MACROECONOMICS 2:
INTERNATIONAL
FINANCE
SUMMARY
@ECOsummaries
→ 20% discount
1
,Macroeconomics 2
Chapter 13
Gross domestic product (GDP): value of the production of final goods and services in a certain period
within a country’s territorial borders
Gross national product (GNP): income that is earned in a certain period by the production factors of
the country
GNP = GDP + income factors from abroad
Net national product (NNP): GNP – depreciation
GNP = Y = national income
The current account (CA): Exports – Imports (trade balance)
National savings (S): S = I + CA
Private savings: S = Y – C – T
Public savings: S = T - G
Trading surplus: the country is lending to other countries and accumulates foreign wealth
Trading deficit: the country is borrowing from other countries and accumulates foreign debt
The balance of payments (BoP):
- Current account: transactions due to exports and imports
- exports + (credit)
- imports – (debit)
- wage, interest, dividend received from abroad + (credit)
- wage, interest, dividend paid to abroad – (debit)
- unilateral transfer without direct return +/- (both)
CA = credit – debit
more export → positive CA
- Financial account: transactions due to international purchase and sale of financial assets
- sale of asset to abroad + (credit)
- purchase of asset from abroad – (debit)
inflow of money (+), outflow of money (-)
FA = debit – credit
more asset sales than it buys → negative FA
- Capital account: transactions due to ‘intangible’ capital (debt remission, patents, copyrights)
debt remission of 2 billion → -2 billion on capital account
CA + FA + CPA = 0 → BoP = 0
Official settlements balance: CA + FA + CPA excluding official reserve transactions
= foreign assets
Reserves in hands of foreign CB: + (credit) on financial account
Reserves in hands of own CB: - (debit) on financial account
2
,Chapter 14
Exchange rate: the price of a country’s currency in terms of another country’s currency
Direct quotation: home currency / foreign currency (€/$)
→ if the exchange rate rises = depreciation of the home currency
→ you have to pay more home currency to obtain foreign currency
Indirect quotation: foreign currency / home currency ($/€)
If the currency of a country depreciates, the goods become cheaper for foreigners
→ you need less of that currency to buy the good
if the currency of a country appreciates, the goods become more expensive for foreigners
→ you need more of that currency to buy the good
Exchange rate (€/$) = 1.5 → 50 dollars = 50 * 1.5 = 75 euros
Exchange rate (€/$) = 1.5 → 50 euros = .5 = 33.33 dollars
Foreign exchange market: foreign currencies and assets are exchanged for domestic ones
1. Commercial banks: main actor
2. Nonbank financial institutes (e.g. pension funds)
3. Corporations
4. Central banks
Arbitrage: buying an asset cheaply on market and selling it at a higher price and at no risk on another
market
Spot exchange rate: a price at which to exchange currencies immediately
Forward exchange rate: specifies a price to exchange currencies in the future.
→ avoiding risk
e.g. ‘’worst’’ spot rate in 30 days could be 1.0 and ‘’best’’ spot rate in 30 days could be 2
at the forward rate, it is decided that the exchange rate will be 1.5 (hedge)
→ guaranteed positive profit and eliminates risk
Foreign exchange swap: is a spot sale of a currency combined with a forward repurchase of the
currency
Rate of return: e.g. interest rate of 5% has a 5% rate of return
Expected rate of return: e.g. you buy a share for 100 euro. After a year, it could be worth 95 or 115.
Both have a probability of 0.5. 🡪 0.5 * -0.05 + 0.5 * 0.15 = 0.5= the expected R.O.R.
Real rate of return: the expected rate of return adjusted for the change in prices.
→ if inflation is 5%, then the real rate of return is 0%
Interest rate on deposits: you obtain an interest rate form the bank. The higher the better
→ if you think that the euro will appreciate i.c.t. the dollar,
euro deposits become more attractive than dollar deposits
Expected rate on euro deposits: R€ + (Ee$/€ – E$/€) / E$/€
→ The investor will rather hold euro than dollar deposits if: R€ + (Ee$/€ – E$/€) / E$/€ > R$
R€ = interest rate on euro deposits (!R = r!)
(Ee$/€ – E$/€) / E$/€ = expected rate of appreciation of the euro
Interest parity condition: Foreign exchange market is in equilibrium → all currencies yield the same
expected rate of return.
3
, Arbitrage mechanism: if returns on the dollar were higher than on the euro, everybody wants to
hold dollar.
→ excess supply of euro deposits
→ dollar appreciates (E$/€ ↓) until the parity condition holds
Risk: important determinant on the decision to hold an asset
Liquidity: a Dutch firm may find it handy to hold dollar deposits if it has U.S. suppliers
Determinants of the exchange rate:
- higher interest rates on the dlaweposits for a currency → appreciation of that currency
- Ex. Exchange rate and the current exchange rate move in the same direction
covered interest parity: R€ + (F$/€ – E$/€) / E$/€ = R$
F$/€ = forward exchange rate
4
INTERNATIONAL
FINANCE
SUMMARY
@ECOsummaries
→ 20% discount
1
,Macroeconomics 2
Chapter 13
Gross domestic product (GDP): value of the production of final goods and services in a certain period
within a country’s territorial borders
Gross national product (GNP): income that is earned in a certain period by the production factors of
the country
GNP = GDP + income factors from abroad
Net national product (NNP): GNP – depreciation
GNP = Y = national income
The current account (CA): Exports – Imports (trade balance)
National savings (S): S = I + CA
Private savings: S = Y – C – T
Public savings: S = T - G
Trading surplus: the country is lending to other countries and accumulates foreign wealth
Trading deficit: the country is borrowing from other countries and accumulates foreign debt
The balance of payments (BoP):
- Current account: transactions due to exports and imports
- exports + (credit)
- imports – (debit)
- wage, interest, dividend received from abroad + (credit)
- wage, interest, dividend paid to abroad – (debit)
- unilateral transfer without direct return +/- (both)
CA = credit – debit
more export → positive CA
- Financial account: transactions due to international purchase and sale of financial assets
- sale of asset to abroad + (credit)
- purchase of asset from abroad – (debit)
inflow of money (+), outflow of money (-)
FA = debit – credit
more asset sales than it buys → negative FA
- Capital account: transactions due to ‘intangible’ capital (debt remission, patents, copyrights)
debt remission of 2 billion → -2 billion on capital account
CA + FA + CPA = 0 → BoP = 0
Official settlements balance: CA + FA + CPA excluding official reserve transactions
= foreign assets
Reserves in hands of foreign CB: + (credit) on financial account
Reserves in hands of own CB: - (debit) on financial account
2
,Chapter 14
Exchange rate: the price of a country’s currency in terms of another country’s currency
Direct quotation: home currency / foreign currency (€/$)
→ if the exchange rate rises = depreciation of the home currency
→ you have to pay more home currency to obtain foreign currency
Indirect quotation: foreign currency / home currency ($/€)
If the currency of a country depreciates, the goods become cheaper for foreigners
→ you need less of that currency to buy the good
if the currency of a country appreciates, the goods become more expensive for foreigners
→ you need more of that currency to buy the good
Exchange rate (€/$) = 1.5 → 50 dollars = 50 * 1.5 = 75 euros
Exchange rate (€/$) = 1.5 → 50 euros = .5 = 33.33 dollars
Foreign exchange market: foreign currencies and assets are exchanged for domestic ones
1. Commercial banks: main actor
2. Nonbank financial institutes (e.g. pension funds)
3. Corporations
4. Central banks
Arbitrage: buying an asset cheaply on market and selling it at a higher price and at no risk on another
market
Spot exchange rate: a price at which to exchange currencies immediately
Forward exchange rate: specifies a price to exchange currencies in the future.
→ avoiding risk
e.g. ‘’worst’’ spot rate in 30 days could be 1.0 and ‘’best’’ spot rate in 30 days could be 2
at the forward rate, it is decided that the exchange rate will be 1.5 (hedge)
→ guaranteed positive profit and eliminates risk
Foreign exchange swap: is a spot sale of a currency combined with a forward repurchase of the
currency
Rate of return: e.g. interest rate of 5% has a 5% rate of return
Expected rate of return: e.g. you buy a share for 100 euro. After a year, it could be worth 95 or 115.
Both have a probability of 0.5. 🡪 0.5 * -0.05 + 0.5 * 0.15 = 0.5= the expected R.O.R.
Real rate of return: the expected rate of return adjusted for the change in prices.
→ if inflation is 5%, then the real rate of return is 0%
Interest rate on deposits: you obtain an interest rate form the bank. The higher the better
→ if you think that the euro will appreciate i.c.t. the dollar,
euro deposits become more attractive than dollar deposits
Expected rate on euro deposits: R€ + (Ee$/€ – E$/€) / E$/€
→ The investor will rather hold euro than dollar deposits if: R€ + (Ee$/€ – E$/€) / E$/€ > R$
R€ = interest rate on euro deposits (!R = r!)
(Ee$/€ – E$/€) / E$/€ = expected rate of appreciation of the euro
Interest parity condition: Foreign exchange market is in equilibrium → all currencies yield the same
expected rate of return.
3
, Arbitrage mechanism: if returns on the dollar were higher than on the euro, everybody wants to
hold dollar.
→ excess supply of euro deposits
→ dollar appreciates (E$/€ ↓) until the parity condition holds
Risk: important determinant on the decision to hold an asset
Liquidity: a Dutch firm may find it handy to hold dollar deposits if it has U.S. suppliers
Determinants of the exchange rate:
- higher interest rates on the dlaweposits for a currency → appreciation of that currency
- Ex. Exchange rate and the current exchange rate move in the same direction
covered interest parity: R€ + (F$/€ – E$/€) / E$/€ = R$
F$/€ = forward exchange rate
4
