chapter 11 an introduction to international finance

Chapter 11

An Introduction to International Finance

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 11-2

Topics to be Covered

• Balance of payments

• Exchange rates

• Prices and exchange rates

• Interest and exchange rates

• Other topics


Balance of Payments (BOP)

• BOP—a record of a country’s economic transactions with the rest of the world.


Trade Surplus vs. Trade Deficit

• Trade surplus—occurs when a country’s merchandise exports exceed its imports.

• Trade deficit—occurs when a country’s merchandise imports exceed its exports.

• The U.S. has consistently run trade deficits, with 1975 as the last surplus year, while Japan, Germany, and Canada have had trade surpluses (refer to Figure 11.1).


Exchange Rates

• Foreign Exchange Market (FEM)—the market where monies of different countries are traded.

• Exchange rate—price of one country’s money in terms of another.


Features of Foreign Exchange Market

• Refer to Table 11.1 FEM Trading Volume

• The total volume of trade in the foreign exchange market was over $2.4 trillion in 2004.

• The largest markets are the United Kingdom, accounting for 31% of the market, and the U.S. with a 19% share.


Features of FEM (cont.)

• Refer to Table 11.2

• The most traded currency is the U.S. dollar, accounting for 90% of the total amount traded.

• The dollar is followed by the euro, Japanese yen, and the British pound.


Prices and Exchange Rates

• Purchasing Power Parity (PPP) holds when two currencies have the same purchasing power in the two countries.

• Chapter 14 will analyze the prices–exchange rate relationship in more detail.


Big Mac PPP

• Refer to Table 11.3 Big Mac PPP

• If the price of a Big Mac hamburger was $1 in the U.S. and ¥100 in Japan and the ¥/$ exchange rate was 100, then the Big Mac PPP holds.

• PPP appears to hold more for Canada.

• China’s yuan is undervalued by 55% against the dollar, thus dollars will buy a lot in China. The reverse is true for Switzerland.


Interest Rates and Exchange Rates

• Figure 11.2 shows that even countries with close and extensive economic ties can have independent movements in their interest rates.

• Interest differentials among countries may reflect expected exchange rate changes as well as risk premiums.

• Chapter 15 will discuss interest rates in more detail.


Additional Major Topics to be Covered Later

• Foreign exchange risk—the risk of an unexpected change in the exchange rate.

• International investment—portfolio investment and direct investment.

• International monetary systems—history of international financial systems.


Additional Topics (cont.)

• International banking—offshore banking and country risk analysis

• International macroeconomics—determination of equilibrium income, interest rates, and exchange rates in a global setting.

chapter 11 an introduction to international finance

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