Unit 1: International finance and forex markets
International Finance and Financial Derivatives notes · PTU syllabus (MBA 915-18)
On this page
- Unit summary
- Overview of international finance
- Scope of international financial management
- Balance of payments fundamentals
- Factors affecting international trade flows
- Evolution of the international monetary system
- Foreign exchange market: functions, structure, participants and quotations
- Key terms
- Quick revision
- Important questions
Unit summary
International finance deals with money crossing borders — trade, investment and the currencies that link them. This unit covers the overview and scope of international financial management, balance of payments fundamentals, factors affecting international trade flows, the evolution of the international monetary system from the gold standard to Bretton Woods and beyond, the foreign exchange market's functions, structure and participants, and exchange rate quotations.
After this unit you can
- Explain the scope of international financial management
- Explain the balance of payments and factors affecting trade flows
- Trace the evolution of the international monetary system
- Explain the forex market and exchange rate quotations
PTU syllabus topics
- Overview and scope of IFM
- balance of payments fundamentals
- factors affecting international trade flows
- evolution of the international monetary system (Gold Standard, Bretton Woods)
- forex market function/structure/participants
- exchange rate quotations
- 1Gold standard
Until 1914
- 2Inter-war period
Instability
- 3Bretton Woods
1944–1971: fixed to USD, USD to gold
- 4Floating rates
Since 1973
- 5Today
Mix of floating and managed regimes
Topic 1
Overview of international finance
- Globalisation: integration of markets for goods, services, capital, technology and people — driven by trade liberalisation (WTO), technology, deregulation of capital flows.
- Multinational corporation (MNC): a firm with operations (production, sales) in several countries — Tata Group, Infosys, Unilever.
- Why firms go global: new markets, lower costs, access to resources and technology, diversification, following clients, tax and regulatory advantages.
Topic 2
Scope of international financial management
- IFM differs from domestic FM due to foreign exchange risk, political (country) risk, market imperfections (taxes, capital controls) and expanded opportunity sets (global sourcing of funds).
- Goal: maximise shareholder wealth of the parent, considering exchange rates, country risk and global cost of capital.
Foreign exchange markets and risk management
International investment decisions
FDI, international capital budgeting
International financing
Euro markets, ADRs/GDRs, ECBs
Working capital and cash management across countries
International taxation and transfer pricing
Political risk assessment
Topic 3
Balance of payments fundamentals
Balance of payments (BoP) is a systematic record of all economic transactions between residents of a country and the rest of the world over a period.
Current account
Merchandise trade, services (IT, travel), primary income (interest, dividends), secondary income (remittances)
Capital account
Capital transfers, non-produced non-financial assets
Financial account
FDI, portfolio investment, loans, banking capital, changes in reserves
Errors and omissions
Statistical discrepancy
- Double entry: every transaction has a credit and a debit, so the BoP always balances in accounting terms; deficits refer to sub-balances (trade or current account).
- India: persistent merchandise trade deficit offset by services exports and remittances (India is the world's largest recipient of remittances); current account deficit financed by capital inflows.
Topic 4
Factors affecting international trade flows
- Inflation: higher domestic inflation reduces exports and raises imports.
- National income: faster income growth raises imports.
- Exchange rates: a weaker currency makes exports cheaper and imports dearer (subject to the J-curve lag).
- Government policies: tariffs, quotas, subsidies, export incentives, trade agreements, sanctions, product standards.
- Others: productivity and costs, global demand, logistics, technology.
Topic 5
Evolution of the international monetary system
- 1Gold standard (1876–1913)
Currencies convertible into gold at fixed rates; automatic adjustment through gold flows
- 2Inter-war period (1915–1944)
Abandonment of gold, competitive devaluations, instability
- 3Bretton Woods (1944–1971)
US dollar convertible into gold at $35 an ounce; other currencies pegged to the dollar; IMF and World Bank created
- 4Collapse (1971–73)
Nixon ended dollar–gold convertibility; Smithsonian Agreement; move to floating
- 5Flexible regime (1973 onward)
Jamaica Agreement 1976 — managed and free floats, pegs, currency boards, euro (1999)
- India: fixed pegs until 1991; dual rate (LERMS) 1992; market-determined rate from 1993 with RBI intervention to curb volatility; current account convertibility from 1994.
Topic 6
Foreign exchange market: functions, structure, participants and quotations
- Structure: a 24-hour, over-the-counter global market; participants — commercial banks (authorised dealers), central banks, corporates, brokers, investors; segments — retail and inter-bank; spot (settlement in two business days), forward, futures, options, swaps.
- India: regulated by RBI under FEMA; FBIL reference rate; currency derivatives on NSE/BSE; RBI intervenes to reduce volatility (managed float).
Meaning
Units of home currency per unit of foreign currency
Units of foreign currency per unit of home currency
Example in India
₹83.50 per US$
US$ 0.01198 per ₹
Used in India
Yes (since 1993)
Earlier
- Bid–ask spread: dealer buys at bid, sells at ask; spread % = (Ask − Bid) ÷ Ask × 100.
- Cross rates: derived through a common currency — ₹/€ = (₹/$) × ($/€).
- Forward premium/discount (annualised): (Forward − Spot) ÷ Spot × 12/n × 100.
Example
Spot ₹83.00/$, 3-month forward ₹83.83/$. Forward premium on dollar = (0.83 ÷ 83) × 4 × 100 = 4% p.a.
Key terms
- Balance of payments
- Record of a country's transactions with the rest of the world
- Current account
- Trade in goods and services plus income and transfers
- Bretton Woods system
- Fixed exchange rates pegged to the dollar, 1944–1971
- Managed float
- Market-determined rate with central bank intervention
- Direct quote
- Price of one unit of foreign currency in home currency
Quick revision
- IFM scope: MNCs, forex risk, global capital, investment decisions.
- BoP: current, capital, financial accounts; double entry; India's pattern.
- Trade flows: inflation, income, exchange rates, policy.
- Gold standard → Bretton Woods → floating; India's evolution.
- Forex market functions, participants, spot and forward, direct and indirect quotes, bid–ask, cross rates.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.What is international financial management?
- Q2.Name the components of the current account.
- Q3.State three factors affecting international trade flows.
- Q4.What was the Bretton Woods system?
- Q5.Name four participants in the forex market.
- Q6.Distinguish direct and indirect quotations.
Long-answer questions
- Q1.Explain the scope of international financial management.
- Q2.Explain the structure of the balance of payments.
- Q3.Trace the evolution of the international monetary system.
- Q4.Explain the functions, structure and participants of the foreign exchange market.
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