INTERNATIONAL

FINANCE

Meaning & Definition

International finance is the branch of
economics that studies the dynamics of
exchange rates, foreign investment and how
these affect international trade

Demonstration of some effects

of change in exchange rate
December 2008
Exchange Rate

US $ 1 = Pak Rupee 60
International
price (US $)

Price in Pakistan
(PKR)

120

Raw Material

100

6000

Foreign Loans

40 billion

2400 billion

FDI

10 billion

600 billion

Imported Commodity (per

unit)

May 2014
Exchange Rate

US $ 1 = Pak Rupee 98

International
price (US $)

Price in Pakistan
(PKR)

196

Raw Material

100

9800

Foreign Loans

40 billion

3920 billion

FDI

10 billion

980 billion

Imported Commodity (per

unit)

Change
Internati
Price I Pakistan (PKR)
onal
December
May 2014
price
(US $) 2008

Change

120

196

76

Raw Material

100

6000

9800

3800

Foreign Loans

40
billion

2400 b.

3920 b.

1520 b.

FDI

10
billion

600 b.

980 b.

380 b.

Imported
Commodity
(per unit)

2.

International Financial
Markets

2.1 Motives for using international

financial markets
2.1.1 Motives for investing in foreign markets
2.1.2 Motives for providing credit in foreign markets
2.1.3 Motives for borrowing in foreign markets

2.1.1

Motives for investing in foreign markets

Economic conditions
International diversification
Exchange rate expectations

A person has Rs 120,000 and want to invest in securities. He has two options, one is to
invest in PKR denominated securities @ 12% and second option is to invest in US$
denominated securities @ 2%.
Exchange rate at start: USD 1 = PKR 60
Expected Exchange rate at end: USD 1 = PKR 85

Calculations
Choice

Investmen
t

Return
Rate

Return

Maturity

conversion

Total
receiving
(Rs)

1
(Rs)

Rs.
120,000

12%

Rs.
14,400

Rs.
134,400

NA

134,400

2
(USD)

$ 2000

02%

$ 40

$ 2040

@ Rs 85

173,400

Differentials

39,000

2.1.2 Motives for providing credit in

foreign markets
High foreign interest rates
Exchange rate expectations
International diversification

2.1.3 Motives for borrowing in foreign markets

Low interest rates

Exchange rate expectations
Nestle Pakistan (subsidiary) is in need of Rs. 600,000 loan. He has two choices, one is
to borrow from Pakistan @ 12% and second choice is to borrow from Switzerland @
2%.
Exchange rate at start: USD 1 = PKR 60
Expected Exchange rate at end: USD 1 = PKR 85

Calculations

Return

Maturity

conversion

Total
Payments
(Rs)

Choice

Borrowing

Return
Rate

1
(Rs)

Rs.
600,000

12%

Rs.
72,000

Rs.
672,000

NA

672,000

2
(USD)

$ 10,000

02%

$ 200

$ 10,200

@ Rs 85

867,000

Differentials

195,000

2.2 Foreign Exchange Market

Foreign exchange transactions

Interpreting foreign exchange quotations

Foreign Exchange Market

A market for converting the currency of one
country into the currency of another.
Exchange rate:
The rate at which one currency is
converted into another
The foreign exchange rate can be defined
as units of a foreign currency per unit of
domestic currency.

Foreign exchange transactions

Spot transaction
Forward transaction
Currency

Ask/Selling

Bid/Buying

UD$

80.3

80.1

Pound

113.38

113.1

Euro

104.4

104.14

C$

63.25

63.1

Switzerland

Swiss

67.82

67.65

Australia

Aus$

53.02

52.89

Country
USA
United Kingdom
Euro
Canada

Bid and ask spread of banks:

Example:
Assume you have Rs. 123,000 plan to travel
from Pakistan to USA. Further assume that
banks bid rate for US $ is Rs. 80 and its ask
rate is Rs. 82. Before leaving on trip, you go
to bank to exchange Rupees for US$. Your
Rs. 123,000 will be converted to US$ 1500 as
follows:
Amount to be converted (PKR)
Price charged by bank per $

= PKR 123,000/ PKR 82 = US$ 1500

Now suppose that because of an

emergency, you cannot take the trip
and you reconvert the US$ 1500 back
to Rupees, just after purchasing the $.
If the exchange rate has not changed,
you will receive
US$ 1500 x Rs. 80 = Rs. 120,000

Bid and ask spread in %

Ask rate Bid rate
Ask rate

Rs. 82 Rs. 80
Rs. 82

= 2.44%

Bid / Ask Spread

1- City Banks bid price for Canadian dollar
is $0.7938 and its ask price is $0.81. what is
the bid/ ask percentage spread?
2- Compute the bid/ ask percentage spread
for Mexican Peso retail transactions in which
the ask rate is $0.11 and the bid rate is
$0.10.

Factors that affect the spread

1- Order cost. Order cost are the costs of
processing orders, including clearing costs
and costs of recording transactions.
2- Inventory Costs: inventory costs are the
costs of maintaining an inventory of a
particular currency.
3- Competition: The more intense the
competition, the smaller the spread quoted by
intermediaries.

Factors that affect the spread

4- Volume: More liquid currencies are less
likely to experience a sudden change in the
price.
5- Currency Risk: Some currencies exhibit
more volatility than others because of
economic or political conditions that cause
the demand for and supply of the currency
to change abruptly.

Interpreting foreign exchange

quotations
Direct Quotation & Indirect Quotation
Direct Quotation: is the home currency price
of a unit of foreign currency.

PKR 98.0200 / USD

Read as 98.02 PKR per USD

Indirect Quotation (inverse quotes): is the

foreign currency price of a unit of home
currency.

USD 0.0102 / PKR

Read as 0.0102 USD per PKR

Direct and indirect Quotations

Direct Quotations:
PKR 98.02 / USD
PKR 80.197/ NZD
PKR 98.926/ AUS$
PKR 146.887 / Pound
PKR 94.769 / C$
PKR 127.154 / Euro

Indirect Quotations
?
?
?
?
?
?

Cross Rates
A cross rate is an exchange rate between two
currencies, calculated from their common
relationships with a third currency.
Formula
Value of 1 unit of currency A in units of currency B =
value of currency A in $
value of currency B in $

Cross Rates:
A cross rate is an exchange rate between two currencies,
calculated from their common relationships with a third currency.
Japanese yen

YEN 121.1300/US$

Mexican peso

Ps9.1900/US$

Indian Rupee

INR 50.8300/US$

Pak Rupees

PKR 98.02/US$

Swiss Franc

CHF 0.8930/US$

Required: Calculate following exchange rates through direct and indirect

methods

Exchange Rates
Yen/peso
Yen/INR
Peso/PKR
Peso/CHF
PKR/Indian Rupee

Direct
Yen 13.1806/Ps

Indirect
Ps0.0759/Yen

Check your answers

Exchange Rates

Direct

Indirect

Yen/peso

Yen 13.1806/Ps

Ps0.0759/Yen

Yen/INR

Yen 2.3830/INR

INR 0.4196/Yen

Peso/PKR

Peso 0.1135/PKR

PKR 8.8085/Peso

Peso/CHF

Peso 10.2912/CHF CHF0.0972/Peso

PKR/Indian Rupee

PKR 1.5926/INR

INR 0.6279/PKR

Cross Rates:
VISIT: http://www.reuters.com/finance/currencies
http://www.bloomberg.com/markets/currencies/fxc.html

USD
1 US $
1 Yen

1.0
0.010149

JPY
98.4300

EUR

CAD

GBP

AUD

0.7375

1.2284

0.6908

1.4288

CHF
1.1259

1.0 0.007491 0.012463 0.007016 0.014509 0.0111428

1 Euro

1.3546 133.4600

1.0

1.6643

0.9361

1.9361

1.5261

1 CAD

0.8137

80.1800

0.6006

1.0

0.5621

1.1623

0.9163

1 GBP

1.4455 142.4200

1.0670

1.7756

1.0

2.0677

1.6290

1 Aus $

0.6997

68.9200

0.5163

0.8595

0.4833

1.0

0.7876

1 CHF

0.8873

87.4200

0.6549

1.0901

0.6138

1.2686

1.0

Forward, Futures and Options

Markets
International Money Market
International Credit Market
International Bond Market

International Stock Markets

In addition to issuing stock locally, MNCs
can also obtain funds by issuing stock in
international markets.
This will enhance the firms image and
name recognition, and diversify the
shareholder base. The stocks may also be
more easily digested.
Note that market competition should
increase the efficiency of new issues