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From Wikipedia, the free encyclopedia

International finance is the branch of economics that studies the dynamics of exchange rates, foreign investment, and how these affect international trade. It also studies international projects, international investments and capital flows, and trade deficits. It includes the study of futures, options and currency swaps. Together with international trade theory, international finance is also a branch of international economics.

Some of the theories which are important in international finance include the Mundell-Fleming model, the optimum currency area (OCA) theory, as well as the purchasing power parity (PPP) theory. Moreover, whereas international trade theory makes use of mostly microeconomic methods and theories, international finance theory makes use of predominantly intermediate and advanced macroeconomic methods and concepts.

Absolute purchasing power parity(APPP) states that the random exchange rate is equal to the ratio of the domestic price level to the international price level. APPP: Random Exchange Rate = Price Level Domestic/Price Level Foreign. The price levels can be determined by the Laspeyres Indices, which are the sumations of the price vector times the quantity vector. There are five factors which cause APPP to fail: taxes, homogeneity, demand for characteristics, politics, and uncertainty.

Relative purchasing power parity(RPPP) states that the estimated exchange rate is equal to the inflation rate differential, which is also equal to the interest rate differential, which is also equal to the ratio of the (foward rate - spot rate)/(spot rate).

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