Question

Analyze and compose the significant components of international and domestic finance.

****This is a International Finance course****

Answer 1

International financial system relates to the management of and trading in international money and monetary assets. These monetary assets are claims on foreign currency, foreign deposits and investments and/or foreign assets. The claims may be denominated in various foreign currencies purchased and sold and involve exchange as between various currencies. Thus, these transactions give rise to (i) Borrowing and lending operations in foreign currencies or trading in financial assets denominated in foreign currencies and (ii) A foreign exchange transaction involving an exchange of one currency for another. The first is called the foreign currency market and the second is the foreign exchange market.

Foreign Exchange Market:

International economic and commercial relations between countries involve exchange of goods and services and payments for these exchanges. The payments lead to conversion of one currency into another. Exchanges between the money and financial assets of one country for money or financial assets of another country constitutes international financial transactions. These transactions are put through the foreign exchange market. The demand for any currency as against its supply in such markets determines the exchange rate. These financial assets could be money or near-money assets, cheques, drafts, mail transfers and other negotiable instruments.

The difference between the domestic financial system and international financial system lies in the introduction of exchange of one currency for another or exchange of one instrument in one currency for another denominated in a different currency. In the process of such exchange, the transfer problem arises in the international markets which relates to the problem of finding the proper source of supply to suit the demand for any foreign currency. This leads to an adjustment process in the balance of payments of the various countries which in turn depends upon the type of international monetary system in vogue.

The International Monetary Fund was established to facilitate transactions as between the member-countries and impart an element of stability in the international monetary scene. Each country can purchase and sell its currency from the International Monetary Fund for another currency of the member country to meet its requirements of international payments for goods and services.

International Currency Markets:

As an adjunct to the exchange markets, there are international currency markets where internationally accepted currencies, namely, the so-called reserve currencies, are traded. These relate to the deposits of such currencies with international banks at an agreed rate of interest. The excess funds in these reserve currencies owned by countries, institutions and governments having surplus receipts over payments would be lent out to banks and other financial institutions for various durations at a rate of interest. The currencies are in demand for meeting the balance of payments deficits or for investment in fixed capital or for working capital purposes.

The other components of the international financial system are international capital markets and bonds markets. The international capital markets such as London, New York, Zurich etc. have lost much of their popularity due to national restrictions and scarcity of funds in those centres. Bond markets in these centres are still operating and international banks are arranging these issues on a selective basis. Now, Euro¬currency and Euro-bond markets are the most popular international means of medium and long-term financing.

The relations between the foreign exchange market and international currency markets are not difficult to comprehend. The trade and other economic and commercial transactions involve receipts and payments as between countries. These will lead to exchange of one currency for others. The demand for and supply of each of the currencies against an alternative currency determines the rate at which two currencies are exchanged. This is called the exchange rate and the market is the foreign exchange market. supply of such currencies is called the international currency market.