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International Finance - Essay Example

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International Finance

One of the major distinctions between the international finance and its domestic counterpart is the exchange rate risk. Exchange rate risk is the uncertainty that professionals inject into international financial decisions. These decisions arise from variances in price of a country’s currency per unit of another country’s currency (Madura, 2009). Other distinctions include foreign investment, risks that result in changes that arise in a political environment, and income. International trade is particularly vital in the country since it indicates the level of economic growth that a country is experiencing. Foreign exchange markets enhance international trade by providing markets where exchange of all currencies of the world can be done. Investments in other countries have facilitated international trade. Where a country establishes businesses in other countries, considerations of taking profits home and government imposed restrictions must exist. The long term motive of foreign exchange is capital formation while the short term objective is trade. Countries have to ensure that they obtain a favourable balance of trade for them to achieve capital formation. Sovereign states have their own business laws, currencies, and political systems. These differences lead to introduction of risks into the process of financial decision making (Madura, 2009). International Fisher Effect (IFE) is a theory in economics that explains that a change expected in the prevailing exchange rate between two currencies is equivalent to the difference between the nominal interests of the countries at that time. One can calculate this by following the equation below.   Where “E” represents the percentage change that occurs in the exchange rate, "i1" represents the interest rate of a country A, and "i2" represents the interest rate of a country B. For instance, in a case where the interest rate of country A is 10% and that of B are 5%, the currency of country B should appreciate by 5% in comparison with country A’s currency. The Fisher effect is expressed by the equation below (Madura, 2009). This implies that the interest rate () is equivalent to the nominal interest rate () when you subtract the rate of inflation () that one expects. For cases of simple rates, the equation of Fisher takes the form of .The nominal interest rate is the rate of interest that the bank offers. In cases where one has a savings account, the nominal rate alerts one on how fast the savings in the account will rise over a given period of time. The real interest rate on the other hand acts as correction to the nominal rate for the effects of inflation to determine the rate at which the purchasing power of the savings will rise in a given period of time. Significance for International Finance International finance is a key area in the international businesses that countries must always familiarize themselves with for successful existence in the market. The world is experiencing changes that arise as a result of liberalization of trade as well as globalization. International Finance helps us to understand various consumption patterns of different economie ...Show more

Summary

International Finance IFE theory, variations are choosing different: countries, time periods, indices, lags, periodicity, and expectations Name Institution Course Date International Fisher Effect theory, variations are choosing different: countries, time periods, indices, lags, periodicity, and expectations Finance is the uncertainty that professionals apply in the decision making and economics of time…
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