International Finance

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					      International finance is the branch of
economics that studies the dynamics of
exchange rates, foreign investment, and how
these affect international trade. It also
studies international projects, international
investments and capital flows, and trade

    It includes the study of futures, options
and    currency     swaps.    Together    with
international   trade   theory,  international
finance is also a branch of international
 Theories in international finance

 Mundell-Fleming model Theory,

 Optimum currency area (OCA) Theory,

 Purchasing power parity (PPP) Theory.
   Mundell-Fleming model
    The Mundell-Fleming model is an economic
model first set forth by Robert Mundell and Marcus

    Typically, the Mundell-Fleming model portrays the
relationship between the nominal exchange rate and
the economy output (unlike the relationship between
interest rate and the output in the IS-LM model) in the
short run. The Mundell-Fleming model has been used
to argue that an economy cannot simultaneously
maintain a fixed exchange rate, free capital movement,
and an independent monetary policy.
   Optimum currency area
       (OCA) Theory
     In economics, an optimum currency area
(OCA), also known as an optimal currency
region (OCR), is a geographical region in
which it would maximize economic efficiency to
have the entire region share a single
currency.    It    describes    the    optimal
characteristics for the merger of currencies
or the creation of a new currency. The theory
is used often to argue whether or not a
certain region is ready to become a monetary
union, one of the final stages in economic
  Purchasing power parity
       (PPP) Theory
     The purchasing power parity (PPP) theory uses the long-
term equilibrium exchange rate of two currencies to equalize
their purchasing power. Developed by Gustav castel in 1920, it is
based on the law of one price: the theory states that, in ideally
efficient markets, identical goods should have only one price.

   This purchasing power SEM rate equalizes the purchasing
power of different currency in their home countries for a given
basket of goods. Using a PPP basis is arguably more useful when
comparing differences in living standards on the whole between
nations because PPP takes into account the relative cost of living
and the inflation rates of different countries, rather than just a
nominal Gross Domestic Product (GDP) comparison.
Sources of Finance for
                                                 IMF gets its funds from
                                                  its 184 member states –
                                                  called ‘quotas’
                                                 Current funds
                                                  in excess of $310 billion
                                                 Quotas determined by
                                                  the economic size of the
                                                  member state
The Headquarters of the IMF in Washington DC.
   The International Monetary
           Fund (IMF)
 Set up in 1944 at the Bretton Woods Conference,
  New Hampshire
 Set up to help put in place an economic structure
  that would help prevent the problems experienced
  by many countries in the 1930s.
 Aims to stabilise the international monetary
  system and help when monetary flow from trade
  causes problems
 Provides help and advice as well as funds to
  countries experiencing balance of payments
         The World Bank
 An agency of the United Nations
A    group of five organisations
  which focus on providing funds
  for projects aimed at alleviating
  poverty, inequality and promoting
 Currently has 184 members
                  The World Bank
The 5 institutions:

The International Bank for Reconstruction and Development
  (IBRD) – provides loans and advice to poor countries to assist
The International Development Association (IDA) – interest free
  credits and grants to countries who are not able to borrow
  through normal market channels
International Finance Corporation (IFC) – providing finance
  through the private sector for development
The Multilateral Investment Guarantee Agency (MIGA) –
  providing investors with protection against risk to promote
  investment in developing countries
The International Centre for the Settlement of Investment
  Disputes (ICSID) – arbitration service in the event of
  investment disputes
       Special Drawing Rights (SDRs)

                                                   Originally set up in 1969 to
                                                    support fixed exchange rates
                                                   Value based on a basket of
                                                    international currencies –
                                                    currently 1.24 SDRs to the £
                                                   Now used as a potential claim
                                                    on currencies of IMF members
                                                    – currencies can be bought in
                                                    exchange for SDRs held by
Ghana participates in the Heavily Indebted Poor
Countries Initiative (HIPC) scheme administered
by the IMF as it attempts to reduce poverty.
The scheme helps it to build new facilities
such as this Salvation Army hostel.
      Foreign Direct Investment (FDI)
 Policies to attract investment
 Such investment often associated with multinational corporations
 Policies need to focus on having the right conditions in place –
    Infrastructure
    Security
    Peace
    Local laws and regulation
    Government corruption
    Freedom of the market
    Local labour supply
    Legal issues – protection for the investor, property rights, etc.
    Tax regime
 Has been criticised as being a means by which MNCs
  can exploit poorer countries
 Bilateral – from one
  to another
 Multilateral –
 aid distributed
 by an agency
 who co-ordinate
                         Aid can be useful for important infrastructure
 donations               projects such as dams which help to generate
                         electricity as well as providing irrigation
              Tax Measures
 Tobin Tax – a tax imposed on currency trading

 Aims to reduce short term speculative trades and
  stabilise currency flows

 Funds raised used to finance development projects

 Political will to implement such a tax?
Domestic Sources
  Of Finance
Business Growth
   External Sources of Finance
                                                          Long Term – may be paid back after
                                                           many years or not at all!
                                                          Short Term – used to cover
                                                           fluctuations in cash flow
                                                          ‘Inorganic Growth’ – growth
                                                           generated by acquisition

The existence of capital markets enable firms to raise
long term loans and share capital.
Copyright: Photolibrary Group
Short Term
 Bank loans – necessity of paying interest on the payment, repayment
  periods from 1 year upwards but generally no longer than 5 or 10 years at
   Overdraft facilities – the right to be able to withdraw funds you do not
    currently have
      Provides flexibility for a firm
      Interest only paid on the amount overdrawn
      Overdraft limit – the maximum amount allowed to be drawn - the
        firm does not have to use all of this limit
   Trade credit – Careful management of trade credit can help ease cash
    flow – usually between 28 and 90 days to pay
   Factoring – the sale of debt to a specialist firm who secures payment and
    charges a commission for the service.
   Leasing – provides the opportunity to secure the use of capital without
    ownership – effectively a hire agreement
Long Term
 Shares (Shareholders are part owners of a company)
    Ordinary Shares (Equities):
         Ordinary shareholders have voting rights
         Dividend can vary
         Last to be paid back in event of collapse
         Share price varies with trade on stock exchange
    Preference Shares:
         Paid before ordinary shareholders
         Fixed rate of return
         Cumulative preference shareholders – have right to dividend carried over to next year
          in event of non-payment
    New Share Issues – arranged by merchant or investment banks
    Rights Issue – existing shareholders given right to buy new shares at
     discounted rate
    Bonus or Scrip Issue – change to the share structure – increases number of
     shares and reduces value but market capitalisation stays the same
Business Angels
 Individuals looking for investment opportunities

 Generally small sums

 Could be an individual or a small group

 Generally have some say in the running of the
                Venture Capital
 Pooling of capital in the form of limited companies –
    Venture Capital Companies
   Looking for investment opportunities in fast growing
    businesses or businesses with highly rated prospects
   May also buy out firms in administration who are going
   May        also     provide       advice,      contacts
    and experience
   In the UK, venture capitalists have invested £50 billion
    since 1983