International finance

International finance



Flow of goods and services

Exports: domestically produced goods and services sold abroad

Imports: goods and services produced abroad sold domestically

Net exports = Exports - Imports



Trade surplus: Net exports > 0

Trade deficit: Net exports < 0

Balanced trade: Net exports = 0



The flow of financial resources is made up of:

  • Financial inflows: investments by foreigners in Canada

  • Financial outflows: investments by canadians in foreign countries



Forms of financial flows:

  1. Foreign direct investment (ex: italian company opens a subsidiary in canada)

  2. Portfolio investment (ex: japanese investor purchases canadian bonds)

  3. Deposits and loans (ex: foreign deposits in canadian banks)



Why have financial flows grown?

  • Deregulation of financial sector and removal of capital controls

    • Capital controls = rules designated to limit financial flow across countries

  • Large institutional investors (pensions funds and mutual funds) have grown over time

    • Seek to diversify their portfolios

  • Technology: secure international wire transfers

  • Financial innovation



Nominal exchange rate: The rate at which you can trade currency of one country for currency of another.

  • In general we will define the nominal exchange rates in units of foreign currency per unit of domestic currency (ex: USD per CAD)



Nominal exchange rate = units of foreign currency / units of domestic currency



Units of foreign currency = nominal exchange rate x units of domestic currency



Depreciation: when the price of a currency falls

Appreciation: when the price of currency rises



Higher price of a dollar:

  • Appreciation of the dollar

  • Depreciation of the other currency

  • Stronger dollar

  • Higher exchange rate

  • Imports are cheaper

  • Exports are more expensive for foreign buyers



Lower price of a dollar

  • Depreciation of the dollar

  • Appreciation of the other currency

  • Weaker dollar

  • Lower exchange rate

  • Imports are more expensive

  • Exports are cheaper for foreign buyers



Foreign exchange market: The market in which currencies are bought and sold. The price of a Canadian dollar is the nominal exchange rate.



The market for canadian dollars:

  • Demanders:

    • From the trade flows: foreigners buying canadian exports

    • From financial inflows: foreigners investing in canada

  • Suppliers:

    • From trade flows: canadians buying imports

    • From financial outflows: canadians investing abroad



Market for Canadian dollars

  • Downward sloping demand

    • A lower price of the Canadian dollar means canadian exports are cheap

    • Buyers from the other country will need more Canadian dollars to pay for those Canadian exports = quantity demanded rises.

  • Upward sloping supply

    • A higher price of the canadian dollar means canadian imports (from the other country) are cheap

    • Canadian imports from the other country rise, canadians need to exchange more canadian dollars into the other currency to pay for imports = quantity supplied rises.



  • The equilibrium exchange rate is determined by the demand and supply of canadian dollars.




Demand shifters:

  • Increase in canadian exports:

  • Increase in world GDP

  • Lower barriers to foreign markets (ex: tariffs)

  • Increased domestic innovation or marketing

  • Higher foreign prices

  • Lower domestic prices

  • Increase in financial inflows

    • Higher canadian interest rates

    • Higher canadian business profitability

    • Higher foreign political risk

    • Higher expected future value of canadian dollar



Supply shifters

  • Increase in imports into canada

    • Increase in canadian gdp

    • Lower barriers protecting domestic producers

    • Increased foreign innovation or marketing¸Higher domestic prices

    • Lower foreign prices

  • Increase in financial outflows

    • Lower canadian interest rates

    • Lower canadian business profitability

    • Lower foreign political risk

    • Lower expected future value of canadian dollar



Real exchange rate: the rate at which a person can trade the goods and services of one country for those of another.

It is a key determinant of how much a country exports and imports



Balance of payments

  • The balance of payments summarizes a country’s transactions with the rest of the world

  • It tracks two sets of transactions:

    • Current account: how much income crosses national borders each year

    • Financial account: tracks the financial flows across borders

  • Current account balance: measures the difference between the income that canadians receive from abroad and the income that Canadians pay to people abroad.

  • Financial account balance: measures the difference between financial inflows and financial outflows.