International business and finance pdf notes

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1. INTERNATIONAL BUSINESS & FINANCE

2. CONTENTS :
FOREIGN EXCHANGE RATE THEORIES
- Mint Parity Theory
_ Purchasing Power Parity Theory
_ Balance Of Payment
- Interest Rate Parity Theory
- Fisher Effect Theory

3. FOREIGN EXCHANGE RATE :



Foreign exchange refers to all the currencies other than
the domestic currency of given country.

Foreign exchange rate refers to the rate at which on
currency is exchanged for another or it's the price of
one currency in terms of another.
Ex: exchange rate of dollar is ₹75 per dollar. i.e, $1 =
₹75.

4. gold standard
It explains the determination of exchange rate between
two countries following gold standard.

In a country on gold standard, the currency is either
made of gold or it's value expressed in terms of gold.

According to this mint parity theory, the exchange
rate is equivalent to the gold content relative to that
of another.

mint rate. This exchange rate is known as mint rate.

MINT PARITY THEORY:
1
3
2
4

5. MINT PARITY THEORY - EXAMPLE:



INDIA - ₹50 per gram.
USA - $1 per gram.

ER = 50/1 or ₹50 =$1

6. PURCHASING POWER PARITY THEORY:



This theory is popularised by Gustav Cassel who was
a Swedish economist.
quotient internal purchasing power o
According to Gustav Cassel " the rate of exchange
between two currencies must stand essentially on the
quotient of the internal purchasing power of the
currencies ".
It's based on the rule/law of one price.

7. PURCHASING POWER PARITY THEORY:-
Ex : Suppose the price of 1 kg rice in India is
₹40 whereas in USA it's $2.

So, ER = 40/2
= ₹20 (quotient)
i.e, we need ₹20 to purchase $1.

8. ASSUMPTIONS :-
①
②
③
Transportation cost is zero.
Currency conversion cost is zero.
No trade barriers & quotas.

9. TWO VERSIONS OF PURCHASING POWER
PARITY THEORY:-
1
RELATIVE PPP THEORYRELATIVE PPP THEORY
2
ABSOLUTE PPP THEORYABSOLUTE PPP THEORY

10. ABSOLUTE PPP THEORY:-


According to absolute version, the exchange rate
should normally reflect the internal purchasing
power of various national currency units.
It states that the exchange rate between the
currencies is equal to the ratio of the price levels
in the two nations.
R = P/P* i.e, R = P/P*

11. RELATIVE PPP THEORY:-


The relative version of the purchasing power parity
theory explains the measurement of the changes or
fluctuations in the rate of exchange.
It deals with the relationship between changes in
internal purchasing power and the changes in
exchange rate.
R1 = P1 / P0
P*1/P*0

× R0

12. RELATIVE PPP THEORY:-


If the prices in the home country are rising faster
than the prices in the partner country / foreign
nation, the home currency will depreciate.

If the prices in the home country are rising slower
than the prices in the partner country / foreign
nation, the home currency will appreciate.

13. RELATIVE PPP THEORY - EXAMPLE
Suppose the price of 1kg rice in India & USA are ₹20
and $1 respectively. Therefore the exchange rate will be
₹20 = $1.
1) ₹20 = $1


₹30
i.e R = ₹30 = $1.
2) ₹20 = 1$



₹10
i.e, R= ₹10 = $1.

depreciation Appreciation

14. BALANCE OF PAYMENT (BOP):



systematic record of all economic transactionsBOP is the systematic record of all economic transactions
made between residents of a country and the rest of the
world during a given period of time.

difference between money inflow and outflowIt's the difference between money inflow and outflow of
a country during a given period of time.

It's the record of all financial transactions of
international trade made by a country's residents.

15. 1CURRENT ACCOUNT
2CAPITAL ACCOUNT
3
OFFICIAL SETTLEMENT
ACCOUNT
COMPONENTS OF BOPCOMPONENTS OF BOP

16. COMPONENTS:-


Current account Current account - It includes exports & imports
of goods and services + unilateral payment +
receipts from assets like stock.
Capital accountCapital account - The inflow and outflow of
capital including foreign investment, gold, foreign
exchange reserves. All international capital
transactions are recorded.

17.  Official Settlement account Official Settlement account :- international
monetary flows related to investment in
business, real estate, bonds and stocks + govt
owned assets like foreign reserves, gold,
direct foreign investment etc...

18. INTEREST RATE PARITY THEORY



The Interest Rate Parity states that the interest rate
difference between two countries is equal to the
percentage difference between the forward exchange
rate and the spot exchange rate.
It plays essential role in foreign exchange markets.
The difference between the interest rates in any two
countries is the same as the difference between the
forward and the spot rates of their respective
currencies.

19. 

Currencies with higher interest rate will depreciate
and with lower interest rate will be appreciated.

When the returns on two currencies are equal, interest
rate parity prevails.

20. FISHER EFFECT THEORY:-



relationship
between
The Fisher Effect is an economic theory created by
economist Irving Fisher that describes the relationship
between inflation and both real and nominal interest
rates.

real interest rate
equals the nominal interest rate minus the expected
inflation rate.
The Fisher Effect states that the real interest rate
equals the nominal interest rate minus the expected
inflation rate.

Therefore, real interest rates fall as inflation increases

21. 

r = i - π


r is real interest, i is nominal and pie represents
inflation For example, if the nominal interest rate
on a savings account is 4% and the expected rate
of inflation is 3%, then the money in the savings
account is really growing at 1%.

22. Nominal & Real Interest Rates :



Nominal interest rates reflect the financial return
an individual gets when he deposits money. For
example, a nominal interest rate of 10% per year
means that an individual will receive an additional
10% of his deposited money in the bank.
Unlike the nominal interest rate, the real interest
rate considers purchasing power in the equation.

23. Thank you