Introducing the concept of international finance, discussing the importance of global financial markets, exchange rates, and the role of multinational corporations in the global economy.
Overview of International Finance
Key concepts, institutions, and mechanisms that shape cross‑border financial activity.
| Element | Description |
|---|---|
| International Finance | Study of monetary interactions among countries: capital flows, exchange rates, and the global financial system. |
| Objectives | • Allocate capital efficiently across borders • Manage currency risk • Support international trade and investment • Stabilize economies through policy coordination |
| Core Questions | 1. How are exchange rates determined? 2. What drives international capital flows? 3. How do governments and institutions influence global finance? |
| Regime | Main Features | Typical Examples |
|---|---|---|
| Fixed (Pegged) | Central bank commits to a set rate against another currency or basket; intervenes to maintain the peg. | Hong Kong dollar (USD peg), Saudi riyal (USD peg) |
| Floating (Flexible) | Rate determined by market forces; central bank may intervene occasionally. | US dollar, Euro, Japanese yen |
| Managed Float (Dirty Float) | Mostly market‑driven but with occasional official interventions to smooth volatility. | Indian rupee, Brazilian real |
| Currency Board | Domestic currency fully backed by foreign reserves; strict conversion at a fixed rate. | Bulgaria (until 2020), Estonia (pre‑Euro) |
| Dollarization / Euroization | Domestic economy adopts a foreign currency as legal tender. | Ecuador (USD), Montenegro (Euro) |
Key Concepts
| Theory | Core Idea | Main Drivers |
|---|---|---|
| Purchasing Power Parity (PPP) | Identical goods should cost the same when expressed in a common currency. | Relative price levels, inflation differentials. |
| Interest Rate Parity (IRP) | Expected return on domestic assets equals return on foreign assets after accounting for exchange‑rate changes. | Interest‑rate differentials, forward/spot rates. |
| Mundell‑Fleming Model | Extends IS‑LM to open economies; shows interaction of monetary/fiscal policy with exchange rates under different capital mobility. | Policy stance, capital mobility, exchange‑rate regime. |
| Portfolio Balance Approach | Exchange rates reflect supply/demand for assets, not just money. | Asset preferences, risk premia, expectations. |
| Behavioural Models | Market participants’ expectations and herd behaviour influence rates. | Sentiment, speculative flows, news. |
| Market | Instruments | Participants |
|---|---|---|
| Foreign‑Exchange (FX) Market | Spot, forward, swaps, options, futures | Banks, corporations, hedge funds, central banks |
| International Money Markets | Treasury bills, commercial paper, certificates of deposit | Sovereign borrowers, multinational corporations |
| International Bond Markets | Eurobonds, foreign‑currency bonds, sovereign bonds | Governments, supranational institutions, corporates |
| Equity Markets | ADRs/GDRs, cross‑listed shares, global ETFs | Investors, issuers, index providers |
| Derivatives Markets | Currency options, interest |