Functions and Time Value of Money and Foreign Exchange Transactions

International Finance and Global Capital
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International Finance and Global Capital
Functions of Money
Chapters 1-3 suggest that money has three crucial functions: serving as a medium of exchange, storing value, and serving as a unit of account (Eun & Resnick, 2015). Before the Discovery of money, people traded in a barter trade system, which involved the directed exchange of goods or services for other goods or services. The system was inherently faulty in that for a person to obtain a particular commodity or service from the supplier, they had to possess another commodity or service with equal value to that of the supplier. In other words, barter trade was only efficient if a phenomenon called a double coincidence of wants or desires existed between the transacting parties (Eun & Resnick, 2015). The probability of the double coincidence of wants is usually low, making exchanging goods or services with other goods difficult. Money eliminates this problem by acting as a medium of exchange to facilitate all transactions, irrespective of whether or not the transacting parties desire each other’s commodities. The Discovery of money has facilitated even international trade resulting in a globalized economy. For example, international trade is marked with international capital flows where the importer of goods gives the exporter a monetary payment, just as it is done at the domestic level. Money also stores value because for it to serve as a medium of exchange, it must hold a particular value over time (Eun & Resnick, 2015). The value each currency holds determines the amount or type of goods or services a person holding money gets. The value of a currency is determined by its supply and demand, which is, in turn, influenced by inflation, interest rates, money supply, and capital flow. The third function of money is that it serves as a unit of account, providing a common unit of measure of the value of commodities being exchanged. Knowing the price or value of a particular commodity in terms of money allows the purchaser and the supplier to decide how much of the good to purchase or supply.
Monetary Policy
Monetary policy refers to measures taken by governments or other authorities, such as international bodies, to influence economic activities, usually by manipulating the supply of money or credit or by altering interest rates (Eun & Resnick, 2015). At the domestic level, the monetary policy is in the realm of the country’s central bank, as observed in the case of the Bank of England since the Classical Standard Gold period. The central banks, such as the Bank of England, use three major instruments to regulate the money supply: open market operations, reserve requirements, and discount rates. International monetary policy or system, on the other hand, refers to a set of universally agreed conventions, rules, and international supporting institutions, such as the International Monetary Fund and the World Bank, that facilitate international investment, global trade, and generally capital flow between countries with different currencies (Eun & Resnick, 2015). For example, there have been various international monetary systems in the world’s history, such as Bimetallism, Classical Gold Standard, the Interwar Period monetary system, Bretton Woods System, and the current system called the Flexible Exchange Rate Regime. All these systems had one thing in common at some point in their history; they all provided acceptable means of payment to sellers and buyers of different states, including deferred payment. Equally, at some point, they inspired confidence that they would provide adequate liquidity for fluctuating levels of global trade and offered means through which international imbalances could be corrected (Eun & Resnick, 2015). The collapse of the Bimetallism, Classical Gold Standard, Interwar Period monetary system, and Bretton Woods System was engineered by their inability to offer these crucial fundamentals.
The Floating Exchange Rate
The floating exchange rate, as opposed to a fixed exchange rate, is an exchange rate system where the foreign exchange market influences the price of the currency in a given country based on the relative supply and demand of other countries’ currencies (Eun & Resnick, 2015). Thus, unlike the fixed exchange rate that is entirely controlled by the government of the nation whose currency is in question, the floating exchange rate is not in any way restrained by government controls or trade limits. Before the adoption of this monetary system, systems such as Classical Standard Gold and Breton Woods System were in use. During the Classical Standard Gold era, nations pegged their respective currencies to gold, with a given amount of gold equating to a certain amount of gold, resulting in a very small exchange rate range. For example, the dollar-sterling-pound exchange rate remained very small, between $4.84 and $4.90 (Eun & Resnick, 2015). The system was abandoned in favor of the Bretton Woods System, where different member countries agreed to peg the currencies to the United States dollar, which was, in turn, pegged to the price of gold. This system resulted in the dollar being the global reserve currency. Pegged currencies to dollars were more rigid, and their prices fluctuated in a narrower range, making the system less efficient (Eun & Resnick, 2015). Nevertheless, it is important to note that pegged system was advantageous in that it promoted economic stability during economic uncertainties, which explains why there have been several economic recessions after the collapse of the Bretton Woods System.
Time Value of Money
The time value of money is a monetary concept stipulating that the value of a particular amount of money today will be lower in the future. The concept suggests that what a given sum of money can buy today might cost more in the future, meaning that money’s value erodes as time passes. It is the concept behind establishing banks and credit institutions, including international banks (Eun & Resnick, 2015). For example, the International Bank, World Bank applies this concept in that it lends to its member countries who use the money to invest in their development projects. Usually, states generate money from taxes that, in most cases, is not needed for tangible development projects. Thus, instead of such countries waiting to accumulate money and use it to implement development projects in the future, they can borrow from the World Bank and use money when its value is still high as opposed to waiting to accumulate the money themselves and use it in development projects in future when its value would be low (Eun & Resnick, 2015). Credit institutions also apply the same principle where the borrowing parties are provided money to invest. Investing will generate money that may offset the lost value of money within a particular period. Inflation is the main cause of decreasing value of money over time. For instance, during the Covid-19 pandemic, the strained global and local supply lines coupled with increased demand for commodities contributed greatly to high inflation rates, reducing the value of money. This means that amount of money that would buy a particular commodity before the pandemic cannot buy the same commodity today.
Foreign Bond
A bond refers to a fixed-income investment representing a loan offered to a borrower by an investor (Eun & Resnick, 2015). Governmental and corporates are the main borrowers of bonds and are usually aimed at raising funds for various projects. Some types of bonds, known as rated bonds, are typically rated by credit institutions to help determine their quality. There are other bonds offered by companies such as Heineken that credit agencies do not rate. A foreign bond is a type of bond where governments or corporates secure sufficient capital from foreign entities to conduct various operations. Foreign bonds are issued by a governmental agency or private corporation in a different country from which the borrowing investor operates. Such bonds are made available to investors in the currencies of the countries in which they operate (Eun & Resnick, 2015). For instance, a corporation in the United Kingdom issues a bond and offers it to investors in the United States in US Dollars. Thus, foreign bonds give borrowers a channel through which they can access new capital markets, allowing them to obtain foreign currency. Additionally, by doing so, investors can invest overseas in their local currencies. Usually, investors are enticed by foreign bonds because they enable them to diversify their portfolios and invest in foreign countries without being affected by exchange rates (Eun & Resnick, 2015). Some foreign bonds include Yankee Bonds issued by foreign borrowers within the United States bond markets, Bulldog bonds available in the United Kingdom markets, and Samurai bonds issued by foreign borrowers in Japanese markets.
Yield to Maturity
When investors decide to purchase bonds, they must consider one crucial piece of information, the Yie...