International Trade and Financial Markets - Coursework Example

 International Trade and Financial Markets     Table of Contents       Introduction 2       Financial Markets 2       International Trade 3       Components of International Trade and Finance 4       The Links between International Trade and Financing 5       Conclusion 6       References 9         Introduction Financial markets are a sector within countries where entities and individual investors can engage in the trade of financial securities, commodities and conduct other fiscal transactions (Wurgler, 2000). Examples of securities include stocks and bonds, with commodity examples, are precious metals, agricultural goods, or oil (Wurgler, 2000). Financial markets are organised and regulated areas where rules and procedures are set into place to ensure the prices set to reflect the laws of supply and demand along with providing a framework where the transaction costs are kept low (Amram and Kulatilaka, 1999). As a means to understand the workings of financial markets in the conduct of this study, this aspect will be explored in the ensuing chapters. This will be approached using the arena of international trade as it is a central gathering point where interested buyers and sellers can interact to find each other and agree on prices (Allen and Gale, 2003). As one can ascertain, financial markets in a country need to be linked to the larger global stage to expose buyers and sellers to the largest possible pool of opportunities or matches (Johnson et al, 2011). Financial Markets Financial markets is a term utilised to refer to markets used for raising finance (Johnson et al, 2011). The above consists of both short-term finance (money markets) and long-term finance (capital markets) (Levine, 2002). The former (money markets) is when instruments are utilised for short-term lending, or buying with maturities that are usually designated as having a year duration (Hartmann et al, 2001). These instruments usually entail commercial paper (backed by assets), treasury bills, certificates of deposit, asset-backed securities, bills of exchange, deposits and repurchase agreements (Hartmann et al, 2001).   The above instruments provide liquidity as they provide different ways for buyers and sellers to conduct transactions (Beck et al, 2000). At the center of money markets is the activity conducted through inter-bank lending (Cocco et al, 2009). This consists of banks engaged in the process of lending and borrowing between themselves through the use of repurchase agreements, commercial paper and other financial instruments (Cocco et al, 2009). In most instances, the above is priced through referencing (meaning benchmarked) to the London Interbank Offered Rate (LIBOR) in the appropriate currency (McAndrews et al, 2009).   Money markets are utilised as a conduit for transferring large amounts of currency, provide governments a vehicle to raise money, aid in setting money policies, and help with the determination of setting interest rates over the short-term (Knez et al, 2012). Capital markets are longer-term measures used for raising funds (Malkiel and Fama, 2012). These entail stock markets for financing through share issuance that can be sold and brought on exchanges, along with bonds that companies or municipalities can issue (Malkiel and Fama, 2012). Other forms used in capital markets are commodities, derivatives, futures, and insurance along with foreign exchange (Fama, 2012). In classifying capital markets, Fama (2012) advises they can be divided into primary and secondary markets. Primary markets represent securities that have just been issued for sale, such as an initial public offering (IPO) (Da Rin et al, 2006). Parties interested in buying or selling securities usually conduct their transactions in secondary markets (Da Rin et al, 2006).   As shown from the above financial markets a process where buyers and sellers can come together, with banks in some cases representing intermediates (Brav and Gompers, 2012). Banks aid in facilitating monetary transfers, the lending of money from a pool of depositors, and also conduct complex transactions in conjunction with agents, exchanges, and companies (Stigliz, 2000). International Trade International trade tends to be self-explanatory; however since it does contain nuances, an understanding of the term is necessary to properly understand the link between it and financial markets. Simply stated, international trade entails the exchange of goods, services or capital that takes place across borders (Dosi et al, 2002). It can consist of the export or import of raw materials, finished or component parts, agricultural products, along with services, which form a significant part of a nation’s Gross Domestic Product (GDP) (Dosi et al, 2002). The reduction of barriers to trade through the use of bilateral/multilateral agreements and the tenets of the World Trade Organization (WTO) are modern day forces driving globalisation (Jensen et al, 2007).   Modern inter-bank and computerised financial systems have greatly increased the ease and speed of transactions along with significantly lowering the transaction costs involved (Banz-Lanzo and Wood, 2002). The above (lower transaction costs) have been an instrumental part of increased international trade as moderate-sized companies can now afford to utilise international systems to arrange for operations such as plants, facilities, component part buying or outsourcing in their operations (Banz-Lanzo and Wood, 2002). To dispel notions of a limited sphere, international trade does not just entail finished good or products. It also consists of individual pieces (screws, nuts, bolts), circuit boards units, diodes, electronic components, raw materials, agricultural products, canned goods, etc. (Romalis, 2005). Components of International Trade and Finance The World Trade Organization (WTO) is one of the most important organisations involved in facilitating international trade (Jaware and Kwa, 2004). The importance of lowering transaction costs is exemplified by the following statement: “Trade facilitation has become an important subject in the Doha Round negotiations” (WTO, 2012). The WTO (2012) adds that through the streamlining of procedures approximately 2% to 15% of the total value of goods currently being traded will be eliminated once it is enacted. One of the key facets of the Doha Round is that it will provide a more level trade foundation for developing countries (WTO, 2012).   In terms of international trade and financial markets, the WTO (2008) states the major issue in international trade is the liquidity used to finance trade credits. This means the organisational sophistication, and diversity of financial markets in countries is an important component fostering heightened international commerce. The more money and capital market avenues that are available to business and governments in their national markets, the more vehicles, instruments, and techniques they have to facilitate the financing of trade transactions (Ahn et al, 2011). In understanding the link between liquidity, international trade, and financial markets, liquidity represents the speed or ease a company is able to convert assets or its credit position to cash (Davidson, 2007). One of the methods above is achieved is through having assets that can be easily converted into cash (Beck, 2002). Other methods include the utilisation of short-term funds such as a line of bank credit, trade credit, and short-term investments (Beck, 2002). The credit standing of a company represents one of the more important measures it can use to raise cash. This is generally accomplished through borrowing or financing, along with the sophistication and developed nature of the financial markets in its home country (Scharfstein and Stein, 2002). The Links between International Trade and Financing The above represents a broad-based explanation of the intertwined nature of international trade and financial markets. Consumers and corporations benefit from the enhanced competition and efficiencies brought about by international trade and financial markets working in conjunction with each other (Hayes, 2006). The reality of global trading is that geographical and economic factors represent reasons for nations seeking multilateral and bilateral trade agreements to help foster enhanced trade cooperation and commerce movement (Prasad et al, 2003). The above is in most instances a result of political necessities grounded in regional considerations, treaties and economic realities (Prasad et al, 2003).   At the root of the growth of international trade is the General Agreement on Tariffs and Trade (GATT), which was enacted in 1945 to rebuild Europe after the Second World War (Bagwell and Staiger, 2005). As a result of GATT, there was a substantial reduction in trade barriers and tariffs that aided in the easing of restrictions impeding international commerce (Bagwell and Staiger, 2005). 1995 saw GATT replaced by the World Trade Organization where the founding principles concerning the reduction of trade barriers and tariffs are still a foundational underpinning today (Paemen and Bensch, 1995). By having a forum and framework to oversee and control the conduct of international trade, the arena for participation by nations and thus companies has an organised structure (Paemen and Bensch, 1995).   The significance of the above is that for a country to avail itself of the benefits represented by a level and standardised playing field for exportation and importation, they must develop their internal financial markets (Pauwelyn, 2000). By having organised financial markets that work in conjunction with global systems, domestic companies and foreign firms located in their borders or considering conducting business there have the means to create financial packages (Martin and Rey, 2004). A developed and broad-based financial market means domestic companies have the resources and means to create or craft financial agreements (Martin and Rey, 2004). Conclusion The above represents a broad-based and detailed exploration of the intertwined nature of international trade and financial markets. Consumers and corporations benefit from the enhanced competition and efficiencies brought about by international trade and financial markets working in conjunction with each other (Hayes, 2006). Prasad et al (2003) advise international financial markets are impacted by trading practices utilised by nations, along with the economic agreements and policies brought into play by regional trading blocs and organisations. At the root of modern international trade is the General Agreement on Tariffs and Trade (Bagwell and Staiger, 2005). As a result of GATT, there was a substantial reduction of trade barriers and tariffs that aided in the easing of restrictions impeding international trade (Bagwell and Staiger, 2005). By having a forum and framework to oversee and control the conduct of international trade, the arena for participation by nations and companies had and has a working structure for cooperation, rules, and procedures (Paemen and Bensch, 1995).   The significance of the above is for a country to avail itself of the benefits represented by a level and standardised playing field for exportation and importation, they must develop their internal financial markets (Pauwelyn, 2000). The more developed and sophisticated the internal financial market of a country is, the better it can utilise the potentials and realities of international trade to its benefit (Martin and Rey, 2004). The important underpinning brought forth under this study is the foundations for international trade need to exist, however, this cannot be properly exploited without internal domestic financial markets. As indicated, the WTO provides the structure to facilitate international trade and development of financial markets to enable transactions to be structured (Barton et al, 2010). Despite this obvious connection, it is the policy of most countries to develop their trade and finance separately (Barton et al, 2010). Trade ministers interact with the WTO and varied regional blocs or groups while finance ministers interact with the International Monetary Fund (IMF) (Bayne and Woolcock, 2011).   The above points out that while there is an obvious symmetry that exists between international trade and financial markets, policymaking is made in separate camps on national and international levels as demonstrated by the separated nature of trade and finance ministers along with the WTO / IMF separation. In his book “Global Trade: Past Mistakes, Future Choices” Buckman (2006) pointed out the laws of supply and demand are the contributing factors to international trade, which fuels intensified competition and solutions to lower the cost of raw materials and related transactions. He also pointed out the globalisation of economies has brought about increased competition concerning how projects are financed and serviced (Buckman, 2006).   Increasingly, information technology has aided in expanding the flow of information and the linkage of trade and financial markets to the point where the two are almost indistinguishable (Ernst and Lundvall, 2004). Information availability on products being traded, global interest rates, exchange rates, commodity prices, and allied factors are examples of the importance of information access in the decision process (Ernst and Lundvall, 2004). These point to be benefits of the liberalisation of restrictions in the knowledge-based services industry that represent banking, insurance, along with professional and technical services (Sampson and Snape, 2007). Through the easing of restrictions underdeveloped countries have and are gaining access to more sophisticated and financial sources to enhance their capabilities (Sampson and Snape, 2007). Direct foreign investment (FDI) is a component of financial markets that increase trade as it provides technical expertise, financial or physical investment, where companies can take advantage of lowered production, transport or developmental costs (Markusen, 2000). Eased restrictions in international trade have increased global commerce, however, it is financial markets that fuel its growth.   References Ahn, J., Khandelwai, A., Wei, S. (2011) The role of intermediaries in facilitating trade. Journal of International Economics. 84(1) Allen, F., Gale, D. 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