Introduction to International Finance

www.sanjivanimba.org.in
406 FIN – International Finance
Unit No. 1
Introduction to International Finance
Presented By:
Dr. K. Meenakshi
1
Sanjivani College of Engineering, Kopargaon
Department of MBA

Meaning/Importance
• The world economy refers to the system of producing, distributing, and consuming goods
and services across the globe. It includes all economic activity, from local businesses to
multinational corporations, and encompasses a range of industries such as agriculture,
manufacturing, finance, and services.
• The world economy is critical because it shapes the livelihoods of billions of people
worldwide. It impacts economic growth, employment, income distribution, poverty, and
access to basic goods and services such as food, shelter, and healthcare. Changes in the
global economy, such as technological advancements or trade policies, can have far-reaching
implications for individuals, businesses, and countries worldwide.

Scope
• The scope of the world economy is vast, covering all countries and regions, and it is
interconnected through trade, investment, and other economic activities. The world
economy has expanded significantly in recent decades, driven by globalization, which has
facilitated the integration of markets and increased the mobility of goods, capital, and people
across borders.
• Globalization has also led to the emergence of new economic actors, such as emerging
economies and multinational corporations, which have reshaped the global economic
landscape. The world economy is complex and dynamic, with economic trends and patterns
continually evolving as new challenges and opportunities arise.

Globalization of the World Economy
• The globalization of the world economy has been one of the most significant economic
transformations of the past century. It has been driven by technological advancements,
liberalization of trade and investment policies, and increased mobility of goods, services,
and people across borders.
• Globalization has created opportunities for countries and businesses to tap into larger
markets, access cheaper inputs, and benefit from economies of scale. It has also enabled the
transfer of knowledge, technology, and best practices across borders, contributing to
economic growth and development.
• However, globalization has also brought challenges, such as increased inequality,
environmental degradation, and job displacement. These challenges have led to debates
about the benefits and costs of globalization and calls for greater attention to the
distributional consequences of economic growth.

Goals of International Finance
The goals of international finance are generally centered around promoting economic growth
and stability across national borders.
• Facilitating trade: International finance seeks to facilitate the flow of goods and services
across national borders by providing a means for payment and transfer of funds between
parties in different countries. This is achieved through various mechanisms such as
international banks, currency exchanges, and payment systems.
• Attracting foreign investment: Countries seek to attract foreign investment by providing a
stable and favorable environment for investors. International finance can help facilitate this
process by providing access to global capital markets, reducing barriers to investment, and
offering incentives such as tax breaks or favorable regulatory frameworks.

• Managing exchange rates: Exchange rates play a critical role in international trade and
investment. International finance aims to promote stable exchange rates that facilitate trade
and investment while minimizing volatility that can create economic uncertainty.
• Promoting financial stability: International finance seeks to promote financial stability by
providing mechanisms for risk-sharing, such as insurance and hedging, and by monitoring
and regulating financial markets to prevent systemic risks.
• Promoting economic development: International finance can play a crucial role in
promoting economic development by providing access to capital for infrastructure projects,
supporting small and medium-sized enterprises, and fostering international partnerships
and collaborations that can stimulate innovation and growth.

Structure and participants of the global financial system
The global financial system is a complex network of institutions, markets, and intermediaries
that facilitate the flow of funds and investments across national borders.
• Central banks: These institutions are responsible for setting monetary policy and regulating
the money supply in their respective countries. They also act as lenders of last resort and
provide liquidity to financial institutions during times of crisis.
• International financial institutions: These include organizations such as the International
Monetary Fund (IMF), World Bank, and regional development banks. They provide
financing and technical assistance to support economic growth and stability in member
countries.
• Commercial banks: These are the primary lenders and borrowers in the global financial
system. They provide a range of financial services to individuals, businesses, and
governments, including deposits, loans, and foreign exchange transactions.

• Investment banks: These institutions provide financial advisory and underwriting services
for corporate clients, such as mergers and acquisitions, initial public offerings (IPOs), and
debt offerings.
• Stock exchanges: These markets provide a platform for buying and selling securities, such
as stocks, bonds, and derivatives.
• Regulators: These include government agencies and international bodies that oversee and
regulate financial markets and institutions to ensure they operate in a safe and transparent
manner.

• Hedge funds and private equity firms: These are alternative investment vehicles that invest
in a range of assets, such as stocks, bonds, and real estate. They typically operate with less
regulation than traditional financial institutions.
• Multinational corporations: These companies operate in multiple countries and may use the
global financial system to finance their operations and manage currency risk.
• Individual investors: These include retail investors who trade stocks and bonds through
online brokers, as well as high-net-worth individuals who may invest in alternative assets or
work with private wealth managers.
The global financial system is constantly evolving, with new players and technologies
emerging to shape its structure and operations.

Functioning of the global financial system in the globalization process
The global financial system plays a critical role in the process of globalization. As countries
become more interconnected through trade and investment, the global financial system
provides the infrastructure and mechanisms to facilitate the flow of funds and capital across
borders.
• Facilitating international trade: The global financial system provides a means of payment
and transfer of funds between parties in different countries, which is essential for facilitating
international trade. International banks, currency exchanges, and payment systems are key
components of the global financial system that help to facilitate this process.

• Attracting foreign investment: Countries can attract foreign investment by providing a
stable and favorable environment for investors. The global financial system helps to facilitate
this process by providing access to global capital markets, reducing barriers to investment,
and offering incentives such as tax breaks or favorable regulatory frameworks.
• Managing exchange rates: Exchange rates play a critical role in international trade and
investment. The global financial system helps to manage exchange rates by providing
mechanisms for trading and hedging currency risk, such as currency swaps and options.
• Providing financing for development: The global financial system can provide financing for
development through institutions such as the International Monetary Fund (IMF) and World
Bank. These institutions provide loans and technical assistance to support economic growth
and stability in member countries.

• Spreading financial risks: The global financial system allows financial risks to be spread
across a larger pool of investors and institutions, which can help to reduce the impact of
financial crises and promote stability. However, it can also amplify the spread of financial
contagion in times of crisis.
• Promoting economic growth and innovation: The global financial system can stimulate
economic growth and innovation by providing access to capital for infrastructure projects,
supporting small and medium-sized enterprises, and fostering international partnerships
and collaborations.
Overall, the functioning of the global financial system in the globalization process has both
benefits and challenges, and requires careful management to ensure that it operates in a safe,
transparent, and sustainable manner.

The Emerging Challenges in International Finance
• Technology and Innovation: Technology is rapidly changing the financial industry, with
new innovations such as blockchain, artificial intelligence, and digital currencies disrupting
traditional business models. These new technologies are challenging the traditional role of
financial intermediaries, such as banks and exchanges, and are creating new risks and
opportunities for financial markets.
• Climate Change: Climate change is a growing concern for the financial industry, as it poses
a range of risks to the global economy and financial system. These risks include physical
risks, such as damage from extreme weather events, and transition risks, such as changes in
policy and regulation that could impact the value of investments.
• Regulatory and Policy Uncertainty: Regulatory and policy uncertainty is a significant
challenge for international finance, as it creates uncertainty and volatility in financial
markets. Changes in policy and regulation can impact the value of investments and create
new risks for financial institutions.

• Geopolitical Risks: Geopolitical risks, such as trade tensions, political instability, and
terrorism, are creating new challenges for international finance. These risks can impact the
global economy and financial system, and create uncertainty for investors and financial
institutions.
• Income Inequality: Income inequality is a growing concern for the financial industry, as it
can impact economic growth and stability. Rising inequality can lead to social and political
instability, and create new risks for financial markets.
• Demographic Changes: Demographic changes, such as aging populations and declining
birth rates, are creating new challenges for international finance. These changes can impact
economic growth, the demand for financial products and services, and the sustainability of
social welfare systems.

Addressing these emerging challenges will require innovative approaches and
collaborative efforts across the international financial community. It will be essential for
financial institutions, policymakers, and regulators to work together to promote financial
stability, sustainability, and resilience in the face of these challenges.

Evolution of International Monetary System
The international monetary system has evolved significantly over the past several
centuries. The following are some of the key stages in this evolution:
• The Gold Standard: The gold standard was the first widely-adopted international monetary
system. Under this system, currencies were pegged to gold, and central banks could
exchange their currencies for gold at a fixed rate. This system was in place from the mid-19th
century until the outbreak of World War I.
• Interwar Period: After World War I, the gold standard was restored, but it was eventually
abandoned due to economic pressures caused by the Great Depression. During the interwar
period, several countries adopted protectionist policies, and the international monetary
system became fragmented.

• Bretton Woods System: In 1944, representatives from 44 countries met in Bretton Woods,
New Hampshire to establish a new international monetary system. The system was based on
the US dollar, which was pegged to gold at a fixed rate, and other currencies were pegged to
the dollar. The Bretton Woods system was in place until 1971, when the US suspended the
convertibility of dollars into gold.
• Floating Exchange Rates: Since the collapse of the Bretton Woods system, most countries
have adopted floating exchange rates. Under this system, the value of a currency is
determined by market forces, and central banks may intervene to influence exchange rates.
• European Monetary Union: The European Monetary Union (EMU) was established in 1999,
and the euro became the common currency of participating countries. The EMU is an
example of a fixed exchange rate system, as the exchange rates between eurozone countries
are fixed.

• Emerging Market Currencies: Over the past several decades, emerging market economies
have become increasingly important in the global economy. Many of these countries have
adopted floating exchange rates, while others have pegged their currencies to a basket of
currencies or the US dollar.
Overall, the evolution of the international monetary system has been shaped by a
variety of economic, political, and social factors, and it will likely continue to evolve in the
future.

Gold Standard System
• The Gold Standard System was an international monetary system in which currencies were
pegged to gold at a fixed exchange rate.
• Central banks held gold reserves, and the exchange rate of their currencies was determined
by the amount of gold they held.
• The Gold Standard was used from the mid-19th century until the outbreak of World War I,
and it helped to promote international trade and investment.

Bretton Woods System
• The Bretton Woods System was established after World War II and was in place from 1944 to
1971. Under this system, the US dollar was pegged to gold at a fixed rate, and other
currencies were pegged to the US dollar. The International Monetary Fund (IMF) was also
established during this period to promote international monetary cooperation and stability.
• However, the Bretton Woods System collapsed in 1971 when the US suspended the
convertibility of dollars into gold. This led to the adoption of floating exchange rates, in
which the exchange rate of a currency is determined by market forces.
• Currently, the majority of countries have floating exchange rates, including the United
States, the United Kingdom, Japan, and Australia. However, some countries, such as China,
maintain a fixed exchange rate or a managed float, in which the exchange rate is allowed to
fluctuate within a certain range.

• In addition, some countries have adopted a currency union, such as the European Union,
where countries share a common currency, the euro. Other countries, such as those in the
West African Economic and Monetary Union, have adopted a fixed exchange rate system
where their currencies are pegged to the euro.
• Overall, the international monetary system has evolved significantly over time, and there are
a variety of exchange rate arrangements used by different countries depending on their
economic and political circumstances.

Issues involved in overseas funding choices
Overseas funding choices can involve a range of issues for both borrowers and lenders.
• Currency risk: Borrowers who take out loans denominated in foreign currency are exposed
to currency risk. Fluctuations in exchange rates can make repayments more expensive, and
may affect the borrower's ability to repay the loan. Lenders may also be exposed to currency
risk if they lend in a foreign currency.
• Interest rate risk: Borrowers who take out loans with variable interest rates are exposed to
interest rate risk. Changes in interest rates can affect the cost of borrowing and may make
repayments more expensive. Lenders may also be exposed to interest rate risk if they lend at
a variable interest rate.
• Regulatory requirements: Borrowers and lenders may be subject to different regulatory
requirements in different countries. Borrowers may need to comply with local laws and
regulations, which can be complex and time-consuming. Lenders may also need to comply
with local regulations, such as restrictions on foreign investment.

• Political risk: Overseas funding choices can be affected by political risk. This can include
changes in government policy, political instability, or economic sanctions. These factors can
affect the ability of borrowers to repay their loans and can make lenders more cautious about
lending.
• Reputation risk: Overseas funding choices can also affect a borrower's reputation. Lenders
may be more cautious about lending to borrowers who have a poor reputation or are
associated with controversial industries or practices.
• Access to funding: Borrowers may face challenges in accessing funding in certain countries
or regions. This may be due to a lack of available lenders, or because lenders are cautious
about lending in certain countries or industries.

• Cultural differences: Cultural differences can also play a role in overseas funding choices.
Different countries may have different approaches to business, which can affect the terms
and conditions of loans, as well as the relationship between borrowers and lenders.
Overall, overseas funding choices involve a range of complex issues that need to be
carefully considered by borrowers and lenders alike. Understanding the risks and challenges
involved can help borrowers and lenders make informed decisions about overseas funding
choices.

International Financial Institutions
International Financial Institutions (IFIs) are organizations that provide financial and
technical assistance to countries and governments around the world. The two main IFIs are the
International Monetary Fund (IMF) and the World Bank, while international credit rating
agencies are private companies that assess the creditworthiness of borrowers.

The International Monetary Fund (IMF)
• The International Monetary Fund (IMF) is an international organization that was established
in 1944 to promote international monetary cooperation and exchange rate stability, facilitate
the balanced growth of international trade, and provide resources to help member countries
in need of financial assistance.
• The IMF has 190 member countries and its headquarters are in Washington, D.C. The IMF's
main activities include providing loans to member countries experiencing balance of
payments problems, monitoring global economic trends, and providing technical assistance
to countries in need.

World Bank
• The World Bank is an international financial institution that was established in 1944 to
promote economic development and reduce poverty in developing countries.
• The World Bank is made up of two organizations: the International Bank for Reconstruction
and Development (IBRD) and the International Development Association (IDA).
• The IBRD provides loans to middle-income countries, while the IDA provides concessional
loans and grants to the world's poorest countries.
• The World Bank's main activities include providing financial and technical assistance to
developing countries, supporting private sector development, and promoting sustainable
development.

International credit rating agencies
• International credit rating agencies are private companies that assess the creditworthiness of
borrowers, including governments, corporations, and other entities.
• The three largest credit rating agencies are Standard & Poor's (S&P), Moody's, and Fitch
Ratings.
• These agencies use a range of factors to assess creditworthiness, including a borrower's
financial stability, ability to repay debts, and credit history.
• The ratings provided by these agencies can have a significant impact on a borrower's ability
to borrow money and the interest rates they must pay.

Balance of Payment - Component, Collection reporting, surplus & deficits.
The Balance of Payments (BOP) is a record of all economic transactions between
residents of one country and residents of other countries during a specific period of time. It
includes transactions in goods, services, and financial assets, as well as transfers of money and
capital between countries. The BOP is divided into two main components: the current account
and the capital and financial account.
1. Current Account: The current account records transactions in goods, services, and income
between a country and the rest of the world. The current account has three main
components:
 Trade in goods: the value of goods imported and exported by a country.
 Trade in services: the value of services imported and exported by a country, such as tourism,
transportation, and financial services.
 Income: the income earned by residents of a country from investments abroad, and the
income earned by foreign residents from investments in the country.

2. Capital and Financial Account: The capital and financial account records the movement of
capital between a country and the rest of the world. The capital and financial account has
two main components:
 Capital account: records the transfer of non-financial assets, such as patents, copyrights, and
trademarks, between a country and the rest of the world.
 Financial account: records transactions in financial assets between a country and the rest of
the world, such as the purchase or sale of stocks, bonds, and foreign currencies.

• Reporting and Collection of BOP Data: The BOP data is usually collected and reported by
the central bank or the national statistical agency of a country. The data is compiled from a
variety of sources, including trade statistics, foreign exchange transactions, and international
investment flows.
• Surplus and Deficits: A surplus occurs when a country's receipts (income) from exports and
capital inflows exceed its payments (expenditures) on imports and capital outflows.
Conversely, a deficit occurs when a country's payments exceed its receipts. A deficit may
result in the accumulation of foreign debt and a decrease in a country's foreign reserves. A
surplus, on the other hand, can lead to an increase in foreign reserves and a decrease in
foreign debt.

Thank You

Introduction to International Finance

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