International Financial Management

The first three chapters of this book provide insights into the nature of foreign exchange markets and foreign exchange risks. To understand these concepts more deeply, you need to understand the economic forces that cause exchange rates to fluctuate. Exchange rates respond to demand and supply of trade currencies. These demands and supplies arise from international trade flows and international capital flows.

Plenty of useful information about these international flows is provided by the balance of payments, which records the payments between residents of one country and the rest of the world over a given time period. As such, it helps shed a great deal of light on the supply and demand for various currencies, the possible evolution of their exchange rates, and the global financial marketplace in general.

Balance of payments statistics are discussed daily by politicians, the news media, and currency analysts at corporations, commercial banks, investment banks, and mutual funds. Currency traders eagerly await the release of new balance of payments statistics because they know exchange rates will move with the new information. We will see how the balances on various subaccounts are linked to domestic and international saving and investment decisions and ultimately how they may determine a country's financial and economic health. For example, multinational firms should recognize that persistent current account deficits in developing countries can signal that currency devaluations are likely to occur there, with potentially dire economic ramifications. In developed countries, persistent current account deficits can lead legislators to unleash protectionist policies, such as tariffs and embargoes on imported goods and services. Every company in the world doing business with China keenly follows the effect that the US trade deficit with China is having on the two countries’ trade policies.

The Balance of Payments: Concepts and Terminology

A country's balance of payments (BOP) records the value of the transactions between its residents, businesses, and government with the rest of the world for a specific period of time, such as a month, a quarter, or a year. Hence, the BOP summarizes the international flows of goods and services and changes in the ownership of assets across countries.