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BOP Financial account

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BOP Financial account

Have you ever made a budget? If you have, you would record your spending limits and how much you wanted to save. And you would record all your financial transactions in it. Governments do the same thing! They record all their financial transactions in this account called the financial account.

What is the financial account in the BOP?

Financial accounts are the records of financial transactions across countries between residents and non-residents.

The financial transactions that are recorded here result in a change of ownership of financial assets or liabilities. The financial account experiences a deficiency when the country’s nationals purchase more foreign assets than foreign buyers purchase domestic assets.

When a country’s residents or multinational corporations (MNCs) invest in other countries, they start receiving money for these investments. In other words, their capital outflow results in inward flow in the proceeding years.

Net capital flow is the difference between the inward and outward flow of capital.

When a country experiences a positive net flow, it means that the country’s investments or capital assets in foreign countries are of greater value than the value of the assets bought by foreign nationals or MNCs in the country. The financial accounts consist of three main components: long-term direct investments, long-term portfolio investments, and short-term ‘hot-money’ capital flows. These are divided into sectors.

Long-term direct investments

Long-term direct investments or long-term capital flows are foreign direct investments (FDIs). As the word suggests, it refers to the investment made in foreign countries. FDIs can either be inward or outward direct investments. When a foreign MNC invests in the country, it is known as inward direct investment, and when the country’s MNC invests in a foreign country, such as when they open a subsidiary, it is known as outward direct investment.

FDIs also acquired in the form of mergers and takeovers or acquisitions are also examples of outward direct investments. Other examples of direct investments include the acquisition of shops, restaurants, hotels, offices, and other such assets in foreign countries.

When the inward direct investments increase, the country receives more money, thereby resulting in a positive financial account. This will result in positive economic growth in the country.

Long-term portfolio investments

Long-term portfolio investments consist of portfolio investments and other financial assets. Portfolio investments are the purchase of a country’s securities.

Securities are financial instruments that have a monetary value and can be interchanged for another asset or good of the same type.

This is typically the purchase of securities issued by foreign governments or shares from companies abroad.

Short-term ‘hot-money’ capital flows

Hot money is the money that moves between financial markets to avail maximum capital gain.

Hot money starts when interest rates rise. For example, if the Bank of England increased the rate for the Pound (£), investors would move their money into UK banks for a higher return on their savings and investments. This would appreciate the value of the £. An appreciation of the currency results in cheaper imports, increasing the volume of imported goods. The country will now become a less competitive exporter, as their domestic products cost more in the foreign market. This will lead to a trade deficit in the country.

It is called short term because investors move their money between financial markets based on the countries’ economic activities. They will continue to move their money to the country with a higher exchange rate.

Financial account balance formula

The balance of the financial account can be calculated using this formula:

Table 1 shows an example of a country’s positive financial account.

ParticularsAmount
Net direct investment£60,000.00
Net portfolio investment -£35,000.00
Asset funding £30,000.00
Errors and omissions
£15,000.00
Balance of financial account
£70,000.00
Table 1. Calculation of financial account - StudySmarter.

Net direct investment = £60,000.00

Net portfolio investment = -£35,000.00

Asset funding = £30,000

Errors and commissions = £15,000

Using the formula:

Balance of financial account = £60,000.00 + -£35,000.00 + £30,000.00 + £15,000.00 = £70,000.00

What is the capital account?

The capital account is a small part of the Balance of Payments.

The capital account records the transfers of non-monetary and fixed assets.

It mainly records the transfers of immigrants and emigrants and other government transfers such as debt forgiveness. The capital account represents the balance of payments for the country.

The balance of the current account can be calculated using this formula:

BOP: Financial Account - Key takeaways

  • Financial accounts are the records of financial transactions across countries between residents and non-residents.
  • The financial accounts consist of three main components: long-term direct investments, long-term portfolio investments, and short-term ‘hot-money’ capital flows.
  • ‘Hot-money’ moves around freely to countries with higher interest rates in order to earn the best rate of return.
  • Balance of financial account = Net direct investment + Net portfolio investment + Assets funding + Errors and omissions.
  • The capital account is the part of the Balance of Payments that records the transfers of non-monetary and fixed assets.
  • The balance on capital account = Surpluses or Deficits of Net Non-Produced + Non-Financial assets + Net Capital Transfers.

Frequently Asked Questions about BOP Financial account

Financial accounts are the records of financial transactions across countries between residents and non-residents. The financial transactions result in a change of ownership of financial assets or liabilities. When the country has claims on its non-residents, it is considered an asset, but, when claims are made on a resident, they are known as liabilities. The financial account experience a deficiency when a country’s nationals purchase more foreign assets than foreign buyers purchase domestic assets. This will result in a negative financial account. 


The financial accounts consist of three main components: long-term direct investments, long-term portfolio investments, and short-term ‘hot-money’ capital flows. 


The Balance of Payments (BOP) summarises a nation’s economic transactions, such as exports and imports of goods, services and financial assets, along with transfer payments with the rest of the world. The BOP helps in monitoring the flow of money and developing the economy. It shows the status of the country’s economy. The BOP gives the government a broad perspective on the range of import and export tariffs as well.


The balance on capital account = Surpluses or Deficits of Net Non-Produced + Non-Financial assets + Net Capital Transfers.


Balance of financial account = Net direct investment + Net portfolio investment + Assets funding + Errors and Omissions.


Final BOP Financial account Quiz

Question

Define financial accounts.

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Answer

Financial accounts are the records of financial transactions across countries between its residents and non-residents. The financial transactions result in a change of ownership of financial assets or liabilities.

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Question

State the three components of financial accounts.

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Answer

Long-term direct investments, long-term portfolio investments, and short-term ‘hot-money’ capital flows. 

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Question

 ______________________ involve the acquisition of different physical assets in other countries. 

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Answer

Long-term direct investments

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_________________ involve the purchase of securities issued by foreign governments or shares from companies abroad.


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Answer

Long-term portfolio investments

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What are capital accounts?


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Answer

It is the part of the Balance of Payments that records all international transactions of the country. They also help in understanding the country’s relative level of economic stability or future stability and identify whether the country is a net importer or exporter. 

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Question

Define net capital flow.


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Answer

Net capital flow is the difference between the inward and outward flow of capital. 

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Question

Define securities.

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Answer

Securities are financial instruments that have a monetary value and can be interchanged with another asset or good of the same type. 

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What is hot money?

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Answer

‘Hot-money’ refers to the money that moves between financial markets to avail maximum capital gain

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Question

Investors move their money out of countries with _______ exchange rate, and into countries with _____ exchange rate

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Answer

lower, higher

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What does the capital account record?

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It mainly records the transfers of immigrants and emigrants and other government transfers such as debt forgiveness.

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What are the two types of direct investments?

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Answer

Inward and outward direct investments.

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Purchasing a country's securities is a ______ investment.

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Answer

long-term portfolio

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Question

When a foreign MNC invests in the country, it is known as __________.

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Answer

inward direct investment

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FDIs acquired in the form of mergers and takeovers, or acquisitions are examples of ____________. 


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Answer

outward direct investments

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Question

Financial accounts are the records of financial transactions across countries between _________ and _________.

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Answer

residents and non-residents

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Question

The financial transactions that are recorded here result in a change of ownership of financial assets or liabilities.  

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Answer

True

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Question

Give an instance where a country's capital outflow results in inward flow in the proceeding years.  

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Answer

When a country’s residents or multinational corporations (MNCs) invest in other countries, they start receiving money for these investments.  

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__________ is the difference between the inward and outward flow of capital. 

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Answer

Net capital flow

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When a country experiences a positive net flow, it means that the country’s investments or capital assets in foreign countries are of greater value than the value of the assets bought by foreign nationals or MNCs in the country. 

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Answer

True

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Question

What are FDIs?

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Answer

It refers to the investment made in foreign countries.  

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FDIs can only be an outwrd direct investment.

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Answer

False

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Question

When the country’s MNC invests in a foreign country, it is known as _________.

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Answer

outward direct investment

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What is an inward direct investment?

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Answer

When a foreign MNC invests in the country, it is known as inward direct investment. 

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The country will experience a positive economic growth when inward direct investments increase.

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Answer

True

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Question

Balance of financial account = Net direct investment + Net portfolio investment + ________ + ________.

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Answer

Asset funding + Errors and omissions

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The __________ records the transfers of non-monetary and fixed assets. 

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Answer

capital account

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Question

If the Bank of England increased the rate for the Pound (£), investors would move their money into UK banks for a ______ return on their savings and investments.  

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Answer

higher

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Question

An appreciation of the currency results in cheaper imports, increasing the volume of imported goods. 

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Answer

True

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