2. bop & exchange rate determination

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Chapter 2



� Importance: Increased interdependence in the Global Village

Increased prosperity

Best utilization of natural resources & specialization of countries

WTO

Technology has connected the world

LPG (Liberalization, Privatization & Globalization) in 1991

� Scope of International Finance

Foreign Trade (Export & Import)

Foreign Direct Investment

Multinational Companies

International Financing

Creation of Trading Blocks



� Different Financial policies & tax rates of different

countries i.e. different financial system

� Trade Barriers : Import quota & tariffs, Export subsidies

� Different Currencies

� Different laws

� Different risk due to different environment (political-

social)



Trading blocks are formed by geographically close countries

� Free Trade Areas

Elimination of tariffs & quantitative import restriction

� Custom Unions

Setting common trade barriers for outsiders

� Common Market

Free flow of factors of production: Labour & capital

� Economic Union

Common Bank, laws, taxes & currency Eg. European Union of 15 countries of

Europe with common currency Euro



A. Current Account

1. Merchandise-

1. Exports ( on f. o. b. (free on board) basis)

2. Imports (on c.i.f. (cost, insurance & freight) basis)

2. Invisible (a + b + c)

a. Services

i. Travel

ii. Transportation

iii. Insurance

iv. G.n.i.e. (Government not included elsewhere)

v. Miscellaneous

� Software Services

� BusinessServices

� FinancialServices

� Communication Services

b. Transfers

i) Official

ii) Private

c. Income

i) Investment Income

ii) Compensation of EmployeesTotal Current Account (I+II)



B. CAPITAL ACCOUNT

1. Foreign Investment (a+b)

a) Foreign Direct Investment (i+ii)

b) Portfolio Investment

2.Loans (a+b+c)

a) External Assistance

i) By India

ii) To India

b) Commercial Borrowings (MT&LT)

i) By India

ii) To India

c) Short Term to India

3. Banking Capital (a+b)

4. Rupee Debt Service

5. Other Capital

Total Capital Account (1to5)

C. Errors & Omissions

D. Overall Balance (Total Capital Account, Current

Account and Errors & Omissions (A+B+C))

E. Monetary Movements (i+ii)

i. I.M.F

ii Foreign Exchange Reserves



Exchange Rate - Amount of one currency neededto purchase one unit of another.

± Spot Rate of Exchange - Exchange rate for animmediate transaction.

± Forward Exchange Rate - Exchange rate for aforward transaction.



� Exchange rates

± Direct quotations vs. Indirect quotations

± Direct: Rs per unit of foreign currency

» Example: Rs 50 per US Dollar

± Indirect: Units of foreign currency per Rupees

» Example: 0.02 USD per Rs

± Cross Rate: Units of foreign currency(f1) in another foreign currency (f2) and

units of f2 and domestic currency.

� Exchange Rates: Forex Operators¶ rates & Interbank rate

± Bid Rate: Buying price of Forex operator

± Ask rate: Selling price of Forex operator



� Fixed

� Floating

Free Float Managed Float

� Hybrid

Crawling Peg



� Bimetallism: Before 1875

� Classical Gold Standard: 1875-1914

� Interwar Period: 1915-1944� Bretton WoodsSystem: 1945-1972

� The Flexible Exchange Rate Regime: 1973-Present



� Letter of Credit� ECGC� Netting & Matching� Hedging

Forwards

Futures Options

Call Option Put Option

Swaps Others

2. bop & exchange rate determination

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