International
Finance
Keith Pilbeam
City University, London
Palgrave(2006),Third edition
1
The structure of the book: Three parts
Part 1 The Balance of payments and
macroeconomic policy in an open
economy

1 The foreign exchange market
2 The balance of payments
3 Elasticity and absorption approaches to the
balance of payments
4 Macroeconomic policy in an open economy
5 The monetary approach to the balance of
payments
2
Part 2 Exchange-rate determination:
theory, evidence and policy
6 Purchasing power parity and floating
exchange rate experience
7 Modern models of exchange rate
determination
8 The portfolio balance model
9 Empirical evidence on exchange rates
10 Fixed, floating and managed exchange rates
3
Part 3 The postwar international monetary
system
11 The international monetary system
12 The Eurocurrency and Eurobond markets
13 Currency derivatives: futures, options and
swaps
14 International macroeconomic policy
coordination
15 The international debt crisis
16 Economic and monetary union in Europe
17 Currency crises and the east Asian financial
crisis
4
Fourth edition:
 Part Ⅰ Balance of payments theory
and policy
 6 Purchasing power parity theory
 15 The Latin American debt crisis
 16 The European monetary system and
European monetary union
 18 Financial innovation and the credit
crunch
5
The teaching contents
Teaching hour: 3×16=48
1,2,3,4,6,10
Self-study:
11,12,13,14,15,16,17,18

6

The reference-book
1.Giancarlo Gandolfo，International Finance
and Open－economy Macroeconomics，
Springer，2002；
2.Thomas A. Pugel: International finance
(Twelfth edition),中国人民大学出版社，2005
（1）；
3.Joseph P. Daniels, David D. VanHoose:
International monetary and financial
economics（Third edition）, 高等教育出版社，
2005（1）；
7
4.马君潞，陈平，范小云：《国际金融》，高教
出版社，2011年6月第一版；
5.姜波克：《国际金融学》，高教出版社，1999
（1）；
6.扬长江，姜波克：《国际金融学》，高教出版
社2008年第3版；
7.劳伦斯·S·科普兰：《汇率与国际金融》，
中国金融出版社，2002（3）；
8.WWW.PALGRAVE.COM/BUSINESS/PILBEAM
8
成绩评价：
1.《国际金融》课程（3学分）

20%（平时1）+30%（平时2）+50%（期末）=100%
2.《国际金融》课程设计（1学分）
50%（小班讨论）+50%（课程设计小论文）=100%
9
我的联系方式：
金融与统计学院 何娟文
13739095315
QQ：1356200105
jwhe1234567@163.com

10

The subject matter of International
Finance
1.It is concerned with the monetary and
macroeconomic relations between countries;
2.It is constantly evolving subject that deals
very much with real world issues such as BOP
problems and policy, the causes of exchangerate movements and the implications of
macroeconomic linkages between economies.
11
Part one
The Balance of payments
and macroeconomic policy
in an open economy
12
Chapter 1
The foreign
exchange market
13
1.1 Introduction
The main contents of this chapter:
1.exchange-rate definitions→1.2;
2.various participants and the basic forces in
the market→1.3~1.4;
3.various
exchange-rate
definitions
and
economic significance→1.5~1.6;
4.the determination of spot rate→1.7~1.8;
5.the determination of forward rate→1.9~1.10.
14
1.2 Exchange-Rate Definitions
1.2.1 Exchange rate: the price of one currency
in terms of another.
1.2.2 Two methods of expressing it:
1.Direct quotation system: domestic
currency units per unit of foreign currency
2.Indirect quotation system: foreign
currency units per unit of domestic currency
15

Note:
1.the second method is the reciprocal of the
former.
2.when talking about a rise or fall in the
exchange rate the meaning will be very
different depending upon which definition is
used.
3.In this chapter, the second definition is used.
In other chapters, the first definition is
employed.
4.After 1 January 1999, €1=￡~.
16
1.2.3 The bid rate and the offer rate
The bid rate: the rate at which a bank will buy
sterling.
The offer rate: the rate at which the bank will
sell sterling in exchange for dollars.
The bid-offer spread: the difference between
the bid rate and the offer rate.
17
Table 1.2 Exchange rate quotations at
close of business, 4 January 2005
(closing mid-points)
Foreign
currency
Per £
Euro zone 1.4169
United
states
United
kingdom
Foreign
currency
Per $
0.7522
Foreign
currency
Per €
1.0000
1.8834
1.0000
1.3293
1.0000
0.5310
0.7058
18
Question:
The us$/￡ quotation is ￡1=us$1.6860-1.6880.
In this quotation, which one is the bid rate
and which one is the offer rate? How many
bips is the bid-offer spread? If a exporter
wants to exchange ￡1 into us$, how many
us$ can he receive?
19
Homework:
1.进入路透中文网，查询当日EUR/USD，GBP/USD，
USD/JPY,USD/CHF,USD/CAD,AUD/USD汇率。
2.进入中国货币网，查询当日银行间即期外汇市场
人民币汇率中间价（基准汇率）和收盘价，并比
较其中的不同。
3.进入中国银行全球门户网站，查询当日人民币对
各种货币外汇牌价。
20
4.2010年8月19日我国银行间外汇市场增加人民
币对马来西亚林吉特的报价交易（CNY/MYR）。
我国为何增加对此货币的交易？对该货币的交
易在标价方法、中间汇率形成方式以及汇率浮
动区间方面与对其他非美货币的交易有何不同？
5.目前我国银行间即期外汇市场有人民币对哪些
外币的交易（按交易启动时间先后顺序、使用
国际标准货币符号排列）？在标价方法、波动
幅度和价格形成方式（是否直接交易）方面有
何不同？
21
1.3 Characteristics and Participants of the
Foreign Exchange Market
1.3.1 Characteristics
1.is a worldwide market;
2.is made up primarily of commercial
banks, foreign exchange brokers and
other authorized agents;
3. the most heavily traded currency is
the US dollar-vehicle currency.
22
1.3.2 Participants
1.retail clients: be made up of businesses,
international investors, multinational
corporations and the like; not directly
purchase or sell, rather placing buy/sell
orders with the commercial banks.
23
2.commercial banks: buy/sell currencies on
behalf of their customers or on their own
account (proprietary trading).
3.foreign exchange brokers: often banks do not
trade directly with one another, rather deal
through foreign exchange brokers.
4.central banks: they normally buy and sell
currency in the foreign exchange market to
keep the external value of their currency
stable.
24
1.3.3 Bulls and bears in the foreign
exchange market
Speculators:
bulls: expect a currency to appreciate in
the future (bullish), and take a long position
on the currency (buy long);
bears: expect a currency to depreciate in
the future (bearish), and take a short position
on the currency (sell short).
25
1.4 Arbitrage in the Foreign
Exchange Market
Arbitrage: the exploitation of price differentials
for riskless guaranteed profits.
1.Financial centre arbitrage: this type of
arbitrage ensures that the exchange rate
quoted in all the foreign exchange markets
will be the same.
Example:
N:£1=$1.89
L:£1=$1.87
£1=$1.88
26
2.Cross currency arbitrage: this type of
arbitrage ensures that there is no exchange
rate differentials between the cross rate and
the actual rate.
Example:
£1=$1.88，€1=$1.30
cross rate：
£1=€1.88/1.30=€1.4462
27
If actual rate: £1=€1.50>1.4462，
sell £ and buy €
£ depreciate and € appreciate
£1=€(1.50+1.4462)/2=€1.4731
28
How to calculate the cross rate?
Example 1:
Suppose:￡1=$1.8440/80
€1=￡0.8020/60
Please calculate $/€.
Solution:
€1=$0.8020×1.8440/0.8060×1.8480
=$1.4789/1.4895

29
Example 2:
Suppose:￡1=$1.8440/80
€1＝$1.4720/60
Please calculate ￡/€.
Solution:
€1=￡1.4720÷1.8480/1.4760÷1.8440
=￡0.7965/0.8004
30
How to arbitrage?
Example 1:
Suppose:
N:£1=$1.8920/80, L:£1=$1.8720/80.
One arbitrager trade with 1million￡,
how much £ can he earn?
Solution:
£ $1.8920 £1.8920/1.8780=1.0075
He can earn £7500.

31
Example 2:
￡1=$1.9240/80
€1=$1.4530/90
￡1=€1.3020/80
￡1=$1.9260
￡1=€1.9260/1.4560
€1=$1.4560
=€1.3228
￡1=€1.3050<1.3228
￡1
$1.9240
€1.9240/1.4590
￡1.9240/(1.4590×1.3080)=￡1.0082
32
1.5 The Spot and Forward
Exchange Rates
1.The spot exchange rate: the quotation
between two currencies for immediate
delivery; normally two-day lag to allow for
verification, paperwork and clearing of
payments.
33
2.The forward exchange rate: the exchange
rate at which economic agents agree today to
exchange currencies at some specified time in
the future, most commonly for 1 month(30
days), 3 months(90 days),6 months(180
days),9 months(270 days) and 1 year(360
days).
34
Spot
1month forward 3months 6months
1.6820/1.6860
40/60
60/100
80/160
Forward premium: F>S
Forward discount: F<S
Spot
1.6820/60
1month
1.6860/1.6920
3months
1.6880/1.6960
6months
1.6900/1.7020
35
Homework:
6.进入中国货币网外汇市场指南，了解我
国外汇市场上人民币对各种外币的交易
品种及相关信息。
7.进入中国货币网市场行情页面，了解人
民币对各种外币的即期报价和远期报价，
并计算相应的远期汇率和远期外汇的升
（贴）水率以及升（贴）水年率。
36
1.6 Nominal, Real and Effective
Exchange Rates
1.6.1 Nominal Exchange Rate
1.Nominal exchange rate: the exchange rate
that prevails at a given date.
It is merely the price of one currency in terms
of another with no reference made to what
this means in terms of purchasing power of
goods/services.
37
2.Nominal exchange rate index(S)
=exchange rate at the report period(S1)/
exchange rate at the base period(S0)
Example:
S0=$1.60/￡1，S1=$1.80/￡1
S=S1/S0=1.80/1.60=112.5%
￡appreciated 12.5% from the base period
to the report period.
38
A depreciation or appreciation of the nominal
exchange rate does not necessarily imply
that the country has become more or less
competitive on international markets, for
such a measure we have to look at the real
exchange rate.
39
1.6.2 Real Exchange Rate
Real exchange rate: is nominal exchange rate
adjusted for relative prices between the
countries under consideration.
Expressed as:
SP
Sr  *
P
P*
Sr  S
P
(IQS)
(DQS)
40
Table 1.4 Construction of nominal and real
exchange rate indices
Period
Nominal
exchange
rate
Nominal
exchange
rate index
UK
price
index
US price
Real
index
exchange-rate
index
1
$2.00
100
100
100
100
2
$2.00
100
120
100
120
3
$2.40
120
120
120
120
4
$1.80
90
130
117
100
5
$1.50
75
150
125
90
41
Sr=SP/P*
 Sr>1, appreciation, international
competitiveness fall.
 Sr<1, depreciation, international
competitiveness rise.
42
1.6.3 Effective Exchange Rate
The effective exchange rate: is a measure
of whether or not the currency is appreciating
or depreciating against a weighted basket of
foreign currencies.
n
S ne   S iWi
i 1
43
Table 1.5 Construction of a nominal
effective exchange-rate index
period
1
Nominal
exchange rate
index of $/£
100
Nominal
Effective
exchange rate exchange rate
index of €/£
index of £
100
100
2
100
90
93
3
120
90
99
4
90
80
83
5
75
85
82
44
1.6.4 Real Effective Exchange Rate Index
Real effective exchange rate index :is nominal
effective exchange rate adjusted for relative
prices between the countries under
consideration.
n
Si P
S re  
Wi
i 1 P *i
45
Homework:
8.查找有关美元指数（US dollar index,
USDX)的资料，了解它是一种什么类型的
指数，是如何编制的，如何对该指数进
行分析，其最高值和最低值大约为多少。
进入和讯网外汇频道，了解即时美元指
数数据。查找美元指数从1999年1月至今
的月度时间序列数据。
46
9.了解华尔街日报美元指数的具体编制方
法，查找该指数至今的月度时间序列数
据。
10.了解复旦人民币汇率指数的有关情况；
进入国际清算银行（BIS）查找人民币名
义有效汇率（NEER）和实际有效汇率
（REER）指数，并了解其编制方法。
47
1.7 A simple model of the
determination of the spot
exchange rate
The basic tenet: the exchange rate (the price)
of a currency can be analyzed like any other
price by a resort to the tools of supply and
demand.
48
1.7.1 The demand for foreign exchange
The demand for currency is a derived
demand: not because they have an
intrinsic value in themselves, but rather
because of what they can buy.
49
Table 1.8 The demand for pounds
Price of Exchange Price of UK Quantity
UK export rate $/£ export good of UK
good in £s
in $s
exports
Demand
for
pounds
10
$1.60
16
1,800
18,000
10
$1.80
18
1,500
15,000
10
$2.00
20
1,200
12,000
50
$/£
Rate
2.00
1.80
Demand schedule :depicts changes
in the demand for currency
with respect to changes
in the exchange rate.
1.60
D
0 12,000 15,000 18,000 Quantity of £s
Figure 1.4 The demand for pounds
The demand curve for pounds slops down from
left to right.
51
Factors affecting the demand for UK export:
 US income⇧
 US tastes in UK goods⇧
 The price of US goods⇧
The demand for UK exports⇧
The demand for pounds ⇧
The demand schedule for pounds shift to the
right.
52
$/£
Rate
2.00
1.60
D
0
D’
12,000 15,000 20000
Quantity of £s
Figure 1.4(1) The change of demand quantity
and the shift of demand schedule
53
1.7.2 The supply of foreign exchange
The supply of pounds
=the UK demand for dollars
54
Table 1.9 The supply of pounds
Price of
Exchange
US export rate $/£
good in $s
Price of US Quantity
export
of US
good in £s exports
Demand
for
dollars
Supply
of
pounds
20
$1.60
12.50
1,000
20,000
12,500
20
$1.80
11.11
1,350
27,000
15,000
20
$2.00
10.00
1,700
34,000
17,000
55
$/£
Rate
2.00
1.80
S
1.60
0
12,500 15,000 17,000 Quantity of £s
Figure 1.5 The supply of pounds
The supply curve of pounds slops up from left
to right.
56
Factors affecting US exports:
 UK income⇧
 UK tastes in US goods⇧
 The price of UK goods⇧
The demand for US exports⇧
The supply of pounds ⇧
The supply schedule of pounds shift to the right.
57
$/£ rate
2.00
S
S’
1.60
0
12,500 17,000 20,000 Quantity of £s
Figure 1.5(1) The change of supply quantity
and the shift of supply schedule
58
$/£ rate
S
1.80
D
0
15,000
Quantity of £s
Figure 1.6 Determination of the dollar-pound
exchange rate
59
1.8 Alternative exchange-rate
regimes


Fixed exchange rate regime
Floating exchange rate regime
60
1.8.1 Floating exchange-rate regime
The authorities do not intervene to
buy or sell their currency in the foreign
exchange market. Rather, they allow
the value of their currency to change
due to fluctuations in the supply and
demand of the currency.
61
$/£ rate
S
2.00
1.80
D2
D1
0
Q1 Q2
Quantity of £s
Figure 1.7(a):demand for pounds↑
demand
curve shift rightward
£↑
62
$/£ rate
S1
S2
1.80
1.60
D
0
Q1 Q2
Quantity of £s
Figure 1.7(b):supply of pounds↑
supply
curve shift rightward
£↓
63
1.8.2 Fixed exchange-rate regime
The authorities do intervene to buy or
sell their currency in the foreign
exchange market to eliminate the
excess demand or supply for a
currency to keep the exchange rate
stable.
64
$/£ rate
S1
intervene S2
1.80
D1
0
Q1
D2
Q2
Quantity of £s
Figure 1.8(a)
65
$/£ rate
S1
S2
1.80
Intervene
D1
D2
0
Q1
Q2
Quantity of £s
Figure 1.8(b)
66
1.9 The determination of the
forward exchange rate
The forward exchange market: where
buyers and sellers agree to exchange
currencies at some specified date in the
future.
According to their motives for participation in
the forward exchange market, the
participants can be divided into three groups:
67
1.Hedgers——agents( usually firms) that
enter the forward exchange market to
protect themselves against exchange-rate
fluctuations which entail exchange-rate
risk.
Exchange risk: the risk of loss due to
adverse exchange-rate movement.
68
Example:
UK importer pay US exporter
$15,500 in one year time
At present:
spot: £1=$1.60 pay £9,687.50
(must have necessary funds at present)
one year forward: £1=$1.55 pay £10,000
(need not have necessary funds at present)
69
One year later:
spot £1=$1.30
£1=$2.00
pay £11,923>£10,000
pay £7,750<£10,000
In effect, hedgers avoid exchange risk by
matching their assets and liabilities in the
foreign currency.
In the future
at present forward market
Liabilities
buy forward exchange
Assets
sell forward exchange
70
2. Arbitrageurs——agents( usually banks)
that aim to make a riskless profit out of
discrepancies between interest-rate
differentials and what is known as the
forward discount or forward premium.
Forward premium: forward rate>spot rate
Forward discount: forward rate<spot rate
Expressed as:
Forward premium/discount= F  S  100
S
71
The presence of arbitrageurs ensures that
what is known as the covered interest
rate parity (CIP) condition holds
continually.
CIP:
F
1+r*
F-S
r*-r
S
1+r ,
S
1+r
F S
 r * r
(IQS)
S
72
An UK investor:
UK: 1×(1+r)
US: 1×S×(1+r*)
F
If S(1+r*) >(1+r),
F
then buy $ spot, sell $ forward, S F ,
Till S(1+r*)/F=(1+r),
That is F
1+r*
S
1+r
73
Example:
UK:8%(r) spot:£1=$1.8 US:5%(r*)
UK investor:
invest in UK: £1×(1+8%)
invest in US: £1×1.8×(1+5%)/F
[covered interest-rate arbitrage]
if £1×(1+8%)= £1×1.8×(1+5%)/F
F= [£1×1.8×(1+5%)]/[£1×(1+8%)]
=S(1+r*)/(1+r)= $1.75/£
74
F S
 r * r
S
It says:


If domestic interest rate>foreign interest rate
Domestic currency at a forward discount
If domestic interest rate<foreign interest rate
Domestic currency at a forward premium
75
3. Speculators——agents that hope to make a
profit by accepting exchange-rate risk. They
believe
the future spot rate
≠
the quoted forward rate
76


If the quoted forward rate <the future spot
rate
Buy forward then sell spot( buy long)
(Taking long position)
If the quoted forward rate >the future spot
rate
Sell forward then buy spot( sell short)
(Taking short position)
Taking ‘open position’
77
Homework:
11.了解境外人民币NDF市场的相关情况。
（什么是NDF？为什么会出现这样的市场？
与国内人民币远期外汇市场在定价和组
织形式方面有什么不同？如何确立国内
人民币远期外汇市场在定价方面的主导
地位？）
78
1.10 The interaction of hedgers,
arbitrageurs and speculators
In the forward market, the net demand for the
currency sums to zero:
NDH+NDA+NDS=0
Where:
NDH: net demand of hedgers;
NDA: net demand of arbitrageurs;
NDS: net demand of speculators.
79
The forward rate is determined by the
interaction of hedgers, arbitrageurs
and speculators and is jointly
determined with the spot exchange
rate.
80
$/£ rate
$/£ rate
S
$1.80
A
$1.75
A
$1.70
D
0
DS
DH
Q1 Quantity net forward DS1
DH1 net forward
of £s
sales of £s
purchases of £s
(a) spot market
(b) forward market
Figure 1.9 The joint determination of the spot and forward
exchange rate
81
Conclusion:


Speculation and hedging determine
the level of the spot and forward
quotations;
Arbitrage ties the spot and forward
market quotations together via the
CIP condition.
82
Further reading:
1.严智杰，《人民币实际有效汇率REER和美中贸
易逆差的关系——基于1996－2005年季度数据
的实证分析》，《华东经济管理》，2007/12。
2.吴先智，《人民币远期汇率的定价及风险管
理》，《新金融》，2008/01.
3.黄学军、吴冲锋，《离岸人民币非交割远期与
境内即期汇率价格的互动：改革前后》，《金
融研究》2006/11.
4.林伟斌，《人民币远期汇率定价和市场建设研
究》，《金融研究》，2006/11.
83
5. Callen J. L. & Chan M. L., Kwan C. CY.(1989),
Spot and forward exchange rates: a causality
analysis, journal of business finance &
accounting, 16(1), 105-118.
6. Ross Levine(1989), the pricing of forward
exchange rates, Journal of International
Money and Finance, Volume 8, Issue 2, June
1989, Pages 163-179.
84
On the web:



Obtain spot rates and bid/offer rates from the
Financial Times. Register for free at:
http://www.ft.com.
For effective exchange rates for a number of
currencies, visit the web site of the Bank of
England at http://www.bankofengland.co.uk.
For weekly articles on the global economy,
visit the Economist magazine at
http://www.economist.com.
85