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International Finance

International Finance. You must make transactions with the proper currencies, thus we need “foreign exchange markets” Nations must have a way to value their currency relative to others Foreign Exchange Rate – Expressed two ways: # of units of another’s currency that = one dollar

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International Finance

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  1. International Finance • You must make transactions with the proper currencies, thus we need “foreign exchange markets” • Nations must have a way to value their currency relative to others • Foreign Exchange Rate – Expressed two ways: • # of units of another’s currency that = one dollar • ($1.00 = 117.6 yen = 1.091 euros) • US dollar value for each unit of foreign currency • (1 yen = .0085 dollars, 1 euro = .9166 dollars)

  2. What determines values? • Mostly, the forces of supply and demand • S and D for a currency are largely determined by S & D for goods and services • Example: If there is a large demand for goods from Japan, there will be a large demand for Yen. • Political or Economic Instability • High interest rates in a nation create a demand for that nation’s currency • Exchange rates float and are constantly changing – govts often intervene

  3. Is it good to have a “strong dollar”? • Can have a negative effect on US exports, positive effect for countries selling to US • EX: 2 British pounds = 1 US dollar OR • 1 British pound – ½ US dollar • $100 US watch would sell for 200 pounds in Britain • If Dollar strengthens: • 3 pounds = 1 dollar OR 1 pound = 1/3 dollar • The same watch now costs 300 pounds in Britain and demand for it would decrease

  4. Also, the quantity of British goods demanded in the US would increase • EX: British clothes costing 200 pounds would have originally cost 100 dollars in the US • After the dollar strengthened, the clothes would now cost $66.66 (200/3) • (pound went up by 33%, dollar denominated item will )fall by 33%

  5. Currency Speculation • Investors buy and sell currencies in hopes of making a profit • PPP (Purchasing Price Parity) – exchange rate moves to a “correct” price so goods cost relatively the same in both countries • “Big Mac Index” – Theory of PPP • Big Mac in US costs $2.42, in Japan costs 294 yen • Exchange rate should be 294/2.42 = 121 • If rate is higher than 121, the Yen is undervalued, will rise against the dollar in the future

  6. Balance of Trade • The difference between the dollar value of exports and the dollar value of imports • US has run a trade deficit in all years except one (75) since 1971 • About 25% of our trade deficit is due to oil

  7. Is our trade deficit a problem? • Depends which economist you ask • Some believe we are “borrowing” from foreign nations to finance our consumption • As dollars flow out of our economy • They get more money for their products, can buy more US assets. • Others believe it is not a problem

  8. Balance of Payments • An accounting record of all monetary transactions with other countries • Includes imports and exports, flows of investment funds in and out of the country, loans between nations, etc • Broken down into: • Current Account: goods, services bought and sold and income earned with foreign nations (business / work transactions) • Capital Account: flow of money or capital between nations (investments). Will often flow to nations where interest rates are high.

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