Definition: Balance of payments
- All the transactions (good, service or asset) of the residents of a nation with the residents of all other nations are recorded during a particular period of time, usually a calendar year
- International transactions made between the residents of all other nations are recorded during a particular period of time (usually a calendar year)
2 The purpose of the balance of payments:
- To inform the government of the international position of the nation
- To formulate the monetary, fiscal and trade policies (the process of policy making helps in monitoring the flow of money and developing the economy
- Credit transaction (+): The export of goods and services, as well as primary income, secondary income, and capital transfers receivable from abroad.
- Debit transaction (-): The imports of goods and services, as well as primary income, secondary income, and capital transfers payable to foreign residents.
- Net lending (+) from current- and capital-account transactions occurs when the total credits exceed the total debits in the nation’s current and capital accounts.
- Net borrowing (−) from current- and capital-account transactions occurs when the total debits exceed the total credits in the nation’s current and capital accounts.
- Financial inflow: an increase in foreign assets in the nation or a reduction in the nation's assets abroad.
- Financial outflow: an increase in the nation's assets abroad or a reduction in foreign assets in the nation.
Each international transaction is recorded twice, once as a credit and once as a debit of an equal amount.
* Total BOP account must always in balance
Example 1: Suppose that a VN firm exports $2,000 of goods to be paid for in 6 months.
(Transaction that give rise to a receipt from abroad )
(Receipts from exports or increase in claims on foreigners or an increase in VN’s asset abroad )
Example 2: Suppose that a VN resident visits Bangkok and spends
$500 on hotel, meals, clothes, etc.
Overseas transaction by VN resident
* Record all the transactions relating to:
● Export and import of goods and services
Net earnings (dividends, interest) and compensation to employees
Ex: Net earnings on US investments abroad; minus payments on foreign assets in the US
Transfer of goods and services or financial assets Private transfer payments
Current account – types of balance
● Balance of trade= Export – Import
● Trade surplus: EX > IM (EX - export; IM - import)
● Net investment income: net income receipts from assets
● Net international compensation to employees: net compensation of employees
● Gifts or grants received from foreign countries - gifts or grants to foreign countries
Ex: The U.S government sends $100,000 worth of food aid to a poor nation.
* Current Account Balance= Trade balance + Income Balance + Net Unilateral Transfer
If the current account > 0 => Current account surplus
If the current account < 0 => Current account deficit b, Capital and financial account (CFA):
A country's capital account tracks all international capital transfers, measuring income and expenditures through the inflow and outflow of funds from investments and loans A deficit in the capital account signifies that more money is leaving the country, whereas a surplus indicates an influx of funds.
● Along with non-financial and non-produced asset transactions, the capital account includes
● Dealings such as debt forgiveness
Kinh t ế qu ố c t ế Đại học Kinh tế Quốc dân
H Ộ I NH Ậ P KINH T Ế QU Ố C T Ế - Bài t ậ p h ộ i nh ậ p kinh t ế qu ố c t ế
Kinh tế quốc tế None
C Ộ NG HOÀ XÃ H Ộ I CH Ủ NGHĨA VI Ệ T NAM
Kinh tế quốc tế None
Những yếu tố tác động đến hội nhập kinh tế quốc tế
Kinh tế quốc tế None
Kinh tế quốc tế None
Kinh tế quốc tế None
Foreign trade policy and imports - exports Grand Duchy of Luxembourg from 2015 to 2022 and Lessons for Vietnam
Kinh tế quốc tế None
● The transfer of goods and financial assets by migrants leaving or entering a country
● The transfer of ownership of fixed assets and of funds received for the sale or acquisition of fixed assets
● Death levies, patents, copyrights, royalties
● Uninsured damage to fixed assets
●The financial account measures increases or decreases in international ownership of assets, whether they be individuals, businesses, governments, or central banks.
●Direct investment and portfolio investment assets (both short and long term)
●Financial derivatives and employee stocks options
Fig 4 - Calculating the Balance of Payments
Balance of Payments = Net Current Account + Net Financial Account + Net Capital Account + Balancing Item
In examining the balance of payments for Country A, we will analyze the provided data to ascertain whether the economy is experiencing a surplus or deficit By carefully calculating the various components of the balance of payments, we can draw conclusions about the overall economic health of Country A.
● Balance of current account = exports of goods + imports of goods + exports of services + imports of services
● = -$70,000 i.e current account is in deficit
● The balance of capital account =net capital account balance
● = $45,000 i.e capital account is in surplus
● Balance of financial account =net direct investment + net portfolio investment + assets funding + errors and omissions
● = $60,000 i.e financial account is in surplus
Therefore, by using the above-calculated value, we will now calculate the BOP
● The balance of payments = $35,000, i.e., overall, the economy is in surplus.
Relevance and Use BOP Formula
The balance of payments is a crucial indicator that reveals a country's ability to finance its imports and sustain economic growth It highlights whether the nation has sufficient production capacity to support its economic output Typically, this data is reported on a quarterly or annual basis.
A country's balance of payments deficit indicates that it imports more goods, services, and capital than it exports This situation compels the nation to borrow funds from other countries to cover its imports While such borrowing can stimulate short-term economic growth, it may lead to long-term financial challenges.
In the long run, a country that becomes a net consumer of global economic output may face increased debt due to its consumption habits, hindering future growth investments Prolonged deficits could lead to the necessity of liquidating assets, including land, natural resources, and commodities, to manage its debt obligations.
A country with a surplus balance of payments exports more goods, services, and capital than it imports, indicating strong savings among its residents This financial stability allows the country to cover its domestic consumption and even lend to other nations In the short term, a surplus balance of payments can stimulate economic growth by providing sufficient savings to finance loans for countries purchasing its products.
An increase in exports can drive production demands, leading to job creation; however, this reliance on exports may result in vulnerability A robust domestic market serves as a safeguard against fluctuations in exchange rates, providing stability for the economy.
The balance of payments (BOP) is a crucial tool for analysts and economists to assess a country's economic strength relative to others Ideally, the capital and financial accounts should offset the current account, resulting in a BOP of zero; however, this balance rarely occurs Additionally, a statistical discrepancy often arises in these accounts.
Double-entry bookkeeping requires that the balances of current and capital accounts equal the financial account balance of a nation; however, this principle often does not reflect reality.
● Statistics discrepancy results from incorrectly recording or from not recording at all only one side of some transactions:
● Errors may arise because of different reporting requirements, different collecting agencies, wrong estimates of some transactions, and so on.
● Omissions are more likely in service than trade transactions, may arise because of forgetfulness or to evade taxes.
● Information – some is collected, some is estimated
● The statistical discrepancy, which keeps the BOP account in balance d, Official reserve transaction:
●Conducted in the form of international reserve assets by central banks, such as:
● IMF credits and SDR (Special Drawing Right)
●Changes in foreign central bank holding of domestic assets
Changes in domestic central bank holdings of foreign assets can significantly impact currency strength For instance, when the US and foreign governments aim to strengthen the dollar, they often sell foreign currencies, special drawing rights (SDRs), or gold to purchase dollars This activity generates increased demand for dollars, resulting in a positive entry in the balance of payments, even though it may lead to a decline in the central bank's reserves.
When US and foreign governments wish for a weak dollar, they
Selling dollars to purchase foreign currency, SRDs, or gold results in an increase in central bank reserves, recorded as a negative entry despite the growth in dollar supply.
*The significant of official reserve transactions:
1.The official transaction reserve assists in bringing the country’s balance of payments into balance:
Countries maintain official settlement accounts to assess their economic health by tracking the inflows and outflows of investments, loans, services, and products These accounts are crucial components of the international balance of payments, reflecting the current and capital accounts of central banks When there is a balance of payments deficit or surplus, reserve asset inflows or outflows help restore balance Ideally, the total of the current account should equal the total of the capital and finance accounts, ensuring a coherent economic overview.
The procurement of a country's own currency is recorded as a credit item in the balance of payments, while the sale of the currency is noted as a negative item Various transactions, including products, goods, and services, contribute to determining the balance, which encompasses the current account, capital account, and financial account balances A negative net amount in an international transaction account signifies a trade deficit, reflecting all economic transactions between residents and non-residents that alter ownership The trade deficit can be assessed across different categories within the international transaction account, incorporating products, goods, services, and the overall current and capital account balances Net lending or borrowing is derived from the total of the current and capital account balances, alongside the financial account balance and a statistical mismatch Unlike the current and capital accounts that focus on purchases and payments, the financial account specifically measures financial assets and liabilities.
3 It assist in the management of the deficit and surplus in the balance of payments:
Official reserve transactions track central bank activities and are reflected in the financial account of the balance of payments A net increase in official reserves indicates a balance of payments surplus, while a declining official reserve balance suggests a deficit in the country's balance of payments over time.
In a fixed exchange rate system, a trade deficit occurs when a country's demand for imports surpasses its exports, leading to a higher domestic need for foreign currency To maintain a stable exchange rate, the central bank must intervene by selling foreign currency for domestic currency, which can deplete foreign reserves and create a balance-of-payments deficit This deficit arises when there is excess demand for foreign currency in the regulated Forex market, prompting the central bank to adjust its foreign reserves Monitoring the transactions in the official reserve account helps determine whether a country is experiencing a balance of payments deficit or surplus.
5 Balance of trade v/s balance of payment
2 Include all transactions related to visible invisible and capital transfer
4 BOP = current account + capital account +/- balancing items (errors and omissions) Financial Account?
3 Can be favorable or unfavorable
4 BOT = net earning on export - net payments for imports Balance of financial account = Net direct investment + Net portfolio investment + Assets funding + Errors and omissions
*Financial account components include direct investment, portfolio investment, and reserve assets broken down by sector
(portfolio : stocks, government bonds, corporate bonds) (assets funding : the use of a company's balance sheet assets, including short-term investments… To borrow money or get a loan)
● Domestic price of manufactured goods
6 Disequilibrium in the balance of payments
● A disequilibrium in the balance of payment means its condition of Surplus Or deficit.
● • A Surplus in the BOP occurs when Total Receipts exceeds Total Payments Thus, BOP= CREDIT>DEBIT.
● • A Deficit in the BOP occurs when Total Payments exceeds Total Receipts Thus, BOP= CREDIT IM (EX - export; IM - import)
● Net investment income: net income receipts from assets
● Net international compensation to employees: net compensation of employees
● Gifts or grants received from foreign countries - gifts or grants to foreign countries
Ex: The U.S government sends $100,000 worth of food aid to a poor nation.
* Current Account Balance= Trade balance + Income Balance + Net Unilateral Transfer
If the current account > 0 => Current account surplus
If the current account < 0 => Current account deficit b, Capital and financial account (CFA):
A country's capital account tracks all international capital transfers, measuring income and expenditures through the inflow and outflow of funds from investments and loans A deficit in the capital account signifies that more money is leaving the country, whereas a surplus indicates that more money is entering.
● Along with non-financial and non-produced asset transactions, the capital account includes
● Dealings such as debt forgiveness
Kinh t ế qu ố c t ế Đại học Kinh tế Quốc dân
H Ộ I NH Ậ P KINH T Ế QU Ố C T Ế - Bài t ậ p h ộ i nh ậ p kinh t ế qu ố c t ế
Kinh tế quốc tế None
C Ộ NG HOÀ XÃ H Ộ I CH Ủ NGHĨA VI Ệ T NAM
Kinh tế quốc tế None
Những yếu tố tác động đến hội nhập kinh tế quốc tế
Kinh tế quốc tế None
Kinh tế quốc tế None
Kinh tế quốc tế None
Foreign trade policy and imports - exports Grand Duchy of Luxembourg from 2015 to 2022 and Lessons for Vietnam
Kinh tế quốc tế None
● The transfer of goods and financial assets by migrants leaving or entering a country
● The transfer of ownership of fixed assets and of funds received for the sale or acquisition of fixed assets
● Death levies, patents, copyrights, royalties
● Uninsured damage to fixed assets
●The financial account measures increases or decreases in international ownership of assets, whether they be individuals, businesses, governments, or central banks.
●Direct investment and portfolio investment assets (both short and long term)
●Financial derivatives and employee stocks options
Fig 4 - Calculating the Balance of Payments
Balance of Payments = Net Current Account + Net Financial Account + Net Capital Account + Balancing Item
To analyze the balance of payments for Country A, we will utilize the provided data to assess whether the economy is experiencing a surplus or deficit By examining the relevant financial figures, we can determine the overall economic position and understand the implications for Country A's financial health.
● Balance of current account = exports of goods + imports of goods + exports of services + imports of services
● = -$70,000 i.e current account is in deficit
● The balance of capital account =net capital account balance
● = $45,000 i.e capital account is in surplus
● Balance of financial account =net direct investment + net portfolio investment + assets funding + errors and omissions
● = $60,000 i.e financial account is in surplus
Therefore, by using the above-calculated value, we will now calculate the BOP
● The balance of payments = $35,000, i.e., overall, the economy is in surplus.
Relevance and Use BOP Formula
The balance of payments is a crucial economic indicator that reveals a country's ability to finance its imports and sustain its growth It showcases the nation's production capacity and economic output, highlighting its financial health Typically, this information is reported on a quarterly or yearly basis.
A country experiences a balance of payments deficit when it imports more goods, services, and capital than it exports This situation often compels the nation to borrow funds from abroad to finance its imports While such borrowing can stimulate short-term economic growth, it may lead to long-term financial challenges.
In the long run, a country that becomes a net consumer of global economic output may face increased debt due to its consumption habits, hindering future growth investments Prolonged deficits could compel the nation to sell off valuable assets, including land, natural resources, and commodities, to manage its debt obligations.
A country with a surplus balance of payments exports more goods, services, and capital than it imports, indicating strong savings among its residents This financial stability allows the country to cover all domestic consumption and even lend to other nations In the short term, a surplus BOP can enhance economic growth by providing sufficient savings to support loans for countries purchasing their products.
Increasing exports can drive production demands, leading to job creation However, this reliance on exports may pose risks of dependency A robust domestic market can help mitigate the impacts of exchange rate fluctuations, providing stability for the economy.
The balance of payments (BOP) provides crucial insights into a country's economic strength relative to other nations Ideally, the capital and financial accounts should offset the current account, resulting in a zero balance; however, this scenario is rare Additionally, discrepancies in statistics often arise in BOP analysis.
Double-entry bookkeeping requires that the balances of current and capital accounts match the financial account balance of a nation; however, this theoretical equality often does not reflect reality.
● Statistics discrepancy results from incorrectly recording or from not recording at all only one side of some transactions:
● Errors may arise because of different reporting requirements, different collecting agencies, wrong estimates of some transactions, and so on.
● Omissions are more likely in service than trade transactions, may arise because of forgetfulness or to evade taxes.
● Information – some is collected, some is estimated
● The statistical discrepancy, which keeps the BOP account in balance d, Official reserve transaction:
●Conducted in the form of international reserve assets by central banks, such as:
● IMF credits and SDR (Special Drawing Right)
●Changes in foreign central bank holding of domestic assets
Changes in domestic central bank holdings of foreign assets occur when US and foreign governments seek to strengthen the dollar by selling foreign currency, special drawing rights (SDRs), or gold to purchase dollars These transactions create increased demand for dollars, resulting in a positive entry in the balance of payments, despite a decline in the central bank’s reserves.
When US and foreign governments wish for a weak dollar, they
Selling dollars to purchase foreign currency, SRDs, or gold results in an increase in central bank reserves, yet these transactions are recorded as negative entries in the financial accounts.
*The significant of official reserve transactions:
1.The official transaction reserve assists in bringing the country’s balance of payments into balance:
Countries utilize official settlement accounts to assess their economic health by tracking the inflows and outflows of capital, including investments, loans, services, and products These accounts are crucial components of the international balance of payments, encompassing both the current account and capital account of central banks They play a vital role in maintaining economic stability, as reserve asset inflows or outflows help restore balance during periods of balance of payments deficits or surpluses Ideally, the total of the current account should align with the totals of the capital and finance accounts, reflecting a balanced economic state.
The procurement of a country's currency is recorded as a credit item in the balance of payments, while its sale is a negative item Various transactions, including products, goods, and services, help determine the balance The current account, capital account, and financial account balances are computed for foreign transactions A negative net amount in an international transaction account indicates a trade deficit, which is documented in the balance of payments This balance encompasses all economic transactions between residents and non-residents that result in ownership changes Trade deficits can be assessed across multiple categories within an international transaction account The net lending or borrowing is derived from the sum of the current and capital account balances, alongside the financial account balance adjusted for statistical discrepancies Unlike the current and capital accounts that focus on purchases and payments, the financial account specifically measures financial assets and liabilities.
3 It assist in the management of the deficit and surplus in the balance of payments:
Official reserve transactions refer to an account that monitors central bank activities and can be found within the financial account of the balance of payments A net increase in official reserves over time indicates that a country is experiencing a balance of payments surplus Conversely, if the official reserve balance declines consistently, it signals that the country is facing a balance of payments deficit.
In a fixed exchange rate system, a trade deficit occurs when a country's demand for imports surpasses its exports, leading to a higher domestic demand for foreign currency compared to international demand for its own currency To maintain a stable exchange rate, the central bank must intervene by selling foreign currency for domestic currency, which depletes foreign reserves and results in a balance-of-payments deficit Without financial account activities, this trade deficit indicates a balance-of-payments deficit, as excess demand in the private Forex market necessitates central bank action to sell foreign reserves Monitoring the transactions of foreign reserves in the official reserve account helps determine whether a country is experiencing a balance of payments deficit or surplus.
Balance of trade v/s balance of payment
2 Include all transactions related to visible invisible and capital transfer
4 BOP = current account + capital account +/- balancing items (errors and omissions) Financial Account?
3 Can be favorable or unfavorable
4 BOT = net earning on export - net payments for imports Balance of financial account = Net direct investment + Net portfolio investment + Assets funding + Errors and omissions
*Financial account components include direct investment, portfolio investment, and reserve assets broken down by sector
(portfolio : stocks, government bonds, corporate bonds) (assets funding : the use of a company's balance sheet assets, including short-term investments… To borrow money or get a loan)
● Domestic price of manufactured goods
6 Disequilibrium in the balance of payments
● A disequilibrium in the balance of payment means its condition of Surplus Or deficit.
● • A Surplus in the BOP occurs when Total Receipts exceeds Total Payments Thus, BOP= CREDIT>DEBIT.
● • A Deficit in the BOP occurs when Total Payments exceeds Total Receipts Thus, BOP= CREDIT disequilibrium in a country's BOP
Advanced nations have faced challenges in their exports due to the decline of colonial markets, coupled with the growing self-reliance of developing countries and their efforts to reduce imports.
• Economic Development (Due to rapid economic development, the resulting income and price effects will adversely affect the balance of payments position of a developing country.
As income levels rise in these countries, the marginal propensity to import increases, leading to a higher demand for imported goods Consequently, while the demand for domestic products also grows, this may result in a reduced focus on exports.
The rapid population growth in developing countries negatively impacts their balance of payments (BOP) position As the population rises, the demand for imports escalates, while the ability to export diminishes, creating economic challenges for these nations.
Natural calamities such as floods, droughts, and earthquakes disrupt a country's balance of payments (BOP) by damaging agricultural and industrial production This destruction negatively impacts exports and increases the reliance on imports, leading to economic instability.
*Measures to correct disequilibrium in the BOP:
Monetary measures play a crucial role in shaping economic stability, with monetary policy focusing on the management of money supply and credit by the Central Bank By adjusting the money supply, the Central Bank can influence price levels in the economy Additionally, fiscal policy encompasses the government's strategies regarding income and expenditure, as it allocates funds for both development projects and non-developmental needs.
-development expenditure It gets income through taxation and non
Governments can adjust their expenditure based on tax sources to address economic conditions One method to correct balance of payments (BOP) issues is through exchange rate depreciation, which lowers the domestic currency's value, making imports more expensive and exports cheaper, but may also trigger inflation Devaluation, the official lowering of a currency's value, similarly makes exports cheaper and imports pricier, helping to reduce BOP deficits Conversely, deflation involves reducing the money supply to lower prices and incomes, which can decrease domestic consumption but potentially increase exports and foreign exchange earnings Additionally, exchange control mandates that exporters surrender their foreign exchange earnings, which are then rationed among licensed importers, allowing controlled access to foreign currencies for imports.
To enhance export promotion, countries can implement non-monetary measures such as reducing export duties, providing cash assistance and subsidies to exporters, and exempting export-bound goods from taxes Additionally, encouraging the production of import substitutes can help save foreign exchange by reducing reliance on imports Furthermore, import control can be achieved through various strategies, including quotas and tariffs, where the government sets a maximum limit on the quantity of goods and services that can be imported within a specified timeframe.
The quota system allows the government to set a maximum limit on the quantity or value of a commodity that can be imported within a specific timeframe This restriction on imports helps to reduce trade deficits and enhances the balance of payments position.
Tariffs are taxes levied on imported goods, leading to higher prices for these products This price increase typically results in decreased demand for imports, while simultaneously encouraging domestic producers to increase the supply of local alternatives.
7 The importance of the BOP for the government
● Helps government determine potential industry -> develop policies to encourage production
● Provides government with a broad view of a import and export levies
->boost exports to achieve self-sufficiency
� Help government identify the economy status and plan expansion of the country through monetary and fiscal policy based on BOP.
From 2011 to 2018, Vietnam's current account balance consistently remained in surplus, with the exception of 2015, which was crucial for addressing the country's balance of payments issues This ongoing surplus has contributed to economic stability, allowing interest rates to stay low for an extended period, with only a slight rise at the end of 2018 As a result, businesses have been encouraged to enhance production and exports, leading to a significant increase in exports, a reduction in trade deficits, and an overall surplus in the trade balance, further bolstering the current account surplus.
From 2011 to 2018, Vietnam's financial account consistently recorded a surplus, reflecting the country's active engagement in diplomatic efforts and enhanced cooperation driven by globalization, particularly highlighted in 2017.
Since 2011, Vietnam has consistently maintained a surplus in its balance of payments, a success attributed to the Government's commitment to macroeconomic stability, sustainable growth, economic restructuring, and enhancing the efficiency and competitiveness of the economy.
SCHOOL OF ADVANCED EDUCATION PROGRAMS
GROUP ASSIGNMENTTOPIC: FOREIGN EXCHANGE MARKET
1.1 Types of transaction in FX 2
Functions of Foreign Exchange Market 3
2.2 Supply and Demand in Foreign Exchange Market4 2.2.1 Demand for Foreign Exchange 4
The role and influence of central banks on the foreign exchange market 6
4.1.3 Controlling the supply of money in circulation 7 4.1.4 Central bank – the “last lending” resort 7 4.2 The influence of central banks 7
4.2.1 Raising or lowering the key interest rate 7 4.2.2 Strengthening or weakening the currency 8 4.2.3 The currency peg 8
The foreign exchange market, commonly referred to as FOREX or FX, is a global over-the-counter (OTC) marketplace that enables individuals, firms, and banks to buy and sell foreign currencies.
1 Types of transaction in FX
Spot exchange: A spot exchange occurs when 2 parties agree to exchange the currency and execute the deal immediately Spot exchange rate changes continually.
Example: Company A bought 200 CAD on Tuesday (07/03/2022) Then, the debit row of company A’s account is recorded with +200 CAD
A forward exchange involves an agreement between two parties to execute a transaction at a predetermined date in the future The exchange rate that applies to these future transactions is known as the forward exchange rate.
Example: Today, company X signed a contract exchanging 1000 USD into VND with the time for payment being 90 days and the exchange rate is 1 USD = 23.705 VND After 3 months, X will receive
23.705.000 VND no matter the spot exchange rate at that moment. Currency swap: similar to a conventional forward exchange but ensures the dealer against foreign exchange risk.
→ Foreign exchange market is dominated by the foreign exchange swap and spot markets.
High liquidity: Because of the market's size as well as its geographical spread, FX processes US$5.1 trillion worth of transactions per day.
The importance of the BOP for the government
● Helps government determine potential industry -> develop policies to encourage production
● Provides government with a broad view of a import and export levies
->boost exports to achieve self-sufficiency
� Help government identify the economy status and plan expansion of the country through monetary and fiscal policy based on BOP.
Vietnam’s BOP
From 2011 to 2018, Vietnam's current account balance consistently remained in surplus, with the exception of 2015, which was crucial in addressing the country's balance of payments issues This ongoing surplus has played a significant role in enhancing economic stability, allowing interest rates to stay low for an extended period, with only a slight rise at the end of 2018 Consequently, these favorable conditions have empowered businesses to boost production and exports, leading to a significant reduction in trade deficits and contributing to the overall current account surplus.
Between 2011 and 2018, Vietnam's financial account, similar to its current account, consistently recorded a surplus During this time, the country actively engaged in diplomatic efforts and fostered international cooperation, reflecting the impacts of globalization, particularly highlighted in 2017.
Since 2011, Vietnam's balance of payments has consistently remained in surplus, a testament to the Government's successful efforts in stabilizing the macro-economy, fostering reasonable growth, restructuring the economy, and enhancing overall efficiency and competitiveness.
SCHOOL OF ADVANCED EDUCATION PROGRAMS
GROUP ASSIGNMENTTOPIC: FOREIGN EXCHANGE MARKET
1.1 Types of transaction in FX 2
Functions of Foreign Exchange Market 3
2.2 Supply and Demand in Foreign Exchange Market4 2.2.1 Demand for Foreign Exchange 4
The role and influence of central banks on the foreign exchange market 6
4.1.3 Controlling the supply of money in circulation 7 4.1.4 Central bank – the “last lending” resort 7 4.2 The influence of central banks 7
4.2.1 Raising or lowering the key interest rate 7 4.2.2 Strengthening or weakening the currency 8 4.2.3 The currency peg 8
The foreign exchange market, commonly referred to as FOREX, FX, or the currency market, is a global over-the-counter (OTC) marketplace where individuals, firms, and banks engage in the buying and selling of foreign currencies.
1 Types of transaction in FX
Spot exchange: A spot exchange occurs when 2 parties agree to exchange the currency and execute the deal immediately Spot exchange rate changes continually.
Example: Company A bought 200 CAD on Tuesday (07/03/2022) Then, the debit row of company A’s account is recorded with +200 CAD
A forward exchange is an agreement between two parties to execute a transaction at a predetermined date in the future, with the exchange rate for this future transaction known as the forward exchange rate.
Example: Today, company X signed a contract exchanging 1000 USD into VND with the time for payment being 90 days and the exchange rate is 1 USD = 23.705 VND After 3 months, X will receive
23.705.000 VND no matter the spot exchange rate at that moment. Currency swap: similar to a conventional forward exchange but ensures the dealer against foreign exchange risk.
→ Foreign exchange market is dominated by the foreign exchange swap and spot markets.
High liquidity: Because of the market's size as well as its geographical spread, FX processes US$5.1 trillion worth of transactions per day.
The foreign exchange market is highly dynamic, offering numerous opportunities for profit unlike equity markets, which rely solely on the appreciation of owned stocks In forex trading, investors can profit from fluctuations in currency values, whether they rise or fall This unique characteristic significantly contributes to the market's vast size and attracts a diverse range of participants.
The foreign exchange market operates 24 hours a day, connecting major trading centers like New York, Tokyo, and London, which are only closed for a brief three-hour window During this time, trading continues in smaller centers such as San Francisco and Sydney High-speed computer networks seamlessly integrate these global centers, ensuring minimal discrepancies in trading conditions across the market.
The U.S dollar dominates the global currency market, being involved in over 85% of all foreign exchange transactions Central banks globally maintain 60% of their reserves in dollars, highlighting its significance Following the dollar in importance are the European Euro (€), Japanese Yen (¥), British Pound (£), and Chinese Yuan (元) Due to its pivotal role in numerous exchange deals, the dollar serves as a primary vehicle currency in international trade.
The foreign exchange market offers low trading costs due to minimal entry barriers and low broker fees, allowing participants to retain more capital for trading This cost efficiency benefits smaller traders, making the market more accessible and broadening its overall participation.
2 Functions of Foreign Exchange Market
It is the primary function of the foreign exchange market
The transfer of purchasing power in foreign exchange transactions between countries enables the exchange of goods and services Purchasing power refers to the quantity of products and services that a single unit of currency can buy, highlighting the value of currency in international trade.
The function of transferring funds is carried out using credit instruments such as bills of exchange, bank drafts, and telephonic transfers This process facilitates the movement of money or foreign currencies between countries to settle accounts.
A Vietnamese company importing goods from Japan requires Japanese yen for payment To obtain the yen, the company must exchange Vietnamese dong for Japanese yen on the foreign exchange market, a process facilitated by banks.
The Credit Function of the Foreign Exchange Market implies the provision of credit in terms of foreign exchange for the export and import of goods and services.
The main purpose of credit is to help the importer in taking possession of goods, sell them and obtain the money to pay the bills.
For this, bills of exchange are generally used for making payments internationally The duration of Bills of Exchange is usually three months
A bill of exchange is a short-term negotiable instrument that represents a signed, unconditional written order It binds one party to pay a specified sum of money to another party either on demand or at a predetermined date.
It implies protection against risk related to fluctuations in the foreign exchange rate in the future
Under this system, buyers and sellers agree to sell and buy goods on a future date at some commonly agreed rate of exchange
2 Supply and Demand in Foreign Exchange Market
The demand for foreign exchange arises when a person has to make a payment in foreign currency In simple terms, it indicates the outflow of foreign currency
When importing goods and services from abroad, the importer must make payments in foreign currency, which generates a demand for foreign exchange in the Foreign Exchange Market.
Unilateral transfers sent abroad refer to free transfers made by individuals or governments, including gifts and grants to other countries These transfers are termed "unilateral" because they do not involve any expectation of receiving something in return, necessitating the use of foreign exchange.