Download I. What Is The Balance Of Payments (BOP)?

ASSIGNMENT
On the Following Questions
I.
What Is The Balance Of Payments (BOP)?
II.
What is Balance Of Trade (BOT)?
III.
Difference between Balance of Trade and Balance of Payment.
IV.
What are the Significance of
V.
VI.
VII.
VIII.
IX.
X.
Write down the Causes of disequilibrium in BOP.
What are the functions of IMF & WB?
What are the International Trade Barriers?
Factors that affect currency rates.
How to predict exchange rate fluctuations?
Describe Foreign Exchange Derivatives.
Submitted to::..
Course Teacher
: Mr. Ashraf Ali
Name of course
: International Finance & Financial Institutions
Program
: BBA
Department
: Business administration,
The Millennium University
Submitted by::..
Name (in full)
ID No.
: Muhammad Ibrahim Sohel
: 112 BBA 00 21
Batch
: 21st (class with 15th)
Program
: BBA
Department
: Business administration,
The Millennium University
DATE OF SUBMISSION
Pages
Words
Paragraph
1|Page
10
3510
153
28 June 2013
I.
What Is The Balance Of Payments (BOP)?
The balance of payments (BOP) is the method countries use to monitor all international
monetary transactions at a specific period of time. Usually, the BOP is calculated every quarter
and every calendar year. All trades conducted by both the private and public sectors are
accounted for in the BOP in order to determine how much money is going in and out of a
country. If a country has received money, this is known as a credit, and if a country has paid or
given money, the transaction is counted as a debit. Theoretically, the BOP should be zero,
meaning that assets (credits) and liabilities (debits) should balance, but in practice this is rarely
the case.
www.investopedia.com
The Balance of Payments records financial transactions between a
country and the international economy. The accounts are split into
two sections with the current account measuring trade in goods and
services and the capital account tracking capital flows in and out of
the country. This includes portfolio capital flows (e.g. share
transactions and the buying and selling of Government debt)
and direct capital flows arising from foreign direct investment.
II.
What is Balance Of Trade (BOT)?
The difference between a country's imports and its exports. Balance of trade is the largest
component of a country's balance of payments. Debit items include imports, foreign aid,
domestic spending abroad and domestic investments abroad. Credit items include exports,
foreign spending in the domestic economy and foreign investments in the domestic economy. A
country has a trade deficit if it imports more than it exports; the opposite scenario is a trade
surplus.
III.
Difference between Balance of Trade and Balance of Payment
Following is the list which is showing difference between balance of trade and balance of
payment. It has been made on some basis.
BASIS OF
BALANCE OF TRADE (BOT)
BALANCE OF PAYMENT (BOP)
DIFFERENCE
1. Definition
Balance of trade may be
defined as difference between
Balance of payment is flow of cash
between domestic country and all other
export and import of goods and
services.
foreign countries. It includes not only
import and export of goods and services
but also includes financial capital transfer.
2. Formula
BOT = Net Earning on
Export - Net payment for
BOP = BOT + (Net Earning
on foreign investment - payment made to
imports
foreign investors) + Cash
Transfer + Capital Account +or - Balancing
Item
or BOP = Current Account + Capital
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Account + or - Balancing item ( Errors
and omissions)
3.
Favourable
If export is more than
import, at that time, BOT will be
Balance of Payment will be
favourable, if you have surplus in current
or
Unfavourable
favourable. If import is more
than export, at that time, BOT
account for paying your all
past loans in your capital account.
will be unfavourable.
Balance of payment will be unfavourable, if
you have current account deficit and you
took more loan from foreigners. After this,
you have to
pay high interest on extra loan and this
will make your BOP unfavourable.
4. Solution of
Unfavourable
To Buy goods and services
from domestic country.
To stop taking of loan
from foreign countries.
Following are main factors
which affect BOT
Following are main factors
which affect BOP
a) cost of production
a) Conditions of foreign lenders.
b) availability of raw materials,
c) Exchange rate
b) Economic policy of Govt.
c) all the factors of BOT
d) Prices of goods manufactured
at home
If you see RBI' Overall
balance of payment report, it
shows debit and credit of
current account.
Credit means total export of
different goods and services and
debit means total import of
goods and services in current
account.
Credit means to receipt and earning both
current and capital account and debit
means total outflow of cash both current
and capital account and difference
between debit and credit will be net
balance of payment.
Problem
5. Factors
6. Meaning of
Debit and
Credit
IV.
Significance of BALANCE OF PAYMENT
BOP statistics are regularly compiled, published and are continuously monitored by companies,
banks and government agencies. A set of BOP accounts is useful in the same way as a motion
picture camera.
The accounts do not tell us what is good or bad, nor do they tell us what is causing what. But
they do let us see what is happening so that we can reach our own conclusions. Below are 3
instances where the information provided by BOP accounting is very necessary:
1. Judging the stability of a floating exchange rate system is easier with BOP as the record of
exchanges that take place between nations help track the accumulation of currencies in the
hands of those individuals more willing to hold on to them.
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2. Judging the stability of a fixed exchange rate system is also easier with the same record of
international exchange. These exchanges again show the extent to which a currency is
accumulating in foreign hands, raising questions about the ease of defending the fixed exchange
rate in a future crisis.
3. To spot whether it is becoming more difficult for debtor counties to repay foreign creditors,
one needs a set of accounts that shows the accumulation of debts, the repayment of interest
and principal and the country’s ability to earn foreign exchange for future repayment. A set of
BOP accounts supplies this information. This point is further elaborated below.
V.
Causes of disequilibrium in BOP
These forms of disequilibrium may be caused by the following factors;
1. Population growth: Most countries experience rapid population growth which lead to a high
quantity of import that exceeds the quantity of export. This leads to a disequilibrium of deficit.
2. Development Programs: Developing countries which have embarked upon planned
development programs require to import capital goods, some raw materials which are not
available at home and highly skilled and specialized manpower. Since development is a
continuous process, imports of these items continue for the long time landing these countries in
a balance of payment deficit.
3. Demonstration Effect: When the people in the less developed countries imitate the
consumption pattern of the people in the developed countries, their import will increase. Their
export may remain constant or decline causing disequilibrium in the balance of payments.
4. Natural Factors: Natural calamities such as the failure of rains or the coming floods may
easily cause disequilibrium in the balance of payments by adversely affecting agriculture and
industrial production in the country. The exports may decline while the imports may go up
causing a discrepancy in the country's balance of payments.
5. Cyclical Fluctuations: Business fluctuations introduced by the operations of the trade cycles
may also cause disequilibrium in the country's balance of payments. For example, if there occurs
a business recession in foreign countries, it may easily cause a fall in the exports and exchange
earning of the country concerned, resulting in a disequilibrium in the balance of payments.
6. Inflation: An increase in income and price level owing to rapid economic development in
developing countries, will increase imports and reduce exports causing a deficit in balance of
payments.
7. Poor Marketing Strategies: The superior marketing of the developed countries have
increased their surplus. The poor marketing facilities of the developing countries have pushed
them into huge deficits.
8. Flight Of Capital: Due to speculative reasons, countries may lose foreign exchange or gold
stocks People in developing countries may also shift their capital to developed countries to
safeguard against political uncertainties. These capital movements adversely affect the balance
of payments position.
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9. Globalisation: Due to globalisation there has been more liberal and open atmosphere for
international movement of goods, services and capital. Competition has beer increased due to
the globalisation of international economic relations. The emerging new global economic order
has brought in certain problems for some countries which have resulted in the balance of
payments disequilibrium.
10. Price-Cost Structure:
Changes in price-cost structure of export industries affect the volume of exports and create
disequilibrium in the balance of payments. Increase in prices due to higher wages, higher cost of
raw materials, etc. reduces exports and makes the balance of payments unfavorable.
11. Changes in Foreign Exchange Rates:
Changes in the rate of exchange is another cause of disequilibrium in the balance of payments.
An increase in the external value of money makes imports cheaper and exports dearer; thus,
imports increase and exports fall and balance of payments become unfavourable. Similarly, a
reduction in the external value of money leads to a reduction in imports and an increase in
exports.
12. Fall in Export Demand:
There has been a considerable decline in (he export demand for the primary goods of the
underdeveloped countries as a result of the large increase in the domestic production of
foodstuffs raw materials and substitutes in the rich countries. Similarly, the advanced countries
also find a fall in their export demand because of loss of colonial markets. However, the deficit in
the balance of payment due to the fall in export demand is more persistent in the
underdeveloped countries than in the advanced countries.
VI.
What are the Functions of IMF & WB?
Key IMF activities
The IMF supports its membership by providing

policy advice to governments and central banks based on analysis of economic trends and crosscountry experiences;

research, statistics, forecasts, and analysis based on tracking of global, regional, and individual
economies and markets;

loans to help countries overcome economic difficulties;

concessional loans to help fight poverty in developing countries; and

Technical assistance and training to help countries improve the management of their economies.
The World Bank seeks to

promote the economic development of the world's poorer countries

assists developing countries through long-term financing of development projects and programs
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
provides to the poorest developing countries whose per capita GNP is less than $865 a year special financial
assistance through the International Development Association (IDA)

encourages private enterprises in developing countries through its affiliate, the International Finance
Corporation (IFC)
VII.
What are the International Trade Barriers?
Trade barriers are government-induced restrictions on international trade. Man-made trade
barriers come in several forms, including:

Tariffs

Non-tariff barriers to trade

Import licenses


Export licenses
Import quotas

Subsidies

Voluntary Export Restraints

Local content requirements

Embargo

Currency devaluation

Trade restriction
Most trade barriers work on the same principle–the imposition of some sort of cost on trade that
raises the price of the traded products. If two or more nations repeatedly use trade barriers
against each other, then a trade war results.
Technological Barriers
Standards-related trade measures, known in WTO parlance as technical barriers to trade play a
critical role in shaping global trade.
KEY POINTS

Governments, market participants, and other entities can use standards-related
measures as an effective and efficient means of achieving legitimate commercial and policy
objectives.

Significant foreign trade barriers in the form of product standards, technical regulations
and testing, certification, and other procedures are involved in determining whether or not
products conform to standards and technical regulations.

Significant foreign trade barriers in the form of product standards, technical regulations
and testing, certification, and other procedures are involved in determining whether or not
products conform to standards and technical regulations.
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Cultural Barriers
It is typically more difficult to do business in a foreign country than in one’s home country due to
cultural barriers.
KEY POINTS
With the process of globalization and increasing global trade, it is unavoidable that
different cultures will meet, conflict, and blend together. People from different cultures find it
is hard to communicate not only due to language barriers but also cultural differences.

It is typically more difficult to do business in a foreign country than in one’s home
country, especially in the early stages when a firm is considering either physical investment in
or product expansion to another country.


Expansion planning requires an in-depth knowledge of existing market channels and
suppliers, of consumer preferences and current purchase behavior, and of domestic and
foreign rules and regulations.
The Argument Against Barriers
Economists generally agree that trade barriers are detrimental and decrease overall economic
efficiency.
KEY POINTS
Trade barriers are often criticized for the effect they have on the developingworld.
Even countries promoting free trade heavily subsidize certain industries, such as
agriculture and steel.

Most trade barriers work on the same principle: the imposition of some sort of cost on
trade that raises the price of the traded products. If two or more nations repeatedly use trade
barriers against each other, then a trade war results.


The Argument for Barriers
Some argue that imports from countries with low wages has put downward pressure on the
wages of Americans and therefore we should have trade barriers.
KEY POINTS
Economy-wide trade creates jobs in industries that have a comparative advantage and
destroys jobs in industries that have a comparative disadvantage.

Trade barriers protect domestic industry and jobs.


Workers in export industries benefit from trade. Moreover, all workers are consumers and
benefit from the expanded market choices and lower prices that trade brings.
Economics
Trade barriers are government-induced restrictions on international trade, which generally
decrease overall economic efficiency.


KEY POINTS
Trade barriers cause a limited choice of products and, therefore, would force customers
to pay higher prices and accept inferior quality.
Trade barriers generally favor rich countries because these countries tend to set
international trade policies and standards.
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
Economists generally agree that trade barriers are detrimental and decrease overall
economic efficiency, which can be explained by the theory of comparative advantage.
Ethical Barriers
Despite international trading laws and declarations, countries continue to face challenges around
ethical trading and business practices.
International trade is the exchange of goods and services across national borders. In most
countries, it represents a significant part of gross domestic product (GDP). The rise of
industrialization, globalization, and technological innovation has increased the importance of
international trade, as well as its economic, social, and political effects on the countries involved.
KEY POINTS

Although some argue that the increasing integration of financial markets between countries
leads to more consistent and seamless trading practices, others point out that capital flows
tend to favor the capital owners more than any other group.

With increased international trade and global capital flows, critics argue that income
disparities between the rich and poor are exacerbated, and industrialized nations grow in
power at the expense of under-capitalized countries.

Anti-globalization groups continue to protest what they view as the unethical trading
practices of multinational businesses and capitalist nations, often targeting groups such as the
WTO and IMF.
VIII.
What are the Factors that affect currency rates?
Exchange rates continuously fluctuate, there are several factors such as interest rate
expectations, inflation, macro economic risks and events.
Short-term factors

Interest rates: a government may decide to lower interest rates in an attempt to
stimulate growth in the economy. Generally, this means that investment funds will flow
out of one currency into another currency that has higher interest rates. So when looked
at in isolation, lower interest rates could weaken the currency.

Trade flows: a trade surplus is where there is a greater demand for goods and services
from a country, which means its currency (needed to pay for those goods) will be
stronger. Conversely, a trade deficit will usually weaken the currency.

Natural disasters: think about the earthquakes in Japan and New Zealand and the
effect this has had on their currencies. The currencies initially weakened on the events due
to the unknown damage made to the economy. They then strengthened as insurance
funds and other sources of funding flowed back to these countries from overseas to fund
the repairs. Then the currencies weakened due to action taken by their central banks to
aid economic recovery, such as injecting additional funding into the financial market and
reducing interest rates, had a negative impact on the currency.

Economic growth: an investor may choose to hold one currency over another simply
because that country is growing at a faster pace than the other or is perceived to do so in
the future.
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
Links to commodity based currencies: currencies such as Norwegian Krone or
Canadian dollar are commodity linked currencies and their exchange rates tend to increase
in value when there is a rise in commodities such as oil.

Conflict: there may be a period of time where there is no official government in place
or when a person or organisation has taken power illegally. This will naturally have an
effect on the currency and will be ongoing as the conflict continues.

Short term inflation: if inflation is starting to rise then the natural response for the
authorities will be to limit the rise of inflation by increasing interest rates, therefore clients
may convert into that currency in anticipation of gaining a better return on their money.
Long-term factors

Long term inflation: this is a rise in the general level of the prices of goods and
services in an economy over a period of time. When the price level rises, each unit of
currency buys fewer goods and services. Consequently, inflation wears away the
purchasing power of money in that country. So higher inflation in a country typically
weakens its currency.

Economic growth: it can take many years for an economy to recover i.e. the subprime
crisis in the US took place over three years ago, and it has taken many years for the US
economy to recover to the level it's currently at.
IX.
How to predict exchange rate fluctuations
In order to correctly forecast future fluctuations in currency exchange rates, it is critical to keep
abreast of political events, to monitor economic indicators, and to keep a ‘track record’ of
previous changes in currency exchange rates. You will be able to significantly reduce your losses
and increase your gains if you carefully analyze the current status of your Forex account and
prepare detailed action plans to follow if exchange rates fluctuate dramatically.
FUNDAMENTAL ANALYSIS
It is postulated that price fluctuations in the securities, commodity, and currency markets are
impossible to predict. Not surprisingly, very few people adhere to this view. The average
member of society who watches the news on TV could not but notice that, over the past several
years, starting from 2001, the state of the US economy has deteriorated significantly. Since
then, the exchange rate of the euro against the US dollar has increased from approximately 85
cents per euro to 1 dollar 37 cents per euro (as of end 2004). Meanwhile, market pundits and
active market participants constantly monitor a far greater number of economic indicators,
which are calculated to gauge the health of the world’s leading economies. This means they are
better informed about current events, which helps them respond more quickly and accurately to
fluctuations in exchange rates and, therefore, earn hefty gains. As a rule, forecasts, based on
the careful analysis of economic parameters, underlying indicators, and news flows, lay the
groundwork for the so-called fundamental analysis.
Fundamental analysis is a valuation method used to forecast future fluctuations of exchange
rates, estimated on the basis of economic parameters, underlying indicators, and news flows.
TECHNICAL ANALYSIS
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Additionally, certain patterns in price movements have been detected through trial-and-error
and consistent analysis of price charts. Some of these patterns were discovered and described
hundreds of years ago. Moreover, today theoretical foundations have been identified for these
patterns. Forecasts, issued on the basis of price charts, analyzed with the help of technical
indicators, are collectively called technical analysis.
Technical analysis is a valuation method, based on the analysis of price charts with the use of
technical indicators and linear instruments.
DECISION-MAKING
After making his/her forecasts, a market participant needs to assess the current status of
his/her Forex account, a possible number of open positions, as well as to develop an action plan
if the market reverses against him/her. Then he/she opens all or a part of the trading positions,
continuously monitors the current status of his/her account, and makes a decision either to close
positions or to open additional positions. Strictly speaking, this process called Money
Management is not a forecasting technique, but it does help ramp up gains and reduce possible
losses.
X.
Describe Foreign Exchange Derivatives
Definition:
Any financial instrument that locks in a future foreign exchange rate. These can be used by
currency or forex traders, as well as large multinational corporations. The latter often uses these
products when they expect to receive large amounts of money in the future but want to hedge
their exposure to currency exchange risk. Financial instruments that fall into this category
include: currency options contracts, currency swaps, forward contracts and futures contracts.
In international finance, derivative instruments imply contracts based on which you can
purchase or sell currency at a future date. The three major types of foreign exchange (FX)
derivatives: forward contracts, futures contracts, and options. They have important differences,
which changes their attractiveness to a specific FX market participant.
FX derivatives are contracts to buy or sell foreign currencies at a future date. The table
summarizes the relevant characteristics of three types of FX derivatives: forward contracts,
futures contracts, and options. Because the types of FX derivatives closely correspond to the
identity of the FX market participant, the table is based on the derivative type-market
participant relationship.
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