Fundamentals of International Finance

About the textbook (some distinctive features of international finance)

This textbook marks our attempt to provide a comprehensive and understandable theoretical framework of international finance that can be used for in-class lectures. Since the textbook is carefully structured and written in a straightforward, easy-to-understand yet informative and engaging manner, it is an excellent self-study source for students and professionals.

Here is what you can expect when you read this textbook:

• Summary of key points. From the students’ perspective, we deeply understand their difficulties in acquiring complex knowledge and informative lectures. Therefore, in this textbook, essential points have been consistently emphasised and numbered for each chapter and section. Correspondingly, readers can check their understanding and go back to any point that they are unsure about.
• Graphs and practical examples. In this textbook, many graphs and practical examples are presented in such a way to build an in-depth understanding of a concept or scenario. In fact, the textbook focuses on key concepts and their application rather than merely theories. Meanwhile, graphs provide visual aids for concepts and models, and ‘real-world’ examples further explain the theoretical underpinnings and how they are applied in practice.
• Case studies and exercises with detailed answers. There are case studies and exercises at the end of each chapter that require readers to apply the concepts and theories to resolve ‘real-life’ situations. This unique feature encourages the absorption of knowledge, while creating more interest and motivation for learners. In this way, they can overcome vague understanding and further test theories and models with numbers. They will as a result be able to apply what they learn from the textbook into practice with complete confidence. This is also an advantage of this textbook over other previously published books on this topic.

Intended audience

International finance is closely linked with the way the open or free market economy operates today. Currently, increasing economic integration requires economics experts, researchers, policymakers, managers and those professionals who require sufficient knowledge related to this field, especially modern and new concepts or ‘ways of doing things’ that are widely applied in the world of finance. This textbook is dedicated to providing a fundamental framework for university subject majors such as: international finance; money, banking and finance; international financial management; international business; and international economics. These apply to both undergraduate and postgraduate levels. For postgraduate courses, further extended debates located at the end of the chapters and more challenging questions and exercises are also recommended to students.

Structure

The primary purpose of this textbook is training, especially for students and self-learners, and supporting their study and analysis processes effectively. The content of this textbook is structured into three parts, including fourteen chapters, with a strict format layout and presented in a coherent and easy-to-understand manner. Each section covers a major topic, consisting of chapters that are closely linked to address a basic academic field of study. The highlight of this textbook is the way it is structured, from simple to complex, from theoretical to practical, and verified by vivid real-life situations. Each concept, issue and phenomenon are explained and analysed clearly and coherently using specific examples. Readers are, therefore, equipped with systematic knowledge that will serve as a solid basis for research, teaching and practical application.

All chapters are pedagogically organised as follows: chapter’s title, keywords, chapter’s objectives, main items, summary, key terms, guided questions and guided exercises, questions and exercises without answers, and further reading.

Part I – The international financial environment

Part I includes four chapters (<Chapter 1> to <Chapter 4>), including introductory knowledge, clarifying the concepts needed to unify the interpretation for the rest of the textbook.

<Chapter 1> – An introduction: This chapter answers basic questions regarding the definitions and importance of international finance as well as the reasons for studying this subject.

<Chapter 2> – The foreign exchange market: This chapter explains various definitions of exchange rates, classification of exchange rates used in business transactions, and foreign exchange trading strategies, especially techniques of cross-exchange trading. At the end of the chapter we update the list of world currency symbols according to the ISO (International Organization for Standardization) standard.

<Chapter 3> – International monetary system: International monetary relations are subject to frequent changes. In order to understand the merits of alternative international monetary systems, the chapter presents the history of international monetary processes and discusses current trends.

<Chapter 4> – The balance of payments and international investment position: Despite the popularity of BoP among both academics and practitioners, there is a lack of comprehensive understanding about what this term actually means. This chapter is dedicated to covering details about the BoP based on the latest version of Balance of Payments and International Investment Position Manual by IMF (6^th edition). The chapter highlights the concepts of surpluses and deficits, how such imbalances can be resolved over time and double-entry principles, with many case studies and exercises with numbers.

Part II – Determinants of exchange rate and exchange rate policy

Part II includes five chapters (<Chapter 5> to <Chapter 9>), providing in-depth and advanced knowledge about the mystery of exchange rates and exchange rate policy.

<Chapter 5> – Exchange rate and exchange rate regimes: As a crucial determinant of most macroeconomic variables, exchange rates are of particular interest to both academics and practitioners. This chapter will shed light on key issues such as the impact of exchange rates on import and export activities, evaluation of exchange regimes, export pricing policies for export promotion, methods of determining the exchange rate of special drawing rights (SDR) and some other currencies according to a currency basket via case study.

<Chapter 6> – Theory of purchasing power parity; <Chapter 7> – Theory of interest rate parity: These two chapters concentrate on international parity conditions, explaining the underlying exchange rate theories, such as the basis of the exchange rate formation and factors affecting exchange rates in the long and short term, etc. The outstanding feature of these chapters lies in their non-conventional approaches to explaining exchange rate theories (based on the real exchange rate and the principle of choosing currencies for investment and borrowing practices). Moreover, there are many examples for learners to achieve a deep understanding of theories and conclusions.

<Chapter 8> – Determinants of exchange rate – the complete view: This chapter provides a comprehensive view of all factors that affect exchange rates in both the long and short term other than inflation and interest rates. It is a distinct approach incorporating the employment of graphs, models and case studies with numbers. Interestingly, this chapter also explains in detail an exceptional phenomenon known as ‘exchange rate overshooting’.

<Chapter 9> – Monetary, fiscal and exchange rate policy (IS–LM–BP approach): This chapter studies the impacts of monetary, fiscal and exchange rate policies on internal and external balance in an open economy. Theoretically, a fundamental difference between an open economy and a closed economy is that the latter always achieves an external balance, while that is not always true for the former. This is a complex chapter and therefore suitable for a postgraduate level course or programme. Nonetheless, the logical method of delivery (from simple to complex) and well-explained examples for each assumption and new content, will enable the acquisition of knowledge to be relatively straightforward.

Part III – The foreign exchange derivatives

This part covers <Chapter 10> to <Chapter 14>, concentrating on the study of foreign exchange derivatives and exchange rate risk hedging. Since each tool has its own advantages and disadvantages, this section not only provides fundamental knowledge but also advises on choosing an effective tool. This section is suitable for majors such as international financial management, international business and international banking, at both the undergraduate and postgraduate level.

<Chapter 10> – Identification of exchange rate risks: Based on an intuitive approach, this chapter identifies exchange rate risk through foreign exchange positions, which arise from on-balance sheet and off-balance sheet activities. The highlight of this chapter is that the foreign currency position is explained and illustrated by concrete examples and in a logical order, from simple to complex. Moreover, the exchange rate risk is identified within specific scenarios for businesses and financial institutions.

<Chapter 11> – Foreign exchange forwards: This chapter covers the core issue of what is known as quoting the bid rate and the offer rate. Several case studies on applying forwarding contract as a tool of exchange rate risk hedging for import-export businesses, investors and international borrowers, as well as forex trading, are included here.

<Chapter 12> – Foreign exchange swaps: This chapter demonstrates an extension of the forward transaction in <Chapter 11>. The main content of the chapter focuses on stretching and shortening foreign currency positions, so that forward transactions become more flexible in hedging exchange rate risk. Moreover, this chapter leaves room for an important discussion on currency swaps.

<Chapter 13> – Currency futures: This chapter explains the performance of the futures market through the marking-to-market rule. On that basis, we point out the applications of the futures market to hedging exchange rate risk and exchange rate speculation activities utilising futures contracts.

<Chapter 14> – Currency options: In this chapter, options strategies are presented through graph models to enable a fundamental understanding of this topic. Each strategy has a case study to illustrate its practical application.