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International Monetary System
International Monetary System
Under this system, each nation defined its currency in terms of gold.
Exchange rate
between nations
$ 200/10grms of gold
Rs. 2000/10grms of gold
or 1 $ = Rs. 10
$ 0.1/ Re
Under the Gold Standard, Money Supply was directly linked to the
stock of Monetary Gold.
Gold Standard could not with stand abnormal periods like war &
depression.
Any new system had to have facilities for the extension of credit for
countries to defend their currency values. (multilateral credit
mechanism)
Under this system, each member country of the IMF was required to
define the value of its currency in terms of gold or the US dollar & to
maintain (to peg) the market value of its currency within _+1%
Bretton Woods System failed because the governments all over the
world were unable to maintain their parity under the gold or Dollar
system since it required reserve assets. An expansion in trade required
increase in international liquidity.
The persistent & burgeoning BOP deficit of the US & the huge
accumulation of the dollar outside the US led to the breakdown of the
par value (US liabilities rose to $68 billion) Central Bank of Germany
alone held enough dollar to exhaust entire gold of US.
Speculators & MNCs became very eager to unload dollars & to acquire
other currencies.
IMFs par value system officially ended on 15, Aug 1971. President
Nixon withdrew USs commitment to buy & sell gold @$35 per ounce,
thus abrogating the IMF agreement.
Indian rupees was pegged to a basket of five currencies for its rate
determination. These currencies are $, , Franc,Yen & Deutch mark.
Intervention in other currencies (US) was allowed & had been undertaken
on a substantial scale.
The grid of bilateral central rates & intervention limits was supplemented
by the divergence indicator, which showed the movement of the
exchange rate of each EMS currency against the (weighted) average
movement of others
Benefits of Euro
Single Currency brings.
Single interest rate.
Eliminate currency risk.
Give equity & bond markets the necessary.
Scope & liquidity to attract big investors.
Imports
Bank
Exporters
Country Bank
hedging on FE Market
Spot & Forward Exchanges
At discount w.r.t. spot rate when one dollar buys fewer rupees in the
forward than the spot market.
Premium & discount are expressed as a % deviation from the spot rate
on a per annum basis.
2 types of options
European
Exercised only at the
maturity or expiration
date of the contract
&
American
exercised at any time
during the contract.