International Finance

International Finance

The International flows of goods and capital are behind the subject of International Finance. When we visit a departmental store we find cameras and electrical equipment from Japan, clothing from HongKong and China, on the street we find automobiles from Germany, Japan, Sweden and France using Gasoline from Nigeria, Saudi Arabia, Great Britain, Mexico and Kuwait. We have become so used to enjoying these product from distant lands that it is easy to forget that they are the result of the complex international trading and financial linkages.

Reason for the growing importance of international trade is due to liberalisation of trade and investment, which has occurred via reduction in tariffs, quotas and currency control. Apart from the unprecedented shortage of economic space that is a resultant of rapid improvement in communication and transportation technologies, our habits and standard of living depend to a large degree on what happens in many off-shore distant economies.

The international financial environment is intimately related to the macroeconomic performance of the individual countries that participate in the world economy. An economy's transaction with non-resident reflected in the balance of payment affect the economy's output, consumption and employment performance. The magnitude of balance of payments induced effects on the overall economy is likely to be many times larger that the magnitude of the transaction figuring in balance on payment itself.

The theories currently being used in fundamental analysis can generally be broken down into two categories: a balance of payment flow adjustment model and the asset market stock adjustment model. The forecasting models used to apply these frames can be subjective, econometric or a combination of the two. There is a close relationship between the foreign exchange market and interbank segments of these markets where regulation is minimal and costs are low.

Forward contracts are valuable to importers, exporters and cross-border investors for off-setting risks that could result from moves in the spot exchange rate. The exchange rate of all currencies is given against the US dollar. The exchange rate between two currencies not involving for future delivery of foreign exchange can be made in over the counter markets or on the organized exchanges. The option pricing models developed by theorists are based on certain basic rules of arbitrage practiced by professional traders. The Black Scholes (and its extensions) is an exact pricing formula for European style options.

The development of the swap market has had a profound impact on the evolution of the international financial market in providing a bridge between different markets, different currencies and different financial instruments. As a result the principle of comparative advantage long applied to the market for goods and services is relevant to financial services. Government, Companies and Institutions can now borrow where they have a relative cost advantage. A secondary swap market is developing rapidly although it is far from being as liquid as the market for stocks and bonds.