International Financial Management

International Flow of Funds

SENIOR FINANCE
Academic Year : 2024 -
2025
Learning Objectives:

You should understand:

 The key components of the balance of

payments.
 The growth of International trade activity over
time.
 How international trade flows are influenced
by
economic factors and country characteristics ?
 The common agencies that facilitate the
international flow of funds.
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Balance of Payments
 The balance of payments is
a measurement of all transactions
between domestic and foreign
residents over a specified period of
time.
 Each transaction is recorded as

both a credit and a debit.

 The transactions are presented in

three groups – a current

account, a capital account, and a 3
Balance of Payments
 The current account summarizes the
flow of funds between one specified
country and all other countries
due to the purchases of goods or
services, the provision of income on
financial assets, or unilateral current
transfers (e.g. government grants and
pensions).
 A current account deficit suggests a

greater outflow of funds from the 4

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Balance of Payments
 The current account is commonly
used to assess the balance of trade,
which is simply the difference
between merchandise exports and
merchandise imports.

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Balance of Payments
 The capital account includes and
summarizes the flow of funds
resulting from the sale of assets, not
current income. E.g. the sale or
purchase of rights to natural
resources or patents, trademarks, etc.

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Balance of Payments
 The financial account summarizes the
flow of funds resulting from
direct foreign investments,
investments in securities, etc.

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International Trade Flows
 Different countries rely on trade to
different extents.
 The trade volume of European
countries is typically between 30
– 40% of their respective GDP,
while the trade volume of
U.S. and Japan is typically between
10 – 20% of their respective GDP.
 Nevertheless, the volume of trade has

grown over time for most countries.

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 International Trade Flows
 In 1975, the U.S. exported $107.1
billions in goods, and imported
$98.2 billions. Since then,
international trade has grown, with U.S.
exports and imports of goods
valued at
$773.3 and $1,222.8 billions
respectively for the year of 2000.
 Since 1976, the value of U.S.
imports has exceeded the value of 13

U.S. exports, causing a balance of

 International Trade Flows
 Recent Changes in North American
Trade

 Passed in 1993, the North American Free

Trade Agreement (NAFTA) removes
numerous trade restrictions among
Canada, Mexico, and the U.S.
 In 2001, trade negotiations were
initiated for a free trade area of the
Americas. 34 countries are involved.
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 International Trade Flows
 Recent Changes in European Trade
 The Single European Act of 1987
was implemented to remove explicit and
implicit trade barriers among European
countries.
 Consumers in Eastern Europe now have
more freedom to purchase imported
goods.
 The single currency system implemented
in 1999 eliminated the need to convert
currencies among participating
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countries.
 International Trade Flows
 Trade Agreements Around the World
 In 1993, a General Agreement on Tariffs
and Trade (GATT) accord calling for lower
tariffs was made among 117
countries.
 Other trade agreements include:
 Association of Southeast Asian Nations
 European Community
 Gulf Cooperation Council (GCC)

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 International Trade Flows
 Friction Surrounding Trade Agreements

 Trade agreements are sometimes broken

when one country is harmed by
another country’s actions.
 Dumping refers to the exporting of
products by one country to other
countries at prices below cost.

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Factors Affecting
International Trade Flows
 Inflation
 A relative increase in a country’s inflation
rate will decrease its current account, as
imports increase and exports decrease.
 National Income
 A relative increase in a country’s income
level will
decrease its current account, as imports
increase.

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Factors Affecting
International Trade Flows
 Government Restrictions
 A government may reduce its country’s
imports by imposing tariffs on
imported goods, or by enforcing a
quota.
 Sometimes though, trade restrictions
may be imposed on certain products for
health and safety reasons.

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Factors Affecting
International Trade Flows
 Exchange Rates
 If a country’s currency begins to rise in
value, its current account balance will
decrease as imports increase and exports
decrease.

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 Correcting
A Balance of Trade Deficit
 By reconsidering the factors that
affect the balance of trade, some
common correction methods can be
developed.
 For example, a floating exchange rate

system may
since the trade correctwill aaffect
trade
imbalance
demand and automatically
supply the the
of involved. currencies

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 Correcting
A Balance of Trade Deficit

 Currency devaluation
 However, a weak home currency may

not necessarily improve a trade deficit.

 Foreign companies may lower prices
their maintain their to
competitiveness.
 Some other currencies may
weaken too.
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International Capital Flows
 Capital flows usually represent
portfolio investment or direct foreign
investment.
 The DFI positions inside and outside the

U.S. have risen substantially over

time, indicating increasing
globalization.
 Outsourcing

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 Factors Affecting DFI
 Changes in Restrictions
 New opportunities may arise from the
removal of government barriers.
 Privatization
 DFI has also been stimulated by the
selling of government operations.
 Potential Economic Growth
 Countries with higherpotential
economic growth are more likely to
attract DFI. 24
 Factors Affecting DFI
 Tax Rates
 Countries that impose relatively low tax
rates on corporate earnings are more
likely to attract DFI.
 Exchange Rates
 Firms will typically prefer to invest their
funds in a country when that country’s
currency is expected to strengthen.

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 Factors Affecting
International Portfolio Investment
 Tax Rates on Interest or Dividends
 Investors will normally prefer countries
where the tax rates are relatively low.
 Interest Rates
 Money tends to flow to countries with high
interest rates.
 Exchange Rates
 Foreign investorsmay be attracted if
the local currency is expected to
strengthen. 26
 Agencies that Facilitate
International Flows
International Monetary Fund (IMF)
 The IM F is an organization of 183
member countries. Established in
1946, it aims
 to promote international
monetary cooperation and exchange
stability;
 to foster economic growth and high
levels of employment;
 to provide temporary financial assistance
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to help ease imbalances of payments.
Agencies that Facilitate
International Flows
International Monetary Fund (IMF)
 Each member country of the
IMF is assigned a quota based
on a variety of factors reflecting
its economic status. Members
are required to pay this assigned
quota. The amount of funds
that each member can then
borrow from the IMF depends on 28

its particular quota.

 The IM F uses a quota system, and its
unit of account is the SDR (special
drawing right).

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Agencies that Facilitate
International Flows
International Monetary Fund (IMF)
 The weights assigned to the
currencies in the SDR basket are as
follows:
Currency 2001 Revision 1996 Revision
U.S. dollar 45 39
Euro 29
Deutsche mark 21
French franc 11
Japanese yen 15 18
Pound sterling 11 11
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 Agencies that Facilitate
International Flows
World Bank Group
 Established in 1944, the Groupassist
development with the primary s o
focus
helpingthe poorestpeople and the f
poorest countries.
 It has member countries,
183 and is three
composed organizations - IBRD,
of IDA,
IFC. 31
 Agencies that Facilitate
International Flows
IBRD: International Bank for Reconstruction
and Development
 Better known as the World Bank, the

IBRD provides loans and

development assistance to middle-
income countries and creditworthy
poorer countries.
 In particular, its structural adjustment

loans are intended to enhance a

country’s long- term economic 32
 Agencies that Facilitate
International Flows
IDA: International Development Association
 IDA was set up in 1960 as an agency

that lends to the very poor developing

nations on highly concessional
terms.
 IDA lends only to those countries that

lack the financial ability to borrow from

IBRD.

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 Agencies that Facilitate
International Flows
IFC: International Finance Corporation
 The IFC was set up in 1956 to

promote sustainable private sector

investment in developing
countries, by
 financing private sector projects;
 helping to mobilize financing in the
international financial markets; and
 providing advice and technical
assistance to businesses and
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governments.
 Agencies that Facilitate
International Flows
World Trade Organization (WTO)
 Created in 1995, the WTO is the

successor to the General Agreement

on Tariffs and Trade (GATT).
 It deals with the global rules of trade

between nations to ensure that trade

flows smoothly, predictably and
freely.

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Agencies that Facilitate
International Flows
World Trade Organization (WTO)
 Its functions include:
 administering WTO trade
agreements;
 serving as a forum for trade
negotiations;
 handling trade disputes;
 monitoring national trading policies;

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 Agencies that Facilitate
International Flows
Bank for International Settlements (BIS)
 Set up in 1930, the BIS is an
international organization that
fosters cooperation among central
banks and other agencies in
pursuit of monetary and financial
stability.
 It is the “central banks’ central
bank” and “lender of last resort.”
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Agencies that Facilitate
International Flows
Bank for International Settlements (BIS)
 The BIS functions as:
 a forum for international
monetary and financial cooperation;
 a bank for central banks;
 a center for monetary and economic
research;

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 Agencies that Facilitate
International Flows
Regional Development Agencies
 Agencies with more regional
objectives relating to economic
development include
 the Inter-American Development Bank;
 the Asian Development Bank;
 the African Development Bank; and
 the European Bank for
Reconstruction and Development.
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Impact of International Trade on an MNC’s Value
National Income in Foreign Countries Inflation in Foreign Countries

Trade Agreements Exchange Rate Movements

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