INTERNATIONAL FINANCE

INDU NATH JHA

ASSITANT PROFESSOR
IMPACT COLLEGE
 BRETTON WOODS
• United Nations Monetary and Financial Conference commonly
known as Bretton Woods conference, was a gathering of 730
delegates from all 44 Allied nations.
• To regulate the international monetary and financial activities.
• Fear over Great Depression Many nations wanted protection
from a repeat
• Linked economies don’t go to war
• Support for Govt. intervention in Economic development
• Tools to reconstruct post-war world
 BRETTON WOODS
• The International Bank for Reconstruction and Development
(IBRD); part of world bank
• The General Agreement on Tariffs and Trade (GATT)
• The International Monetary Fund (IMF).
• The Bretton woods system of exchange rate management was
set up
 BRETTON WOODS GOLAS
• The nations should consult and agree on international monetary
changes which affect each other
• They should outlaw practices which are agreed to be harmful
to world prosperity.
• They should assist each other to overcome short-term exchange
difficulties
• The International Monetary Fund (IMF).
• The Bretton woods system of exchange rate management was
set up
 BRETTON WOODS AGREEMENTS
• Formation of the IMF and the IBRD (World Bank)
• Adjustably pegged foreign exchange market rate system:
 The exchange rates were fixed, with the provision of changing them if necessary
• Currencies were required to be convertible for trade related
and other current account transactions
• All member countries were required to subscribe to the IMF's
capital.
• Using the US dollar as a global gold standard
 WORLD BANK
• International Bank for Reconstruction and Development (IBRD)
• International Development Association (IDA)
• International Finance Corporation (IFC)
• Multilateral Investment Guarantee Agency (MIGA)
 IMF SDR BASKET
• U.S. Dollar
• Pound Sterling
• Euro
• Chinese Renminbi
• Japanese Yen
 International Monetary System
• An international monetary system is a set of internationally agreed
rules, conventions and supporting institutions that
facilitate international trade, cross border investment and generally
the reallocation of capital between nation states.
 Historical Perspective of International System
• Bi-metallism system (before 1875)
• Classic Gold system (1875-1914)
• Inter War system (1914-1944)
• Bretton wood system (1944-1972)
• Flexible exchange rate regime: (1973-Present)
 Bi Metallism System
• A “double standard” in the sense that both gold and silver were used as money
• Some countries were on the gold standard, some on the silver standard, some on
both.
• Both gold and silver were used as international means of payment and the
exchange rates among currencies were determined by either their gold or silver
contents
• Gresham’s Law : Bad money drives out good money
 Gold Standard
• Each country defined the value of its
currency in terms of gold.
• Only gold to be used for international
payments
• Two way convertibility between gold &
currency at fix rate.

Advantages:
•Automatic exchange rate correction
•BOP maintained
•Monetary discipline
•Certainty in Exchange rate
 Inter War System
• Gold standard was followed, but
was not classical
• Sterilization of gold was followed
• Period of de-globalization
• Gold standard was dead due to
competitive devaluation
 Bretton Woods System
• The goal was exchange rate
stability without the gold
standard.
• U.S. dollar was pegged to
gold at $35 per ounce and
other currencies were pegged
to the U.S. dollar.
• Triffin Dilemma
 Failure of Bretton woods
• Excess supply of Dollar
• Credibility of Dollar
• Finite nature of gold
• Cold war & international competition
• Nixon shock
 Modern monetary system
• 1976 – Jamaican agreement
• Gold was demonetized
• Currency rate determined by
market forces
• Free float exchange rate
• Managed float exchange rate
 Foreign Exchange
According to Hartly Withers, “ Foreign exchange is the art and science of
international monetary exchange
• Foreign Currency
• Exchange Rate
 FOREX MARKET
A foreign exchange market is the one where one currency (foreign currency)
is bought and sold against another currency (domestic or home currency).
• The major participants in this market are commercial banks,
forex brokers, and authorised dealers and the monetary
authorities
• World’s largest financial market, Over $4 trillion dollars
worth of currency are traded each day
• 24*7 open market
• The main currency used for forex trading is the US dollar.
 Features of Forex Market
• It’s already the world’s largest market and it’s
still growing quickly
• It makes extensive use of information technology
– making it available to everyone
• Traders can profit from both strong and weak
economies
• Trader can place very short-term orders – which
are prohibited in some other markets
• Market is not regulated
• Brokerage commissions are very low or non-
existent
• Always Open Market
 FOREX MARKET - Terminologies
• Foreign exchange reserves- holdings of other countries currencies
• Foreign exchange controls- controls imposed by a government on
the purchase/sale of foreign currencies
• Retail foreign exchange platform- speculative trading of foreign
exchange by individuals using electronic trading platforms
• Foreign exchange risk- arises from the change in price of one
currency against another
• International trade- the exchange of goods and services across
national boundaries
• Foreign exchange company- a broker that offers currency exchange
and international payments
 Participants in ForEx Market
• Central Bank
• Commercial Bank
• Foreign Exchange brokers
• Arbitrageurs (profit by discovering
price differences between pairs of currencies
at different dealers or banks)

• Speculators
• Individuals
1 $ = 10 rupee
1 yen = 1 rupee
1 $ = 5 yen

10 rupee = 1 $ , 10 yen
10 yen = 2 $

10 rupee = 2 $
 Types of ForEx Market
• Spot Market: It is the market where transactions are done for
immediate settlement.
• Forward Market: It is the market where transactions are entered into
for settlement on a future date.
 SPOT MARKET
• Transactions of buying and selling are done
for immediate delivery
• Over-the-counter (OTC) market (a worldwide
linkage of currency traders, non-bank dealers,
foreign exchange brokers who are connected
to one another via a network )
• Most significant currencies in terms of volume
of their trade are dollar, yen, euro, UK pound
and Swiss franc.
• market can be divided into three major
market segments: Australasia, Europe and
North America
 FORWARD MARKET
• Exchange of currencies takes place after some
period from the date of the deal
• In other words, forward rate is the price of one
currency against another to be settled on a
future date
• There is a risk of default on either side
• The currencies of only the major developed
countries are normally traded in the forward
market
• US dollar, euro, Japanese yen, UK pound,
Canadian dollar, Australian dollar, Swiss franc
 Exchange Rate
• Exchange rate means the price of one unit of a
currency in terms of some units of another
currency
($1 = ₹ 70. Meaning, it costs ₹ 70 to buy one dollar (or $0.014 to buy ₹ 1)
• If Exchange rate decreases from 70 Rs./$ to 65 Rs./$
then it is called depreciation of $.
• A rise in exchange rate is called an appreciation.
• When the domestic currency depreciates it buys less of
the foreign currency and when it appreciates it buys
more.
• ForEx rate is one of the most important means through
which a country’s relative level of economic health is
determined.
 Factors affecting Exchange Rate
• Inflation Rates – Changes in market inflation cause changes in currency exchange rates.
• Interest Rates – Increases in interest rates cause a country's currency to appreciate
because higher interest rates provide higher rates to lenders
• Country’s Current Account / Balance of Payments
• Government Debt
• Terms of Trade
• Political Stability & Performance
• Recession
• Speculation
Market Forces behind Exchange Rate Determination
 Demand Supply of Foreign Currency

DD Curve SS Curve

1 $ = ₹ 60 E2 DD < SS

1 $ = ₹ 73 E1 Equilibrium

1 $ = ₹ 80 E3

DD > SS

Quantity of Foreign Exchange

 Modern Exchange Rate System
1. Fixed exchange rate
2. Floating exchange rate
3. Crawling peg
4. Target-zone arrangement
 FIXED EXCHANGE RATE
• Central bank of a country itself decides the
exchange rate of local currency to foreign
currency
• The forces of supply and demand do not
determine the rate.
• Government uses fiscal and monetary policies to
control aggregate demand.
• Pegging to a single currency
• Pegging to a basket of currency
• Pegging to SDRs
• 53 countries have some or the other kind of
fixed exchange rate.
 FLOATING MARKET RATE
• Rate of exchange is determined purely by the
demand and supply of that currency on the
foreign exchange market.
• Independent Floating
• Managed floating
• No government intervention.
• Any change in supply or demand for a currency
will cause a depreciation or appreciation in the
exchange rate
• 35 out of 187 countries have an independent
floating system, The other 51 countries have
managed floating system.
 CRAWLING PEG
• Crawling peg is a compromise between fixed
rate and floating rate regimes
• government maintains a fixed rate regime but
devalues/re-values the currency periodically in
order to keep the exchange rate abreast with
the floating rate.
 TARGET ZONE AGREEMENT
• Target-zone arrangement is found in case of
countries forming some kind of regional
monetary union
• The intra-union exchange rate is fixed through
the help of a common currency, although the
member countries do have their own currency.
 Exchange Rate as Indicator of Economy
• NEER: The nominal effective exchange rate (NEER) is an unadjusted
weighted average rate at which one country’s currency exchanges for a
basket of multiple foreign currencies.
• NEER is an indicator of a country’s international competitiveness in terms of the
foreign exchange (forex) market

• REER: The real effective exchange rate (REER) is the weighted average
of a country’s currency in relation to an index or basket of other major
currencies.
• This exchange rate is used to determine an individual country’s currency value
relative to the other major currencies in the index.
 IMF & International Liquidity
• IMF was converted into a type of ‘Pool of Reserve’
• IMF will pay them a small interest rate for deposits
• IMF would lend this money to a member facing
balance of payment crisis.
• IMF would allot an artificial currency / accounting
unit called SDR (Special Drawing Right) to the
members based on their deposits
• SDR can be traded among the members, it can be
converted into members’ currencies.
• In IMF, a member’s voting power depends on his SDR
quota contribution. (India: 8th largest, 2.75%)
 CURRENCY EXCHANGE IN INDIA
• 1860 onwards: Fixed Fiduciary System (trust +
gold)
• 1935 onwards: Proportional Reserve (gold based)
• 1946 onwards: Bretton Woods / IMF system of
fixed exchange rate (dollar based)
• 1956 onwards : Par Value System (Minimum ForEx
reserve + gold)
• 1991 – 1994 : Partial Convertibility under LERMS
(Liberalized Exchange Rate Management System)
• 1994 onwards : Market based exchange regime
 CURRENCY WAR
• Competitive Devaluation
• A condition in international
affairs where countries seek to
gain a trade advantage over
other countries by causing
the exchange rate of
their currency to fall in relation
to other currencies.