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CHAPTER 12 INTERNATIONAL MARKETS CHAPTER OBJECTIVES 1. To introduce several basic concepts including exchange rate risk, determination of interest rates, balance of payments accounting, purchasing power parity. 2. To describe the continuing internationalization of financial markets. The student should understand how international payment flows are generated, the role banks play in mediating international transactions, and why exchange rates fluctuate. 3. To describe the process of financing international trade; explain how foreign exchange risk can be managed through forward and options transaction. 4. An additional objective of the chapter is to explain the linkages that exist between spot exchange rates, forward exchange rates, domestic interest rates, and domestic inflation in different countries. CHANGES FROM THE LAST EDITION 1. Time-sensitive tables and figures have been updated. 2. The following subsections have been revised: “The equilibrium exchange rates”, “Currency quotations”, “Government intervention in foreign exchange markets”, “Fixed exchange rates”, “Politics and exchange rates”, “Forward market”, “Example of a forward transaction” 3. A new People & Events box, “Prices and Earnings: a Global Comparison”, replaced the one dealing with the global scandal involving Parmalat. 4. One of end-of-chapter questions (#14 in the previous edition) has been deleted. CHAPTER KEY POINTS 1. The supply of and demand for currencies in foreign exchange markets set exchange rates. The three major force influencing exchange rates are international trade flows, capital flows, and political flows. The concept of purchasing power parity may help explain changes in commodity prices across the world. 2. The balance of payments can explain changes in exchange rates. If a deficit in the current account (imports exceeding exports) is offset by the surplus in the capital account (foreign investors buying domestic securities), then a country’s currency may not depreciate against those of major trading partners. 1
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3. Governments may intercede in the exchange markets or attempt to regulate private investment and currency flows to alter domestic exchange rates. 4. Foreign exchange markets facilitate international trade. These markets represent a network of large commercial banks trading currency around the clock. The Eurodollar market developed, in part, because the U.S. dollar is a major trading currency that is sometimes subjected to governmental controls. Eurodollars (and other Euro-currencies) have grown in popularity in that they provide one way that governmental controls on domestic currencies can be avoided. Eurodollar markets now play a major role in world financial transactions. A combination of historical, economic, and technological factors has contributed to the rapid internationalization of financial markets. 5.
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