance programs: In addition to identifying exchange rate regimes, the IMF provides financial assistance to member countries provided they agree to adopt certain policies which will stabilise the economy and save it from distress Flexible exchange rates: The Jamaica agreement in 1976 formalised the break from fixed exchange rates. As part of this move, the IMF began to permit countries to select and maintain an exchange rate arrangement of their choice and keep the IMF informed

The EURO

The European Monetary Union has its roots in the European Monetary system (EMS) put in place in 1979. It was set up as a means of creating exchange rate stability within the European community (EC) A series of exchange rate relationships linked the currencies of most members through a parity grid As the countries narrowed the fluctuations in their exchange rates the stage was set for the replacement of EMS with the European Monetary union (EMU) In order to join the EMU countries have to comply to several criteria relating to deficit, inflation, debt, interest rates and exchange rate regime. Only 5 of the 27 EMU countries have adopted the Euro in 2008, today there are 17 countries who have adopted the euro Euro is governed by the European Central Bank (ECB)

Determining exchange rates

Currencies that float freely respond to supply and demand conditions free from govt. intervention In this case exchange equilibrium is achieved based on market forces In practice however governments through their central banks do intervene in the market

Different approaches to intervention

Govt. policies change over time depending on economic conditions and the attitude of the prevailing administration in power, irrespective if the currency considered to be freely floating or not US is a good example: In 1989 George H.W.Bush administration intervened on 97 days in the year and sold 19.5 billion USD The first two and a half years of the first Clinton administration the FED intervened on only 18 days and spent 12.5 Billion USD During the first term of George W Bush the FED hardly intervened. They let the USD slide as the hoping that the weakening of the dollar will change the trade deficit in its favour Worried with the falling dollar The Bank of Japan intervened in the market but despite all efforts the Yen gained 11 % between 2003 and 2004 The dollar continued to weaken leading both the EU and Japan to threaten further intervention as their exports to the US to fall