International financial System (Essay Sample)

International Financial System
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International Financial System
1 How George Soros made money in the international currency market
George Soros has made billions of dollars by trading in the international monetary market over the years. For example, he made around $2 billion after a speculation against the British pound and the lira in the financial derivatives market (Thompson, 1993). Soros good understanding of the international financial system allows him make his money. It enables him speculate movements in currency exchange rates, which he takes advantage of. For example, in the 1992 case, he borrowed British pounds, which he converted into German marks. Later, the value of the pound decreased, and he was able to pay his lenders using the new low value, making the huge profit in the process.
2 Risks involved in the international currency markets
The international currency markets have a number of risks associated with them. it is important for investors to know about these risks before making decisions of investing in the international market. These risks are as discussed here below.
* Exchange rate risk- this kind of risk exist because of the market forces of demand and supply of currencies. Investors should ensure that they trade within certain manageable limits to minimise exposure to exchange rate risk, which are position limit and loss limit (Exchangeforeignmoney.net, 2014).
* Interest rate risk- these are risks associated with currency swaps, futures, options, and forwards in the international financial system. It refers to the profits/losses from fluctuations of forward spreads and maturity gaps of the various transactions in the international currency market (Exchangeforeignmoney.net, 2014).
* Credit risk-it is the risk that the counterparty defaults, or fails to pay or perform on agreed upon transactions. However, in case the counterparty defaults, the other party to the trade may be forced to return to the market to obtain the currency it had expected to receive from the defaulter (Exchangeforeignmoney.net, 2014).
* Country risk- this is the risk of government interference in international currency market, thereby affecting the free flow of currencies (Exchangeforeignmoney.net, 2014).
3 Soros loses his money in the international financial markets.
During the global financial crisis of 2008, George Soros lost a lot of money in the financial market, especially in China and in India. Soros did not have a good understanding of the financial crisis. Soros failed to reduce his exposure to currency market risks, which made him lose more money in India than he had made in the previous year. In an effort to reduce and offset the losses, he overtraded, taking too large positions in the increasingly volatile markets. During the crisis, Soros did not understand that the commercial paper market had ceased to operate, which brought interbank lending to a standstill (Soros, 2008). The standstill made credit spreads widen to unprecedented levels, which made the stock exchange overwhelmed by panic and hence the losses he incurred due to overtrading.
4 Determinants of exchange rates
A number of factors, which are discussed here below, determine the exchange rates used in international currency markets.
* Trade balance
The amount of exports and imports and the trade balance of a country greatly influence the demand of the currency of such country (Kalra, 2005). An increase in trade surplus increases the demand for the local currency, making the currency more expensive. On the other hand, trade deficit leads to decreased demand for the local currency, thus weakening it.
* Relative purchasing power parity
This is the worldwide price that any free good or service commands, after consideration of nominal exchange rates. Purchasing power parity (PPP) is the exchange rate that represents a tradable basket of goods and services in a foreign currency in relation to its price in US dollars, and normally gives the exchange rate in terms of the foreign currency per dollar (Kalra, 2005).
* Relative interest rates
If the local interest rates on bonds are higher than foreign interest rates, foreign capital is attracted to the country to purchase the bonds. This increases the demand for the local currency and hence its price. The local interest rate becomes higher than foreign interest rates either through rising by the central bank as a way to defend the local currency or by depreciation of the foreign interest rate (Kalra, 2005). On the other hand, when the local interest rate is lower than the foreign interest rate, foreign investors dispose their investments in the local bonds, t...