1. Financial forces in international
Rai, Manju Kumari
Thapa Magar, Dipesh
2. Foreign Exchange
• Foreign exchange, or Forex, is the conversion of one
country's currency into that of another.
• The value of any particular currency is determined by
market forces based on trade, investment, tourism,
and geo-political risk
• Foreign exchange is handled globally between banks
and all transactions fall under the auspice of the Bank
of International Settlements.
3. Factors affecting Demand and Supply of
• Imports and Exports
a rise in import will increase the supply of one’s currency
consequence, is depreciation of the currency. Vice versa
• Money supply of the currency
decrease in money supply of the currency will reduce its
supply in the market and shift the supply curve to left
giving a rise to the price of the currency
• Increase in foreign cash inflow
an increase in foreign inflow of cash will increase the
demand for the currency appreciating the price.
6. Example of foreign exchange rate implication on
• For example, a firm completes a project in Germany and is
paid 1,000,000 Euros for doing so. However, the firm's
domestic currency (the US dollar) is strong and is worth 2
Euros. As such, the exchange of the currency when the profits
are brought home will yield a $500,000 profit domestically.
Contrastingly, if the dollar is weak and 1 Euro is worth $2, the
project will yield the company $2,000,000 in profit after the
exchange of funds. Because exchange rates change
daily, profits realized from a lengthy foreign project can be
eroded unexpectedly. The company can leave the profits
overseas until markets improve, but many countries (including
the US) are beginning to tax companies for doing so in an
effort to have them bring money home sooner
7. Exchange rate systems and international
• In a free-floating exchange rate system, governments and
central banks do not participate in the market for foreign
• A free-floating system has the advantage of being self-
8. • Suppose, for example, that a dramatic shift in world
preferences led to a sharply increased demand for
goods and services produced in Canada. This would
increase the demand for Canadian dollars, raise
Canada’s exchange rate, and make Canadian goods
and services more expensive for foreigners to buy.
Some of the impact of the swing in foreign demand
would thus be absorbed in a rising exchange rate. In
effect, a free-floating exchange rate acts as a buffer
to insulate an economy from the impact of
9. • The primary difficulty with free-floating exchange
rates lies in their unpredictability
• Fluctuating exchange rates make international
transactions riskier and thus increase the cost of doing
business with other countries.
10. Managed Float Systems
• Government or central bank participation in a floating
exchange rate system is called a managed float.
• Countries that have a floating exchange rate system intervene
from time to time in the currency market in an effort to raise
or lower the price of their own currency
• Still, governments or central banks can sometimes influence
their exchange rates. Suppose the price of a country’s
currency is rising very rapidly.
• Suppose the price of a country’s currency is rising very rapidly.
The country’s government or central bank might seek to hold
off further increases in order to prevent a major reduction in
12. • Initially, the equilibrium price of the British pound equals
$4, the fixed rate between the pound and the dollar. Now
suppose an increased supply of British pounds lowers the
equilibrium price of the pound to $3. The Bank of England
could purchase pounds by selling dollars in order to shift the
demand curve for pounds to D2. Alternatively, the Fed could
shift the demand curve to D2 by buying pounds.
13. • Fixed exchange rate systems offer the advantage of
predictable currency values—when they are working.
• But for fixed exchange rates to work, the countries
participating in them must maintain domestic economic
conditions that will keep equilibrium currency values close to
the fixed rates.
• Sovereign nations must be willing to coordinate their
monetary and fiscal policies. Achieving that kind of
coordination among independent countries can be a difficult
14. Taxation and tariffs
• A tariff or customs duty is a tax levied upon goods as
they cross national boundaries, usually by the
government of the importing country. The words
tariff, duty, and customs are generally used
• Tariffs may be levied either to raise revenue or to
protect domestic industries,
15. Tariffs are implied by the government because;
• To protect fledgling domestic industries from foreign
• To protect aging and inefficient domestic industries from
• To protect domestic producers from dumping by foreign
companies or governments. Dumping occurs when a foreign
company charges a price in the domestic market which is "too
low". In most instances "too low" is generally understood to
be a price which is lower in a foreign market than the price in
the domestic market. In other instances "too low" means a
price which is below cost, so the producer is losing money.
16. How tariff is affecting international trade?
• It makes foreign products more expensive, which means that
consumers have to pay more.
• It also means the inefficient firms in the protected industry
get a free ride. That is very bad for the economy. It means
people will earn less in the country over all, and pay more for
foreign goods. It means less people will have jobs. It means
inflation will be higher.
• . In the long term, businesses may see a decline in efficiency
due to a lack of competition, and may also see a reduction in
profits due to the emergence of substitutes for their products.
18. • The overall effect is a reduction in imports, increased
domestic production and higher consumer prices.
19. Inflation and deflation
• Inflation can be defined as an increase in the average price
level of goods and services.
• Deflation can be defined as a fall in the average price level of
goods and services
20. Causes of inflation
• 1. Demand-pull. This means buyers want to buy more than sellers
can actually produce; so sellers start to put prices up.
• 2. Cost-push. This means business costs start to rise (eg oil prices
rise, or wages start to rise) and sellers need to put prices up to
• 3. Monetarist view. This means the government allows too much
money to be created . If the supply of money rises, then the price
falls just as if the supply of potatoes rises, then the price falls. The
price of money here is how many goods and services it will buy. If
the price of money falls, then it will buy fewer goods and services ie
prices of goods and services rise and the value of money falls. This
21. The impact of inflation on international business
• Cost increases can be passed on to consumers more easily if there
is a general increase in prices.
• The real value of debts owed by companies will fall. This means
that, because the value of money is falling, when a debt is repaid it
is repaid with money of less value than the original loan.
Thus, highly geared companies see a fall in the real value of their
• Rising prices are also likely to affect assets held by firms, so the
value of fixed assets, such as land and building, could rise. This will
increase the value of business and, when reflected on the balance
sheet, make the company more financially secure.
• Since stocks are bought in advance and then sold later, there is an
increased margin from the effect of inflation.
22. • during inflation that are not excessive, business could decide to raise their
own prices, borrow more to invest and ensure that increased asset value
appear on their balance sheet. However, high rates of inflation say 10%
and above can be damaging for the business
• Staff will become much more concerned about the real value of their
incomes. Higher wage demands are likely and there could be an increase
in industrial disputes.
• Consumers are likely to become much more price sensitive and look for
bargains rather than big names.
• Rapid inflation will often lead to higher rates of interest. These higher
rates could make it very difficult for highly geared companies to find the
cash to make interest payments, despite the fact that the real value of the
debts is declining.
• Cash flow problems may occur for all businesses as they struggle to find
more money to pay the higher costs of materials and other costs.
23. • If inflation is higher in one country than in other countries
then business will lose its competiveness in overseas market
• Business that sell goods on credit will be reluctant to offer
extended credit periods the repayments by creditors will be
with money that is losing value rapidly.
• Consumers may stockpile some items or transfer their
disposable income t commodities that are more likely to hold
or increase value.
• Business may be forced to cut back spending, cut profit
margins to limit their price rises, reduce borrowing to levels at
which the interest payments are manageable hindering
stimulation of investment, and layoff workers.
24. Balance Of Payment: Another financial
• The balance of payment is a statistical record of a country’s
transactions with the rest of the world
• Payments made to other countries are tracked as debit(-),
while payments from other countries are tracked as credits(+).
The BOP is considered as a double-entry accounting
statement in which total credit and debits are always equal
26. Why a Current account is considered harmful to economy
• If a current account deficit is financed through borrowing it is said
to be more unsustainable.
• Borrowing is unsustainable in the long term and countries will be
burdened with high interest payments. E.g. Russia was unable to
pay its foreign debt back in 1998. Other developing countries have
experience similar repayment problems Brazil, African c (3rd World
• Foreigners have an increasing claim on UK assets, which they could
desire to be returned at any time. E.g. a severe financial crisis in
Japan may cause them to repatriate their investments
• Export sector may be better at creating jobs
• A Balance of Payments deficit may cause a loss of confidence
27. However a current account deficit is not
• Current Account deficit could occur during a period of inward
investment (surplus on financial account)
• E.g. US ran a current account deficit for a long time as it borrowed
to invest in its economy. This enabled higher growth and so it was
able to pay its debts back and countries had confidence in lending
the US money
• Japanese investment has been good for UK economy not only did
the economy benefit from increased investment but the Japanese
firms also helped bring new working practices in which increased
• With a floating exchange rate a large current account deficit should
cause a devaluation which will help reduce the level of the deficit
• It depend on the size of the budget deficit as a % of GDP, for
example the US trade deficit has nearly reached 5% of GDP (02/03)
at this level it is concerning economists
28. What is indebtness?
• Indebtness is the state of a nation being in debt. The national
debt of nation can be raised from domestic market as well as
• Deflation The reduction in demand reduced business activity
and caused further unemployment.
• In a more direct sense, more bankruptcies also occurred due
both to increased debt cost caused by deflation and the
reduced demand effectively made debt more expensive
start of rapid
money supply recession