123477060 international financial management chapter 5 by pg apte

7/21/2019 123477060 International Financial Management Chapter 5 by PG Apte

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1P.G.Apte International Financial Management

International Financial ManagementP G Apte


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5.1 Introduction

The International Monetary System facilitatestransfer of funds between parties, conversion of

national currencies into one another, acquisition

and liquidation of financial assets, and

international credit creation

An important constituent of the lobal financial

system


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5.1 Introduction (contd.)

The relevant aspects of the system

"#chane rate reimes, current and past

International liquidity

The International Monetary $und

The ad%ustment process i&e& how does thesystem facilitate the process of copin withpayments imbalances between tradin nations

'urrency bloc(s and unions such as the "M)


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5.2 Exchange Rate Regime

Exchange Rate Regime

+The IM$ classifies member countries into eiht

cateories

'urrency )nion -o separate leal tender.

'urrency /oard Arranement 'onventional $i#ed 0e Arranements

0eed "#chane ates within ori3ontal /ands

'rawlin 0e

'rawlin bands

Manaed float

Independent float


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5.2 Exchange Rate Regime! A

"itorical Perpecti#e$he Gold %tandard

+Gold Specie Standard; Gold Bullion Standard

Gold ExchangeStandard

Mint Parit&5 The e#chane rate between any pair of currencieswill be determined by their respective e#chane rates aainstold

The old standard reime imposes very riid discipline on thepolicy ma(ers 5

The money supply in the country must be tied to the amount ofold the monetary authorities have in reserve&6hen a country

loses old, money supply must contract&

7omestic economy overned by e#ternal sector&


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5.2 Exchange Rate Regime! "itor&

$he 'retton ood %&tem

The e#chane rate reime that was put in place after 66II canbe characteri3ed as Gold Exchange %tandard

The )S overnment undertoo( to convert the )S dollarfreely into old at a fi#ed parity of 9!4 per ounce

:ther member countries of the IM$ areed to fi# the paritiesof their currencies with the dollar with variation within 1;on either side of the central parity bein permissible

It was anAdjustable Pegsystem& 'entral parity could be chaned

in the face of


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+In return for underta(in this obliation, the member

countries were entitled to borrow from the IM$ tocarry out their intervention in the currency mar(ets

+6henever the e#chane rate tended to move out ofthe 1; band, the central ban( had to sell or buy the

forein currency to brin it bac( within the band&7evaluation?upvaluation when disequilibriumpersisted + Fundamental ie*uili+rium


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Intervention operations affect the domestic

money supply and then the price level, -0 etc&

These effects may have an automatic corrective

effect + 'entral ban( sells fore#, money supply

contracts, price level reduces, -0 reduces,imports decline, the pressure on home currency

reduces&

'entral ban( can


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+ This system could wor( as lon as other countries hadconfidence in the stability of the )S dollar and in theability of the )S treasury to convert dollars into oldon demand at the specified conversion rate

+ The system came under pressure and ultimately bro(e

down when this confidence was sha(en due to variouspolitical and some economic factors startin in mid1B8Cs&

+ Abandoned in 1B>! after some attempts to fi# it andrevive it&

+ Ma%or currencies started floatin in early 1B>!&


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Is there an


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+:ne school of thouht feels there will be only two

types of e#chane rate reimesTruly fi#ed rate arranements

Truly mar(et determined, floatin rates

+The


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$"E IMP,%%I'-E $RII$/

Full Capital Controls

Monetary 0olicy Stable "#chane

Independence ate

Floating Rate Interation Currency Union


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5.0 $he International Monetar& Fund

(IMF)

$he role o IMF+ $ramewor( of the Articles of Areement adopted at

/retton 6oods in1B**

Increasin international monetary cooperation

0romotin the rowth of trade 0romotin e#chane rate stability

"stablishin a system of multilateral payments,eliminatin e#chane restrictions which hamper therowth of world trade and encourain proress

towards convertibility of member currencies /uildin a reserve base


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(IMF)

$undin facilities+ :peration of the ad%ustable pe requires a country to

intervene in the forein e#chane mar(ets to support itse#chane rate when it threatens to move out of the

permissible band+ eserve Tranche E 'redit Tranche& Their

conditionalities

+ :ther fundin facilities such as "SA$, I0' initiativeetc& and their implications for recipient countries&

+ IM$ often criticised for imposin conditions which domore damae than ood&


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(IMF)

International -i*uidit& and %pecial raingRight (%R)+ International Giquidity and International eserves

International liquidity refers to the stoc( of means of

international payments International eserves, are assets which a country

can use in settlement of payments imbalances thatarise in its transactions with other countries

International eserves H eserve position in IM$ S7s $ore# assets held by central ban(


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+Special 7rawin ihts S7s. S7 is international fiat money created by IM$ and

allocated to member countries&

'an be used by 'entral ban(s to settle paymentsamon themselves& Selected other institutions

allowed to hold and use S7s In order to ma(e S7s an attractive asset to hold,

the $und pays interest on holdins in e#cess of amemberJs cumulative allocation and it charesinterest on any shortfalls

ave not become popular as reserve asset


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5.0 International -i*uidit&

7emand for eserves and 'omposition of eserves

+ In the positive tradition, reserve stoc( is related to thevolume of imports, marinal propensity to import, variabilityof e#port earnins and so forth

+ In the optimi3in approach, reserve holdins are arrived atby equatin the marinal cost of holdin reserves to the

marinal benefit+ The problem of currency composition of reserves has been

posed as a problem in portfolio selection alon the lines ofthe Mar(owit3KSharpe portfolio choice models

+


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The ole of IM$ in the 0ostK/retton 6oods 6orld

+ )nder the /retton 6oods system the IM$ was

responsible for the functionin of the ad%ustable pe

system

)nder the current FnonKsystemF that role has

considerably diminished if not eliminated+ The $und is mandated to Fe#ercise firm surveillance

over the e#chane rate policies of membersF

+ The $und has played an important role in tac(lin the

debt crisis of developin countries


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5.3 $he Pro+lem o Ad4utment

"very open economy, from time to time faces the problem ofimbalance on its e#ternal transactions

The /:0 disequilibria may be transitory or permanent innature

The country must choose between financin the imbalance orunderta(in a proramme of ad%ustment& elevant factors5

"#chane ate eimeL Availability of $inancinL

'reditworthiness of the 'ountryL "#portKImport 7emand"lasticitiesL Savin and Import 0ropensitiesL /ehaviour of

7omestic 'ostsL State of the "conomy

Ad%ustment more urent for deficit countries&


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5.5 $he Economic and Monetar&

nion (EM)! "itor&

Ad%ustable pe system called Snakewas bornamon the countries belonin to the "uropean"conomic 'ommunity ""'. in 1B>2

In 1B>B, the sna(e became the "uropean Monetary

System "MS. The feature that distinuished "MS from the sna(e

was the "uropean 'urrency )nit "')., a S7Kli(e bas(et of currencies

The "') was the precursor of the commoncurrency "uro


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5.5 EM! "itor&

Monetary )nion had been

envisaed as a part of themove towards creatin a sinle economic 3one in "urope

ust when it appeared that "urope will steadily marchtowards an economic and monetary union as envisaedin the FMaastricht treatyF, the system received severe

%olts Frowth and Stability 0actF in 1BB8

The sinle currency F"uroF came into e#istence onanuary 1 1BBB


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5.5 $he Economic and Monetar&

nion

After 2CC2, their individual currencies will cease

to e#ist

The parities of the eleven member currencies

aainst each other and aainst the "uro wereirrevocably fi#ed when "uro was born&

At the start 1 "uro H 1 "')

The "M) and the "uro provide a model for othercurrency unions

123477060 international financial management chapter 5 by pg apte

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