1. International Financial
System
By:- Vikram.G.B
Lecturer, P.G. Dept. of Commerce
V.D.C
Bangalore-55

2. Meaning:-
• In finance, the financial system is the system that
allows the transfer of money between savers (and
investors) and borrowers. A financial system can
operate on a global, regional or firm specific level.
• Gurusamy, writing in Financial Services and
Systems has described it as comprising "a set of
complex and closely interconnected financial
institutions, markets, instruments, services,
practices, and transactions."

3. • A financial system can be defined at the global,
regional or firm specific level.
• The firm's financial system is the set of
implemented procedures that track the financial
activities of the company.
• On a regional scale, the financial system is the
system that enables lenders and borrowers to
exchange funds.
• The global financial system is basically a
broader regional system that encompasses all
financial institutions, borrowers and lenders
within the global economy.

4. • The global financial system (GFS) is
the financial system consisting
of institutions and regulators that act on the
international level, as opposed to those that act
on a national or regional level. The main players
are the global institutions, such as International
Monetary Fund and Bank for International
Settlements, national agencies and government
departments, e.g., central banks and finance
ministries, private institutions acting on the
global scale, e.g., banks and hedge funds, and
regional institutions, e.g., the Euro zone.

5. Difference between IMS & IFS
International Monetary System International Financial System
• It constitutes an integrated • It constitutes the full range
set of money flows and of interest‐ and return‐
related governance bearing assets, bank and
institutions that establish nonbank financial
the quantities of money, institutions, financial
the means for supporting markets that trade and
currency requirements and determine the prices of
the basis for exchange these assets, and the
among currencies in order nonmarket activities
to meet payments through which the
obligations within and exchange of financial
across countries. assets can take place.

6. • Central banks, international • Private equity transactions,
financial institutions, private equity/hedge fund joint
commercial banks and various ventures, leverage buyouts
types of money market funds whether bank financed or not,
— along with open markets for etc. are the best examples for
currency and, depending on international financial system.
institutional structure,
government bonds — are all
• In IMS money (in contrast to
part of the international
monetary system. financial assets) is not interest
bearing. But under IFS it is a
interest bearing.
• Money is used as a unit of
account and/or a medium of
• The IFS lies at the heart of the
exchange to support and foster
the exchange of goods and global credit creation and
services, and capital flows, allocation process.
within and across countries.

7. • Money is used as a unit of • the IFS depends on the
account and/or a medium of effective functioning and
exchange to support and foster prudent management of the
the exchange of goods and IMS and the ready availability of
services, and capital flows, currencies to support the
within and across countries; to payment system.
calibrate values and advance the
exchange of financial assets; and • The IFS encompasses the IMS
to foster the development of — but extends in function and
financial markets. complexity well beyond the
IMS.
• IMS events are often about the
availability of liquidity. • IFS crises are more complex
and far reaching. They can
• IMS events can be resolved involve regulatory and reporting
primarily through central bank changes; they have significant
action and common agreement. and enduring economic effects.

8. Components of Financial System.
1. Money.
2. Banking and Financial Institutions.
3. Financial Instruments.
4. Financial Markets.
5. Central Banks.

9. Money:-
• Money is defined as anything that is generally
accepted in payment for goods and services or in
the repayment of debt.
• Monetary theory ties changes in the money
supply to changes in aggregate economic activity
and the price level.

10. Money and Recession
• The periodic but irregular upward and downward
movement of aggregate output produced in the
economy is referred to as the business cycle.
• Sustained (persistent) downward movements in the
business cycle are referred to as recessions.
• Sustained (persistent) upward movements in the
business cycle are referred to as expansions.

11. • Recessions (unemployment) and booms or
expansion (inflation) affect all of us
• Evidence from business cycle fluctuations in
many countries indicates that recessions may be
caused by steep declines in the growth rate of
money.

12. Money and Inflation
• The aggregate price level is the average price of
goods and services in an economy
• Inflation is a continual rise in the price level. It
affects all economic players.
• There is a strong positive association between
inflation and growth rate of money over long
periods of time. A sharp increase in the growth of
the money supply is likely followed by an increase
in the inflation rate.

13. • Countries that experience very high rates of
inflation have rapidly growing money supplies.

14. Banking and Financial
Institutions:-
• Financial Intermediaries are institutions that
channel funds from individuals with surplus funds
to those desiring funds but have shortage of it.
• Among other services, they allow individuals to
earn a decent return on their money while at the
same time avoiding risk; e.g., banks, insurance
companies, finance companies, investment banks,
mutual funds, brokerage houses,

15. • Banks are financial institutions that accept deposits
and make loans.
• Banks make the monetary system a lot more
efficient by reducing our need to carry a lot of cash.
• Innovations in banking like debit cards, direct
deposit, and automatic bill-paying reduce that
inconvenience even further, and also reduce such
bank-related inconveniences of time spent standing
in line at the bank, writing checks, or visiting the
ATM.

16. Financial Instruments:-
• “Securities” is a name that commonly refers to
financial instruments that are traded on financial
markets.
• A security (financial instrument) is a formal
obligation that entitles one party to receive
payments and/or a share of assets from another
party; e.g., loans, stocks, bonds.
• Even an ordinary bank loan is a financial instrument.

17. Financial Markets:-
• Financial markets are mechanisms that allows
people to easily buy and sell (trade) financial
securities (such as stocks and bonds), commodities
(such as precious metals or agricultural goods), and
other fungible items of value at low transaction
costs and at prices that reflect;
• e.g., Bahrain Stock Exchange, New York Stock
Exchange, U.S. Treasury's online auction site for its
bonds.

18. • Financial markets such as stock market and bond
market are essential to promote greater economic
efficiency by channeling funds from who do not
have productive use of fund (savers) to those who
do (investors).
• While well-functioning financial markets promote
growth, poorly performing financial markets can
be the cause of poverty.
• Thus, activities in financial markets may increase
activities in financial markets affect business cycle.

19. • A financial market is a market in which financial
assets (securities) can be purchased or sold
• Financial markets facilitate financing and investing by
households, firms, and government agencies
• Participants that provide funds are called surplus units
– e.g., households
• Participants that enter markets to obtain funds are
deficit units
– e.g., the government

20. Types of Financial Markets:-
• Money and Capital Market.
• Primary and Secondary Market.
• Debt Market.

21. The Bond Market and Interest Rates
• A bond is a debt security that promises to make
specified rate of interest payments periodically for a
specified period of time, with principal to be repaid
when the bond matures.
• An interest rate is the cost of borrowing or the price
paid for the rental of borrowed funds.
• Everything else held constant, a decline in interest
rates will cause consumption and investment to
increase;

22. • An increase in interest rates might encourage
consumers to save more because more can be
earned in interest income but discourage investors
from taking loans.
• Thus, consumption and investment would decrease.
• The bond markets are important because they are
the markets where interest rates are determined

23. The Stock Market
• A stock (a common stock) represents a share of
ownership of a corporation, or a claim on a firm's
earnings/assets.
• Stocks are part of wealth, and changes in their value
affect people's willingness to spend.
• Changes in stock prices affect a firm's ability to raise
funds, and thus their investment.
• The stock market is important because it is the
most widely followed financial market nowadays.

24. • A rising stock market index due to higher share
prices increases people's wealth and as a result may
increase their willingness to spend.
• When stock prices fall an individual's wealth may
decrease and their willingness to spend may decrease.
• Changes in stock prices affect firms' decisions to sell
stock to finance investment spending.
• Fear of a major recession causes stock prices to fall,
everything else held constant, which in turn causes

25. The Foreign Exchange Market
• The foreign exchange market is where funds are
converted from one currency into another.
• The foreign exchange rate is the price of one
currency in terms of another currency.
• The foreign exchange market determines the
foreign exchange rate.

26. Euro Bond Market:-
• The Eurobond market is made up of
investors, banks, borrowers, and trading agents
that buy, sell, and transfer Eurobonds. Eurobonds
are a special kind of bond issued by European
governments and companies, but often
denominated in non-European currencies such as
dollars and yen.
• They are also issued by international bodies such as
the World Bank. The creation of the unified
European currency, the euro, has stimulated strong
interest in euro-denominated bonds as well;

27. • Eurobonds are unique and complex instruments
of relatively recent origin. They debuted in 1963,
but didn't gain international significance until the
early 1980s. Since then, they have become a
large and active component of international
finance. Similar to foreign bonds, but with
important differences, Eurobonds became
popular with issuers and investors because they
could offer certain tax shelters and anonymity to
their buyers. They could also offer borrowers
favorable interest rates and international
exchange rates.

28. • Conventional foreign bonds are much simpler than
Eurobonds; generally, foreign bonds are simply issued
by a company in one country for purchase in another.
Usually a foreign bond is denominated in the currency
of the intended market. For example, if a Dutch
company wished to raise funds through debt to
investors in the United States, it would issue foreign
bonds (dollar-denominated) in the United States. By
contrast, Eurobonds usually are denominated in a
currency other than the issuer's, but they are intended
for the broader international markets. An example
would be a French company issuing a dollar-
denominated Eurobond that might be purchased in
the United Kingdom, Germany, Canada, and the

29. • Like many bonds, Eurobonds are usually fixed-
rate, interest-bearing notes, although many are
also offered with floating rates and other
variations. Most pay an annual coupon and have
maturities of three to seven years. They are also
usually unsecured, meaning that if the issuer
were to go bankrupt, Eurobond holders would
normally not have the first claim to the defunct
issuer's assets.

30. Forward Markets:-
• An informal agreement traded through a broker-
dealer network to buy and sell specified assets,
typically currency, at a specified price.
• A cash market transaction in which delivery of the
commodity is deferred until after the contract has
been made. Although the delivery is made in the
future, the price is determined on the initial trade
date.

31. • In finance, a forward contract is a non-
standardized contract between two parties to
buy or sell an asset at a specified future time at a
price agreed upon today
• an agreement between two parties in which one
party agrees to buy currency from the other
party at a later date at an exchange rate agreed
upon today.

32. • A special type of foreign currency transaction.
Forward contracts are agreements between two
parties to exchange two designated currencies at
a specific time in the future. These
contracts always take place on a date after
the date that the spot contract settles, and are
used to protect the buyer from fluctuations in
currency prices.

33. • The forward market is the informal over-the-
counter financial market by which contracts for
future delivery are entered into. Standardized
forward contracts are called futures
contracts and traded on a futures exchange

34. Forward Foreign Exchange Contract
Definition:
An agreement to exchange one currency for
another, where
• The exchange rate is fixed on the day of the contract, but
• The actual exchange takes place on a pre-determined date
in the future

35. • In a forward market for foreign exchange,
transactions which take place at a future dates are
covered.
• In a forward market there are parties which
demand or supply a given currency at some future
point of time. Forward transactions also known as
future contacts take place due to two reasons.
Firstly, to minimize risk of loss due to adverse
change in exchange rate and secondly to make
profit. First is called hedging and second is called
speculation.

36. Futures Market:-
• In finance, a futures contract is a
standardized contract between two parties to buy
or sell a specified asset of standardized quantity and
quality for a price agreed upon today with delivery
and payment occurring at a specified future date,
the delivery date.
• A currency future, also FX future or foreign
exchange future, is a futures contract to exchange
one currency for another at a specified date in the
future at a price (exchange rate) that is fixed on the
purchase date

37. • A contractual agreement, generally made on the
trading floor of a futures exchange, to buy or sell
a particular commodity or financial instrument
at a pre-determined price in the future. Futures
contracts detail the quality and quantity of the
underlying asset; they are standardized to
facilitate trading on a futures exchange. Some
futures contracts may call for physical delivery
of the asset, while others are settled in cash.

38. • A futures contract is between two parties with
an intermediary involved, the futures exchange.
The contract requires one
• of the parties to agree to make delivery of a
commodity or financial asset and the other party
to take or accept delivery of
• the same commodity or financial asset.

39. • Foreign exchange future market refers to a
type of financial derivative in which two parties
enter into a contract to buy/sell a particular
currency at a pre-determined price on a specific
future date
• A foreign exchange future market is 'marked
to market' thus making it a portfolio of forward
contracts that are adjusted daily for cash
settlements. This in fact mitigates the credit risk
to a very large extent.
•

40. • These are carried out through the clearing house
of the exchange. The margin payments accrue to
the exchange and the exchange ensures the
proper functioning of the contract.
• A foreign exchange future market contract rarely
results in a delivery. It is used by parties as it is a
highly liquid way of hedging and speculating and
efficient transactions can be fixed up without
delay.