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INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT
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INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT

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  • 1. INBU 4200 INTERNATIONAL FINANCIAL MANAGEMENT Lecture 3 Balance of Payments and Exchange Rates
  • 2. A Country’s Balance of Payments <ul><li>An accounting record of the money value of international transactions between one nation and the rest of the world over a specific period of time. </li></ul><ul><li>The record shows the sum of transactions of individuals, businesses, and government agencies located in one nation, against those of all other nations. </li></ul>
  • 3. Two Important Balance of Payments Measures <ul><li>Current Account: </li></ul><ul><ul><li>Trade in goods and services, investment income earned abroad, and unilateral transfers. </li></ul></ul><ul><ul><li>An important sub category of the current account is the trade balance (exports of goods and services minus imports of goods and services) </li></ul></ul><ul><li>Capital and Financial Account: </li></ul><ul><ul><li>Cross border investments in real estate, foreign direct investment, portfolio investment and bank related fund flows (e.g., bank loans). </li></ul></ul>
  • 4. BOP Surplus and Deficit Transactions <ul><li>Individual balance of payments (BOP) transactions can be viewed as either a surplus or deficit transaction. </li></ul><ul><li>Basic rule to use in determining whether the transaction is a surplus or deficit BOP transaction is to: </li></ul><ul><ul><li>Follow the flow of money: </li></ul></ul><ul><ul><li>If as a result of the transaction money flows into a country , it is surplus transaction. </li></ul></ul><ul><ul><li>If as a result of the transaction, money flows out of a country , the transaction it is a deficit transaction. </li></ul></ul>
  • 5. Examples of Surplus and Deficit BOP Transactions <ul><li>United States importing cars from Japan: </li></ul><ul><ul><li>US: Deficit </li></ul></ul><ul><ul><li>Japan: Surplus </li></ul></ul><ul><li>United Kingdom hedge funds investing in US Government securities: </li></ul><ul><ul><li>US: Surplus </li></ul></ul><ul><ul><li>UK: Deficit </li></ul></ul><ul><li>Chinese companies investing in plant and equipment (FDI) in the United States: </li></ul><ul><ul><li>US: Surplus </li></ul></ul><ul><ul><li>China: Deficit </li></ul></ul><ul><li>See Appendix 1 for further detail. </li></ul>
  • 6. US Balance of Payments, 2006 (Billions of Dollars); Net Figures <ul><li>Current Account Balance: -$856.7 </li></ul><ul><ul><li>Goods and Services: -$765.3 (89.3%) </li></ul></ul><ul><ul><li>Investment Income: -$ 7.3 </li></ul></ul><ul><ul><li>Transfers (workers abroad) -$ 84.1 </li></ul></ul><ul><li>Capital Account Balance: -$ 3.9 </li></ul><ul><li>Financial Account Balance: +$719.1 </li></ul><ul><ul><li>US Owned Assets Abroad: -$1,045.8 </li></ul></ul><ul><ul><ul><li>Stocks -$128.5 </li></ul></ul></ul><ul><ul><ul><li>Bonds -$149.2 </li></ul></ul></ul><ul><ul><ul><li>FDI -$248.9 </li></ul></ul></ul><ul><ul><li>Foreign Owned US Assets: +$1,764.9 </li></ul></ul><ul><ul><ul><li>Stocks +$114.0 </li></ul></ul></ul><ul><ul><ul><li>Corporate Bonds +$406.3 </li></ul></ul></ul><ul><ul><ul><li>FDI +$183.6 </li></ul></ul></ul>
  • 7. Use of BOP Data by Global Businesses <ul><li>Multinational businesses use BOP measures to assess types of business opportunities by country. </li></ul><ul><ul><li>What is a country buying, i.e., their imports (suggests a potential export market or FDI opportunity). </li></ul></ul><ul><li>Forecasters use BOP measures as an indicator of the potential pressure on a country’s exchange rate. </li></ul><ul><ul><li>Surplus BOP countries are generally associated with strong currencies. </li></ul></ul><ul><ul><li>Deficit BOP countries are generally associated with weak currencies. </li></ul></ul><ul><ul><li>In this regard, BOP measures are one possible indication of the potential risk for a global firm associated with their currency exposures. </li></ul></ul>
  • 8. Balance of Payments and Exchange Rates <ul><li>The key question for currency markets is how does the relationship between BOP and exchanges rates proceed. </li></ul><ul><li>There are two possible channels: </li></ul><ul><ul><li>1. Changes in the exchange rates will affect, with some lag, balance of payments components. </li></ul></ul><ul><ul><ul><li>For example, a country’s ability to export, or willingness to import, will be affected by changes in the exchange rate. </li></ul></ul></ul><ul><ul><ul><ul><li>See slide on next page. </li></ul></ul></ul></ul><ul><ul><li>2. Changes in a country’s balance of payments position will put pressure on a country exchange rate. </li></ul></ul><ul><ul><ul><li>This was noted in the previous slide and this relationship will be developed through the remainder of this lecture. </li></ul></ul></ul>
  • 9. Relationship of Exchange Rate to Trade Deficit
  • 10. Current and Capital/Financial Account and the Exchange Rate <ul><li>We can think of the current account as a summary of a country’s trade position and the capital/financial account a summary of a country’s international capital flows . </li></ul><ul><li>If the two are roughly equal in size (but opposite in sign) then we can note that a country’s capital/financial transactions are financing that country’s current account transactions. </li></ul><ul><li>If this is the case, then there should be no resulting BOP pressures on that country’s exchange rate. </li></ul>
  • 11. Current and Capital/Financial Account and the Exchange Rate <ul><li>If the current account and capital/financial account are not in rough balance, then we might expect BOP pressures on that country’s exchange rate. </li></ul><ul><ul><li>The typical relationship of these two accounts for the United States since the early 1980s is for the two accounts to roughly cancel each other out. </li></ul></ul><ul><ul><li>Specifically, a surplus in the US capital/financial account has generally financed the deficit in the US current account. </li></ul></ul><ul><ul><ul><li>See slide next page. </li></ul></ul></ul><ul><ul><li>We also see the same pattern for the UK </li></ul></ul>
  • 12. Current (BCA) and Capital /Financial (BKA) Accounts of the US
  • 13. Current (BCA) and Capital /Financial (BKA) Accounts of the UK
  • 14. Current Account and Capital/Financial Accounts not in Balance <ul><li>Whenever these two accounts do not offset one another, BOP exchange rate pressures are likely to exist. </li></ul><ul><ul><li>If both accounts are in surplus, the currency should come under strengthening pressures. </li></ul></ul><ul><ul><ul><li>Japan in 2003 </li></ul></ul></ul><ul><ul><ul><li>China since 2000 </li></ul></ul></ul><ul><ul><li>If both accounts are in deficit, the currency should come under weakening pressures. </li></ul></ul><ul><ul><ul><li>Thailand 1997 </li></ul></ul></ul>
  • 15. Current (BCA) and Capital/Financial (BKA) Accounts of Japan
  • 16. Japanese Yen 2003
  • 17. Balances on the Current (BCA) and Capital (BKA) Accounts of China
  • 18. Chinese Yuan 2002-2007
  • 19. Current and Capital /Financial Account Balances for Thailand, 1991-1998
  • 20. Response of Exchange Rate to 1997 Thailand Current and Capital Account Imbalance.
  • 21. US Dollar in 2006 <ul><li>Go back to slide 6 and look at the data for the US current account and capital/financial account in 2006. </li></ul><ul><li>What do you see? Are the two roughly in balance and if not, what BOP pressures would you have expected on the US dollar that year? </li></ul><ul><li>Go to one of our foreign exchange web site to see what happened to the dollar in 2006. </li></ul><ul><ul><li>Look at the EUR/USD or GBP/USD rates. </li></ul></ul>
  • 22. Issue for US and US Dollar: Increasing Current Account Deficits
  • 23. Who’s Financing the Current Account Deficit?
  • 24. Sources of Balance of Payments Data <ul><li>The Economist Magazine </li></ul><ul><ul><li>Trade Balance, Current Account Balance and BOP Forecasts for Selected Countries. </li></ul></ul><ul><ul><ul><li>Note: Go to Economic and Financial Indicator Section </li></ul></ul></ul><ul><li>United States Balance of Payments Data: </li></ul><ul><ul><li>http:// bea.gov/International/Index.htm </li></ul></ul><ul><ul><li>http:// bea.gov/bea/di/home/bop.htm </li></ul></ul><ul><ul><li>http:// bea.gov / </li></ul></ul><ul><ul><ul><li>Note: Link to International </li></ul></ul></ul><ul><li>OECD Member Country Balance of Payments Data </li></ul><ul><ul><li>http://www.oecd.org/LongAbstract/0%2C2546%2Cen_2649_33715_2487499_119656_1_1_1%2C00.html </li></ul></ul><ul><li>IMF Balance of Payments Data </li></ul><ul><ul><li>http:// www.imf.org/external/np/sta/bop/bop.htm </li></ul></ul>
  • 25. Appendix 1: Real and Financial Balance of Payments Transactions
  • 26. Real and Financial BOP Transactions <ul><li>Cross Border transactions in Real Assets; i.e., purchase or sale of : </li></ul><ul><ul><li>Goods: </li></ul></ul><ul><ul><ul><li>Cars, computers, clothing, agricultural products, industrial products… </li></ul></ul></ul><ul><ul><li>Services: </li></ul></ul><ul><ul><ul><li>Banking, consulting, air travel, student exchange programs, foreign workers. </li></ul></ul></ul><ul><ul><li>Enterprises: </li></ul></ul><ul><ul><ul><li>Cross border acquisitions of companies in other countries. </li></ul></ul></ul><ul><ul><ul><li>Joint ventures with foreign partners. </li></ul></ul></ul><ul><li>Cross Border transactions in Financial Assets; i.e. purchase or sale of: </li></ul><ul><ul><li>Equity </li></ul></ul><ul><ul><ul><li>Common Stock </li></ul></ul></ul><ul><ul><li>Long term Debt </li></ul></ul><ul><ul><ul><li>Bonds </li></ul></ul></ul><ul><ul><ul><ul><li>Private and Government. </li></ul></ul></ul></ul><ul><ul><li>Short term Assets </li></ul></ul><ul><ul><ul><li>Deposits in overseas banks </li></ul></ul></ul><ul><ul><ul><li>Money market instruments </li></ul></ul></ul>
  • 27. Example of BOP Real Asset Transaction <ul><li>Assume: Japan Airlines purchases aircraft from Boeing (United States manufacturer) </li></ul><ul><ul><li>From U.S. BOP standpoint the transaction is the sale of real assets. </li></ul></ul><ul><ul><ul><li>As a result of Boeing’s aircraft exports, money flows to U.S. </li></ul></ul></ul><ul><ul><ul><ul><li>Thus, this is a surplus BOP transaction. </li></ul></ul></ul></ul><ul><ul><li>From Japan’s BOP standpoint the transaction is the purchase of real assets. </li></ul></ul><ul><ul><ul><li>As a result of Japan Airlines, money flows out of Japan. </li></ul></ul></ul><ul><ul><ul><ul><li>Thus, this is a deficit BOP transaction. </li></ul></ul></ul></ul>
  • 28. Example of BOP Real Asset Transaction <ul><li>British company acquires a U.S. company . </li></ul><ul><ul><li>From U.S. BOP standpoint the transaction is the sale of a real asset. </li></ul></ul><ul><ul><ul><li>As a result of the sale of the U.S. company, money flows to U.S. (to shareholders) </li></ul></ul></ul><ul><ul><ul><ul><li>Thus, this is a surplus BOP transaction. </li></ul></ul></ul></ul><ul><ul><li>From U.K.’s BOP standpoint the transaction is the purchase of a real asset. </li></ul></ul><ul><ul><ul><li>As a result of the UK’s purchase of the U.S. company, money flows out of the U.K.. </li></ul></ul></ul><ul><ul><ul><ul><li>Thus, this is a deficit BOP transaction. </li></ul></ul></ul></ul><ul><ul><ul><li>Note: this is an example of foreign direct investment (DFI). </li></ul></ul></ul>
  • 29. Example of BOP Financial Asset Transaction <ul><li>An American mutual fund buys stock listed on the Mexican stock market. </li></ul><ul><ul><li>From U.S. BOP standpoint the transaction is the purchase of financial assets. </li></ul></ul><ul><ul><ul><li>As a result of the purchase of stock, money flows out of the U.S. </li></ul></ul></ul><ul><ul><ul><ul><li>Thus, this is a deficit BOP transaction. </li></ul></ul></ul></ul><ul><ul><li>From Mexico’s BOP standpoint the transaction is the sale of financial assets. </li></ul></ul><ul><ul><ul><li>As a result of Mexico’s sale of stock, money flows into Mexico. </li></ul></ul></ul><ul><ul><ul><ul><li>Thus, this is a surplus BOP transaction. </li></ul></ul></ul></ul><ul><ul><ul><li>Note: this is an example of portfolio investment. </li></ul></ul></ul>

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