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Part 1 - How would international trade function if there were no foreign exchange markets?

Part 2 - If only spot markets existed, how would international trade function?

Part 3 - Who are the major participants in the foreign exchange market?

Part 4 - What are the effects of an appreciating/depreciating exchange rate on the balance of payments?

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Solution Summary

The the effects of an appreciating/depreciating exchange rate on the balance of payments are implied.

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Part 1- How would international trade function if there were no foreign exchange markets?

The foreign exchange market exists wherever one currency is traded for another. It includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. The foreign exchange market is huge in comparison to other markets. The forex market is a cash inter-bank or inter-dealer market, which was established in 1971 when floating exchange rates began to appear.
If we assume that there is no foreign exchange market, international trade will be conducted through barter or universal equivalent trade.

Under barter trade, two countries will trade commodities at a price set by the comparative advantage theory(or "Ricardo's Law"), if one country is more efficient (at low opportunity cost) at producing goods or services needed by the other. The ratio between how easily the two countries can produce different goods (i.e., the ratio of opportunity costs) could be used to decide the trade price.
[Hardwick, Khan and Langmead (1990) An introduction to modern economics - 3rd Edn]

However, it is sometime hard to settle the deals if the values of commodities from both countries are not the same or even close. Then the a ...

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