ECONOMICS/FINANCE 372 International Finance Course Objective: T o develop an understanding of the significance that the existence of different currencies around the world has on economic and financial activity. The causes and effects of exchange rate behavior will be investigated. As in any economics course, the effects of government policies and the role of government are considered. As in any finance course, the profound influence that uncertainty (a.k.a. risk) has on economic and financial behavior is emphasized.

The Balance of Payments (BOP) Accounts: A record of all economic activity that flows between residents of a country and residents of the rest of the world in a given period of time (e.g., a year), where all values are in terms of the country’s own currency.

The two primary component accounts of the BOP accounts are: 1) the Capital and Financial Account (formerly known just as the Capital Account) 2) the Current Account. All transfers of asset ownership are recorded in the Capital and Financial Account (KFA) All other flows (e.g., of goods, services) across the country’s borders are recorded in the Current Account (CA).

BOP accounting employs double-entry bookkeeping: For every credit there is a debit, and For every debit there is a credit.

Credits in the CA: a flow (of goods or services) that gives rise to a payment “inward” from a non-resident. Debits in the CA: a flow (of goods or services) that gives rise to a payment “outward” to a non-resident. Credits in the KFA: the transfer of the ownership of an asset from a resident to a nonresident. Debits in the KFA: the transfer of the ownership of an asset from a nonresident to a resident.

The Current Account is divided into 3 sub-accounts: The goods account (CA G ) records the flows of goods (across the borders) The services account (CA S ) records the flows of services The factor services account (CA FS ) records the flows of factor services. CA = CA G + CA S + CA FS

The Capital and Financial Account (KFA) is also divided into 3 sub-accounts: The long term, private financial account (KFA LP ) records the flows of the transfer of ownership across the border of long- term assets by private individuals and institutions. The short-term, private financial account (KFA SP ) records the transfer of short-term assets by private individuals and institutions. The government financial account (KFA GOV ) records the acquisition or sale of another country’s currency by the country’s monetary authority. KFA = KFA LP + KFA SP + KFA GOV

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV

There are several “Key Balances” that are constructed using these six sub-accounts: Trade Balance = CA G Basic Balance = CA + KFA LP Official Reserves Transactions Balance (ORTB) (a.k.a. Overall Balance, or, Official Settlements Balance, or, The “Balance of Payments” or “BOP”) = CA + KFA LP + KFA SP KFA PRIVATE = KFA LP + KFA SP

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV A US resident pays a Canadian $10 in exchange for preparing her taxes, paying with a check on a Chicago bank.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 Tax preparation ($10 worth) is provided by the Canadian accountant to the US resident

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 The US resident gives the Canadian a check for $10

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 Key Balances: The CURRENT ACCOUNT (CA) = -$10 (is in deficit by $10)

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 Key Balances: The CAPITAL AND FINANCIAL ACCOUNT (KFA) = +$10 (is in surplus by $10)

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 Key Balances: The BASIC BALANCE (BB) = CA + KFA LP = -$10

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 Key Balances: The (Merchandise) TRADE BALANCE (TB) = CA G = $0

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 Key Balances: The BALANCE OF PAYMENTS (BOP) = CA + KFA LP + KFA SP = $0

A UK resident buys a 5-yr US government bond (from an American) for $20, pays with a check on a British bank.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 $20 $10 The British resident takes ownership of the $20 LT Bond.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 $20 $20 $10 The British resident gives the $20 check to the American.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 $20 $20 $10 CA = -10 KFA = +10 BB = +10 BOP = 0 TB = 0

A US resident receives $30 in interest payments on her 6-mo Peruvian bonds, paid with a check on a Peruvian bank.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 $30 $20 $20 $10 A US resident provides services to the Peruvian borrower worth $30.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 $30 $20 $20 $10 $30 A US resident receives the $30 check on the Peruvian bank.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 $30 $20 $20 $10 $30 CA = +20 KFA = -20 BB = +40 BOP = 0 TB = 0 KFA SP = - $40 (is in deficit by $40)

US Government buys $40 worth of Yen in the foreign exchange markets with newly printed $’s.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 $30 $20 $20 $10 $40 $30 US Government puts $40 worth of Yen in its vault.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 $30 $20 $20 $10 $40 $30 $40 A foreign resident takes possession of 40 newly printed $’s.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 $30 $20 $20 $10 $40 $30 $40 CA = +20 KFA = -20 BB = +40 BOP = +40 TB = 0 KFA SP = 0 (is in balance)

A US resident pays $50 for a 180-day Japanese government security, pays with a Houston bank check.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 $30 $20 $20 $10 $40 $30 $40 $50 A US resident takes ownership of the 180-day Japanese government security (worth $50).

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 $30 $20 $20 $10 $40 $30 $40 $50 $50 The Japanese government takes possession of the $50 check on the US bank from the US resident.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $10 $30 $20 $20 $10 $40 $30 $40 $50 $50 KFA SP = 0 CA = +20 KFA = -20 BB = +40 BOP = +40

US firm sells $60 in lumber to Taiwan firm and is paid with a check on the Taiwan’s firm account in a US bank.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $60 $10 $30 $20 $20 $10 $40 $30 $40 $50 $50 US firm delivers $60 in lumber to Taiwan firm.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $60 $10 $30 $20 $20 $10 $40 $30 $40 $50 $50 $60 The Taiwan firm gives the check for $60 on the US bank to the US seller.

Debit Credit Debit Credit Debit Credit CA G CA S CA FS KFA LP KFA SP KFA GOV $60 $10 $30 $20 $20 $10 $40 $30 $40 $50 $50 $60 KFA SP = -60 BB = +100 BOP = +40 TB = +60 CA = +80 KFA = -80

1. A US resident pays a Canadian $10 in exchange for preparing her taxes, paying with a check on a Chicago bank. 2. A UK resident buys a 5-yr US government bond (from an American) for $20, pays with a check on a British bank. 3. A US resident receives $30 in interest payments on her 6-mo Peruvian bonds, paid with a check on a Peruvian bank. 4. US Government buys $40 worth of Yen in the foreign exchange markets with newly printed $’s. 5. A US resident pays $50 for a 180-day Japanese government security, pays with a Houston bank check. 6. US firm sells $60 in lumber to Taiwan firm and is paid with a check on the Taiwan’s firm account in a US bank.