1 International Financial Management

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MBA I


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Why do we need money- Store of Value

- Measure of Value Characteristics of money- Easily transportable- Universally acceptable


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Gold Specie standard- Use of actual gold coins for trade

Gold Bullion Standard- Value of currency fixed with respect to Gold- Exchange of Currency for Gold- The entire money supply in the economy tied

to Gold- Physical Gold stocked by a nation


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When two economies on the Gold standardexchange their currencies

The exchange rate is determined by theamount of gold represented

Three essentials for Gold exchange standardare:

- Fixed Exchange rate- Physical transport of gold- Money supply linked to Gold- http://www.youtube.com/watch?v=AC1S0zH61rk&feature=relatedhttp://www.youtube.com/watch?v=z6NfXk7Bvc8&feature=related
http://www.youtube.com/watch?v=AC1S0zH61rk&feature=relatedhttp://www.youtube.com/watch?v=AC1S0zH61rk&feature=relatedhttp://www.youtube.com/watch?v=AC1S0zH61rk&feature=related


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Post World War II, the capitalist economies led by theUK embarked upon a new system known as BrettonWoods system

Gold Exchange standard wherein:- The US Government undertook to convert US dollar

freely into gold at fixed parity of 35 $ per ounce- Other member countries fixed their parities against

dollar with a variation within 1%-

If the exchange rate hits either of the limits, themonetary authorities would defend it by standingready to buy or sell dollars

- Credit facilities from IMF- AdjustablePeg. Changes upto 10% permitted


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US $ became the international currency The system depended on the confidence of

the US economy The system came under pressure because of

various factors such as US deficits, BOPdisequilibrium, fluctuation of international

gold prices In 1973, the system was dismantled and it was

left to individual countries to decide theirchoice of exchange rate mechanism


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No separate legal tender- The country adopts the legal tender of some

other country e.g. Ecuador, Panama

(Dollarization)- Group of countries adopting a common currency(Euro, Eastern Caribbean Currency union),Central African Economic & Monetary union)

- Currency Board ArrangementFixed exchange rate along with legislativecommitment to exchange domestic currency eg.Bosnia, Bulgaria, Estonia, Hong Kong


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Conventional Fixed Peg arrangement- Akin to Bretton woods system- Adjustable peg with a variation not exceeding 1%

- Fixed against a specified basket of currencies- 49 countries follow this regime Pegged exchange rate with horizontal bands- Variation permitted between wider bands Crawling Peg- The peg is adjusted periodically- The adjustment may be pre-announced or

discretionary or based on certain factors viz. interestrates, growth etc


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Managed Float- Exchange rate floating in general

- Subject to intervention by the central bankfor controlling price movements and volatility- 53 countries including India

Independently floating- Freely floating, no interventions


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Who is replacing Silvio Berlusconi in Italy? What are the yields for Greek and Spanish Bonds? When did Indian Rupee start floating?

How many countries have a managed float regime? What is the Debt to GDP ratio of Germany? What is the all time low of Rupee vis a vis $? Who heads the Bundesbank and the ECB? How many countries are there in the Eurozone? Who was the President when the Gold standard was

abandoned? What is Fed funds rate?


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Created in 1944 for supervising the BrettonWoods system

Objectives include:

- Increasing International monetary co-operation- Promoting growth in Trade- Promoting exchange rate stability- Promoting free trade and convertibility- Research on Monetary policy issues- Consultation and guidance to membercountries- Lending facilities


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All member countries have to contribute to the Fund theQuota allocated to them

Quota is based on the relative importance of the membercountry in terms of share in world trade, GNP etc

25% of the Quota is contributed in terms of Gold, SDR andforeign currency (reserve tranche)

75% of the quota is contributed in terms of the domesticcurrency

The member country can borrow upto reserve tranche

unconditionally The member country can borrow upto 100% of the quota

subject to certain conditions SDR is the international currency created by IMF


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Allocated to members based on their quotas SDR can be used as currency for international

transactions between countries and IMF Value of the SDR is linked to a basket of 4

currencies (Euro, $,Yen and Pound) SDR is also considered as a part of the reserve

position


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BOP disequilibrium Causes of BOP disequilibrium

- High Imports, Capital inflows, structural issuesBOP to be financed by:- Borrowing from IMF

- Own reserves- Borrowing from other sourcesFactors affecting BOP adjustment- Exchange rate regime- Availability of finance- Credit worthiness- Foreign Capital- Propensity to save and import- Price elasticity of various products- Cost structure

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