Important International Finanace Terms

1) Gold Bullion Standard:

The basis of money remains a fixed weight of gold but the currency in circulation consist of paper notes with the authorities standing ready to convert unlimited amounts of paper currency in to gold and vice-versa, on demand at a fixed conversion ratio. Thus a pound sterling note can be exchanged for say ‘x’ ounces of gold while a dollar note can be converted into say ‘y’ ounces of gold on demand.

2) Gold Exchange Standard:

Gold Exchange Standard was established in order to create additional liquidity in the international markets. Hence the some of the countries committed themselves to convert their currencies into the currency of some other country on the gold standard rather than into gold. The authorities were ready to convert at a fixed rate, the paper currency issued by them into the paper currency of another country, which is operating a gold specie or gold bullion standard. Thus, if rupees are freely convertible into dollars and dollars in turn into gold, rupee can be said to be on a gold exchange standard.

Read More: The Gold Standard Exchange Rate System

3) The Gold Standard:

This is the oldest system which was in operation till the beginning of the First World War and a for few years thereafter i.e. it was basically from 1870 – 1914. The essential feature of this system was that the government gave an unconditional guarantee to convert their paper money to gold at a prefixed rate at any point of time or demand.

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4) Triffins Paradox:

The Bretton Woods System had some contradictions which were pointed out by  Prof. R Triffin  which were :- The system depended on the dollar performing and its role as a key currency. Countries other than the U.S had to accumulate dollar balances as the dollar was the means of International payment.  This meant that the US had to run BOP deficits so that other countries could build up a stock of claims on the US. When the US deficits started mounting, other countries started losing faith in the ability of the US to convert their dollar asset into gold.

Read More: The Bretton Woods System

5) Fixed exchange rate

As the name suggests, under fixed exchange rate system, the value of a currency in terms of another is fixed. These rates are determined by governments or central banks of the respective countries. The fixed exchange rates result from pegging their currencies to either some common commodity or to some particular currency. The rates remain constant or they may fluctuate within a narrow range. When a currency tends crossing over the limits, governments intervene to keep within the band. Normally countries pegs its currency to the currency in which the major transactions are carried out or some countries even peg their currencies to SDR. For example :  US dollar has 24 currencies pegged to itself whereas French franc has 14 currencies and 4 currencies are pegged to SDRs. The major advantage of this system is that it provides stability to international trade and exchange rate risk is reduced to some extent. Because of the fixed exchange rate system, exporters and importers are clear how much they have to pay each other on the due date. The disadvantage is that it is prone to speculation i.e. a speculator anticipating devaluation of pound sterling will buy US dollars at a forward rate so as to sell them when devaluation of the pound takes place.

6) Floating Exchange Rates:

When the relative price of currencies are determined purely by force of demand and supply and when the authorities make no attempt to hold the exchange rate at any particular level within a specific band or move it in a certain direction  by intervening in the exchange markets, it is referred to as Floating Exchange Rate.

Read More: Floating Exchange Rate Systems

7)  Crawling Peg:

A crawling peg rate is a hybrid of fixed and flexible exchange rate systems. Under this system, while the value of a currency is fixed in terms of a reference currency, this peg keeps on changing itself in accordance with the underlying economic fundamentals, thus letting the market forces play a role in the determination of the change in exchange rate. There are several bases which could be used to determine the direction of change in the exchange rate for example – the actual exchange rate ruling the market, t there is gradual modifications with permissible variations around the parity restricted to a narrow band. The change in parity per unit period is subject to a ceiling with an additional short term constraint, e.g. parity change in a month cannot be more than 1/12th of the yearly ceiling. Parity changes are carried out , based on a set of indicators. They may be discretionary, automatic or presumptive. The indicators are : current account deficits, changes in reserves, relative inflation rates and moving average of past spot rates. Countries such as Portugal and Brazil have in the part adopted variants of Crawling Peg.

8) Adjustable Peg:

Adjustable Peg system was established which fixed the exchange rates, with the provision of changing them if the necessity rose. Under the new system, all the members of the newly set up IMF were to fix the par value of their currency either in terms of gold, or in terms of US dollar. The par value of the US dollar was fixed at $ 35 per ounce. All these values were fixed with the approval of the IMF, and were reflected in the change economic and financial scenario in the countries engaged in international trade. The member countries agreed to maintain the exchange rates for their currency within a band of one percent on either sides of the fixed par value. The extreme points were to be referred to as upper and lower support point, due to which requirement that the countries do not allow the exchange rate to go beyond these points. The monetary authorities were to stand ready to buy or sell the US dollar and thereby support the exchange rates. For this purpose, a country which would freely buy and sell gold at the aforementioned par value for the settlement of international transactions was deemed to be maintaining its exchange rate within the one percent band.

9) Special Drawing Rights(SDRs):

The IMF created an asset called The Special Drawing Rights by simply opening an account in the name of each member country and crediting it with a certain amount of SDRs. The total volume created has to be ratified by the governing board and its allocation among the members is proportional to their quotas. The members can use it  for settling payments among themselves as well as for transactions with the fund. E.g. paying the reserve tranche contribution of an increase in their quotas.

Read More: The Special Drawing Rights (SDRs)

10) Devaluation :

The lowering of a country’s official exchange rate in relation to a foreign currency (or to gold) so that exports compete more favorably in the overseas markets. Devaluation is the opposite to revaluation.

11) Lerms:

An acronym for liberalization Exchange Management System that was introduced from March 1, 1992 under which the rupee was made partially convertible. The objective was to encourage exporters and induce a greater inflow of remittances through proper channels as well as bring about greater efficiency in import substitution. Under the system, percent of eligible foreign exchange receipts such as exports earnings or remittances was to be converted at the market rate and the balance 40% at the official rate of exchange. Importers could obtain their requirements of foreign exchange from authorized dealers at the market rate. Because of certain weaknesses, this system was replaced by a unified exchange rate in March 1993. This unification was recommended as an important step towards full convertibility by the committee on balance of payments under the chairmanship of C Ragranajan. Under the unified rate system all foreign exchange transactions through authorized dealers out at market determined rate exchange.

12) Custom Union:

Custom Union is a form of economic integration in which two or more nations agree to free all internal trade amongst themselves while levying a common external tariff on all non-member countries. The theory of custom unions and economic integration is associated primarily with the work of Prof. Jacob Viner in the 1940’s. This theory mainly focuses on optimum utilization of resources present in the member countries. Integration provides the opportunity of industries that have not yet been established as well as for those that have to take advantage of economies of large scale production made possible by expanded markets.

13) Dirty float:

The authorities are intervened more or less intensely in the foreign exchange market in which there are no officially declared parties, but there is official intervention that has come to be known as managed or dirty float.

14) Gold Tranche:

Member countries have an absolute claim on the IMF up-to the amount of gold subscriptions they have made. In operational terms, they can draw this amount (= 25% of their quota) from IMF any time. This is called ‘reserve tranche’ or “gold tranche” and is treated as the reserve of the country concerned. However, this sum is reimbursed to the IMF within a specified period varying from 3 months to 5 years.

15) Credit Tranches :

Any member can unconditionally borrow the part of its quota which it has contributed in the form of SDRs or foreign currency.  When it can borrow up-to 100% of its quota in four further tranches it is called  credit tranches. (Tranche means a ‘slice’)

16)International Liquidity :

It refers to the stock of means of international payment

17) Extended Fund Facility (EFF):

This facility was established in 1974 by the IMF to help countries address more protracted balance-of-payments problems with roots in the structure of the economy. Arrangements under the EFF are thus longer (3 years) and the repayment period can extend to 10 years, although repayment is expected within 4½ -7 years.