balance of payments, exchange rates, prices and interest rates
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balance of payments
country's transactions with the rest of the world.
It reproduces the flows of goods and services, incomes, transfers
the accounting system
currency inflows are recorded as credits (+) and currency
outflows as debits (-). transactions are recorded through
double-entry book keeping. balance of payments (BP) always
balances (total debits = total credits, BP=0).
which three major components does it include ?
the current account (CB) - records payments for traded goods and services, foreign
investment income and unilateral transfers.
the capital account (KA) - reports public and private investment and lengin activities.
official reservce account (ΔRA) - records changes in the cental bank's holdings of
each of these components may have a deficit or a surplus.
However, the sum of these parts is balanced, so the change in the
reserve account must equal the sum of CB and KA.
BP = CB + KA - ΔRA = 0
CB + KA = ΔRA
If ΔRA = 0 - CB and KA balances have to sum up to zero
CB + KA = 0
balance of payments (BP) = A + B + C + D + E + F = 0
A = Merchandise trade balance
B = Services trade balance (A+B = NX)
C = Net factor income (NIRA)
D = Net unilateral transers
E = capital account balance
F = official reserve transactions balance (-ΔRA)
BP = A + B + C + D + E + F = 0 (total debit = total credit)
capital account (KA)
records cross-border changes in holdongs of shares, property, bank deposits
and loans, bonds. One distinguish between long-term and short-term capital flows.
What are short-term and long-term investments ?
- long-term is foreign direct investment. acquisition of assets abroad with a view
of controlling the management. corporate takeovers, establishment of subsidiary production facilities
or purchases of foreign property.
- short-term is mainly speculative purchases and sales of financial assets.
nominal exchange rate S is the price of one unit of foreign currency in
terms of domestic currency.
SCHF/USD=0.88254, this way of quoting is said in American terms
or in direct terms.
European (indirect) terms is the inverse, the price of a unit of
domestic currency in units of foreign currency.
SUSD/CHF = 1.13309.
In interbank market, European terms are conventionally used
for all currency quotations except the British pound and the
Australian and New Zealand dollars.
However the norm in theoretical analysis is in American terms.
What are the participants in foreign exchange market?
- exporters who have foreign currency sales
- importers who have to pay for goods and services in for. currency
- portfolio managers who purchase and sell for. cur. assets and rec.
for. cur. interest payments and div.
-foreign brokers who earn profis by matching orders
- commercial banks who borrow in var. curr. for their own needs and customers
- currency speculators
- central banks that conduct exchange interventions
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