PART II
Intl.fin.
Intl.fin.
countries
INT = change in the interest rates between two
countries
INC = change in the differential in the income levels
of two countries
GC = change in the government controls and
EXP = change in expectations of future exchange
rates
3
Intl.fin.
e
D1
D
Quantity supplied
Intl.fin.
demanded
Changes in demand can affect the exchange
rates
5
Intl.fin.
4. Government controls
influence the exchange rates in
many ways including imposition
of:
1. Foreign exchange barriers
2. Trade barriers
3. Market interventions etc.
6
Intl.fin.
>>
7
Intl.fin.
Intl.fin.
Intl.fin.
turnover)
Large MNCs
Hedge Funds, Pension Funds, Insurance Companies, Mutual Funds
etc.
Forex brokers
Central Banks
>>
11
Intl.fin.
Intl.fin.
Intl.fin.
2.
3.
4.
5.
14
Intl.fin.
Intl.fin.
16
Intl.fin.
market.
N.Y C.T: 3
p.m.
London will
L.A.
remains
open
still be open
when
Frankfurt &
Zurich close
When
Singapore
closes,
Frankfurt &
Zurich
open
When Hong
Kong
closes,
Singapore
is still open
When L.A.
closes
When
Tokyo
closes,
Hong Kong
is still open
It is
opening
time at
Sydney and
Tokyo
biggest
Intl.fin.
Frankfurt
Chicago
London
Tokyo
New York
Bahrain
San Francisco
Hong Kong
Singapore
Sydney
Hong Kong
Foreign Exchange Dealing
Times: GMT
Tokyo & Sydney
Bahrain
Singapore
Frankfurt
London
New York
Chicago
San Francisco
GMT 2300 2200 2100 2000 1900 1800 1700 1600 1500 1400 1300 1200 1100 1000 0900 0800 0700 0600 0500
0400 0300intl.financing
0200 0100
18
-10
-09
-08
-07
-06
-05
-04
-03 -02 -01
-00 +01 +02 +03 +04 +05 +06 +07 +08 +09
+10 +12
Intl.fin.
Intl.fin.
Settlement of Trades
Settlement of trades take place by transfer
Intl.fin.
1999
RBI is the regulator under the powers vested by
FEMA.
Players:
Authorized Dealers (Categories A, B & C) and
Money Changers >>
22
Intl.fin.
Intl.fin.
Clearing Process
A majority of forex transactions in India involves dollar as one
leg;
A multilateral netting mechanism has been created through the
CCIL (Clearing Corporation of India Ltd.) for settlement of all
dollar denominated transactions.
As a central counterparty CCIL guarantees trade settlement.
ADs pass the dollar-related transactions through CCIL for
netting and settlement.
CCIL in turn settles the dollar leg through its correspondent in
the USA.
The rupee leg is settled through the member banks account
with RBI.
Advantage: Substantial cost and time benefit for the ADs.
Transactions in currencies other than dollar are settled directly
by ADs through their respective Nostro bank accounts.
24
Intl.fin.
currency and yyy is the counter currency (or quote currency). E.g.,
USD/JPY, USD/CAD, USD/INR etc
Remember: The value of the base currency is always 1
The three exceptions to this rule are the British pound (GBP), the
Australian dollar (AUD) and the Euro (EUR). For these pairs, where
USD is not the base currency, a rising quote means the US dollar is
weakening and buys less of the other currency than before.
Direct Quote: Exchange Rate is expressed in terms of number of units
of domestic currency per unit of foreign currency.
E.g., 1USD = INR55.42
Indirect Quote: Domestic currency fixed and foreign currency variable.
E.g., Rs.100/$
Market quotes: DM/$ : 1.6688 / 93
Inter-bank quote: DM / $ : 88 / 93
A few currencies are quoted in 100s rather than 1s or 2s. E.g.,
Japanese Yen ($/100Y: 0.9150/52)
25
Intl.fin.
26
Intl.fin.
Inverse Quotes
For every quote A/B there is an inverse quote B/A
E.g., Euro / $ : 1.6688 / 93 is a quotation in Frankfurt.
The quote on the left side is called the Bid (purchase)
rate and that on the right is called the Ask (sale) rate.
Bid always precedes the ask rate.
Bid is the rate at which the bank is prepared to buy
dollars (also means the rate at which it is ready to sell
Euro) and Ask is the rate at which it is prepared to sell
dollars (also means the rate at which it is prepared to
buy Euro).
Hence the Euro / $ bid rate would correspond to $ /
Euro ask rate.
27
Intl.fin.
Inverse Quotes
For the above example,
The implied ($/Euro)bid = 1 / (Euro/$)ask
The implied ($/Euro)ask = 1 / (Euro/$)bid
So the implied inverse rate is:
$ / Euro : 0.5990 / 0.5992
as:
Implied (B/A) quote:
1/(A/B)ask Divided by 1/(A/B)bid
28
Intl.fin.
1.6688/93
The rate on the left side is the bid (buying) rate and that on the
right side is the ask (selling) rate.
A few currencies like Japanese Yen are quoted in units of 100
($/100Y=0.9150/52)
The quote after the decimal points is called basis points.
According to FEDAI Regulations, all rates have to be quoted
to four decimal points, with the last two being multiples of 5
(this rule is ignored for the sake of simplicity and learning)
29
Intl.fin.
influenced by:
Spread = (Order costs + Inventory costs
etc.
Inventory costs are costs of maintaining inventory of a
particular currency. Holding an inventory involves an
opportunity cost.
Competition: Higher the competition, the lower the spread.
Volume: Higher the volume, lower the spread.
Currency risk: Higher the volatility of the currency, higher
the spread as the intermediaries dealing in these currencies
could incur large losses due to abrupt change in the values
of these currencies.
30
Intl.fin.
Intl.fin.
Intl.fin.
Intl.fin.
Forward Rates
A forward rate in a Forward Contract is an
Intl.fin.
4.
5.
36
Intl.fin.
i.
a)
b)
c)
d)
e)
Exchange Margin.
37
Intl.fin.
i.
a)
b)
Exchange Margin.
i. Bills Selling Rate
a)
b)
Exchange Margin.
i. Travellers cheques (TC) selling rate (TT Selling + 0.5%
towards handling charges)
ii. Foreign currency notes selling rate (TC selling + 0.5%)
38
Intl.fin.
39
Intl.fin.
Notional Rates
An assumed rate which is used for
40
exchange rates.
Real exchange rate is price-adjusted nominal exchange rate.
The relation between nominal and real exchange rate can
be written as:
er = eP/P* , where P and P* are domestic and foreign price
indices.
Suppose the WPI in India and USA rises from 100 in 1998 to
120 and 110 respectively in 2001and if the nominal exchange
rate between the two currencies between the two dates remain
at Rs40/$, the real exchange rate will move to:
40 x 120/110
= Rs43.64/$
In a floating rate system the nominal rate moves automatically
with the change in the price level, but it does not happen so in
a fixed exchange system because of the administered rate. As
a result there will be a gap between the two.
41
Intl.fin.
42
Intl.fin.
More on EER
Process of construction of an EER index:
Step 1: Select the basket for the currency (only those
0.65.
Japan=(4000 + 3000) [(4000 + 3000) + (6000 + 7000)] =
0.35
43
Intl.fin.
More on EER
Step 3: Find out the exchange rate index as
follows:
Suppose in 1998, the exchange rate was Rs40/$ and
Rs50/Yen100;
In 2001the exchange rate changed to Rs44/$ and
Rs60/Yen100;
If 1998 is the base year the exchange rate index in
2001 will be 110 (100 + 10% increase) for US$ and
120 (100 + 20% increase) for Yen.
EER 1998 = [(0.65 x 100)+ (0.35 x 100)] = 100
EER 2001 = [(0.65 x 110) + (0.35 x 120) = 113.5
This means that rupee depreciated on an average
by 13.5% during the period 1998 2001.
44
Intl.fin.
45
Intl.fin.
price] x 100
Intl.fin.
Intl.fin.
Intl.fin.
US$1/C$0.78 = `44.87/C$
Selling Rate: `35.20/US$1 X US$1/C$0.76 =
`46.32/C$
Or combining the two, ` / C$ rates are:
`44.87 46.32 / C$
8. Suppose one month forward US$/` rate is
`34.50 34.80 and US$/C$ is C$0.79
0.83, find out the forward rate of C$/`.
49
Intl.fin.
50
Intl.fin.
Canada
Euro Area
Great Britain
Japan
Solution:
Country / Currency
Canada
Euro Area
Great Britain
Japan
51
Intl.fin.
USD
EUR
GBP
JPY
1.2341
0.8247
0.5488
108.83
USD
1.2341
0.8247
0.5488
108.83
EUR
1.4965
0.6655
131.96
GBP
2.2485
1.5026
198.28
JPY
0.0113
0.0076
0.005
-
Intl.fin.
53
Intl.fin.
Solution
Spot
I Month
3 Months
6 Months
$1.4710
1.4810
$1.4710
1.4810
- 0.00650.0044
$1.4710
1.4810
- 0.0145
0.0123
$1.4710
1.4810
- 0.02900.0222
Outright
quotes
$1.4645
1.4766
$1.47651.4687
$1.4420-1.4588
54
Intl.fin.
Intl.fin.
Spot /$ rate
Forward rate
Outright quote
1-month
0.2479
0.2481
0.0003
0.0005
0.2482
0.2486
3-month
0.2479
0.2481
0.0008
0.0007
0.2471 0.2474
6-month
0.2479
0.2481
0.0013
0.0017
0.2466
0.2464
Intl.fin.
57
Intl.fin.
Intl.fin.
Intl.fin.
Forecasting Techniques
The numerous methods available for
Intl.fin.
Technical Forecasting
Technical forecasting involves the use of
Intl.fin.
Fundamental Forecasting
In general, fundamental forecasting is
limited by:
the uncertain timing of the impact of the
factors,
the need to forecast factors that have an
immediate impact on exchange rates,
the omission of factors that are not easily
quantifiable, and
changes in the sensitivity of currency
movements to each factor over time.
62
Intl.fin.
Market-Based Forecasting
Market-based forecasting uses market
63
Intl.fin.
Mixed Forecasting
Mixed forecasting refers to the use
of a combination of forecasting
techniques.
The actual forecast is a weighted
average of the various forecasts
developed.
64
Intl.fin.
can be evaluated:
graphically
by visually comparing the deviations
all periods.
65
Intl.fin.
Intl.fin.
Intl.fin.
Intl.fin.
69
Intl.fin.
Intl.fin.
71
Intl.fin.
Intl.fin.
Econometric Models
The factors used in econometric models are
Intl.fin.
Econometric Models
The coefficients a, b and c in the formula
Intl.fin.
Intl.fin.
76
Intl.fin.
77
Intl.fin.
Transaction
ii. Speculative and
iii. Precautionary
.Transaction motive arise because of
international trade handled by banks.
.Speculative motive arise because of
individuals or corporates engaging themselves
in speculation for profit.
.Central bank reserves however arise as a
precaution against unpredictable flows. >>
i.
78
Intl.fin.
iv.
v.
79
Intl.fin.
Implications of reserve
accumulation
Portfolio inflows are temporary
Whereas current account surpluses tend to endure and have positive
Intl.fin.
81
Intl.fin.
Questions
Discuss the motives for holding foreign exchange
Intl.fin.
>> Questions
Assume that the Federal Reserve believes that dollar
Intl.fin.
>> Questions
How can a central bank use direct
Intl.fin.
Types of Transactions
Transactions can be classified based on the time
Intl.fin.
Forex
Transactions
Forwar
d
Spot
Ready
(Today)
86
Intl.fin.
Tom
(Next
working
day)
Spot
(Two
working
days)
(Any
time
after two
working
days)
Value Dates
The settlement date of a forex transaction is called
Intl.fin.
Value Dates
For example,
If a 3 months (or 90 days) is entered into on
Intl.fin.
Value Dates
Example: If one month forward contract is
Intl.fin.
46.62/70
USD/GBP : 1.6721/26 and 3m USD/GBP :
1.6481/92
The spread between the bid and the ask
90
Intl.fin.
forward rate or
Deduct swap points from the outright forward rate to get the
spot rate.
91
Intl.fin.
92
Intl.fin.
Intl.fin.
Intl.fin.
3
month
s
6
months
/$
2.0015
30
19-17
26-22
42-35
SFr/$
0.6963
68
4-6
9-14
25-38
>>
94
1
mont
h
Pound Sterling
The
outright rates
Maturity
Bid are: Ask
Spread
Swiss Francs
Bid
Ask
Spread
(%)
(%)
Spot
$2.001
5
$2.003
0
0.075
$0.696
3
$0.6969
0.086
%
1 Month
1.9996
2.0013
0.095
0.6972
0.6982
0.143
3 Months
1.9989
2.0008
0.095
0.6972
0.6982
0.143
6 Months
1.9973
1.9995
0.110
0.6988
0.7006
0.257
Intl.fin.
96
Intl.fin.
Intl.fin.
Intl.fin.
Intl.fin.
Option Forwards
Customer of a bank has the option to ask
101
Option Forwards
1. When the bank is buying a currency:
Will add the minimum premium
102
Option Forwards
2. When the bank is selling a currency:
Will add the maximum premium possible (when
Intl.fin.
Option Forwards
Sfr is at a premium
If the bank is selling Sfr, it will load the maximum
Intl.fin.
Option Forwards
Example 2. Currency is at a premium at the
: 3.4930/42
Customer Option to buy Aus$ any time
during the second month, the bank would
quote the rate of SFr3.4945/Aus$ and if the
option were to sell Aus$, the quotation would
be SFr3.4930/Aus$.
105
Intl.fin.
106
Intl.fin.
International Arbitrage
Definition: Capitalizing on a discrepancy in the quoted
107
Locational arbitrage
Triangular arbitrage
Covered interest arbitrage
1. Locational arbitrage:
Example: Two coin shops A & B are in the business of
buying and selling coins. Shop A is prepared to sell a
particular coin at Rs.120 and shop B is prepared to buy
the same coin for Rs.130.
A coin collector can buy the coin at Rs.120 from shop A
and sell the same to shop B for Rs.130 and thus earn a
risk-free profit of Rs.10 in the transaction.
Prices in the shops may vary because of their different
locations. Demand conditions also vary if the two shops
are not aware of each others prices. These factors give
Intl.fin.
rise for arbitrage opportunities. Gains from locational
Intl.fin.
/ Bid - 1.6650/pound
If $1.5422 = 1 and
If 1 = 1.6650
How many Euros = 1$
i.e. (1.5422/1) x (1/1.6650) = 0.9262 or 1 = $1.0796
Since euro is available in Frankfurt at a cheaper rate of
$0.9251 (as against a cross rate of $1.0796) there is an
arbitrage opportunity.
109
Intl.fin.
Currency Arbitrage
Let us assume that the trader begins in
Intl.fin.
Currency Arbitrage
In the preceding example, the arbitrage
Intl.fin.
quotes are expressed as one unit of currency on the left side per unit
of currency shown at the top row.
Curr
ency
SFr
DKr
GBP
JPN
SFr
DKr
Pound Stg.
Japanese
Yen
US $
0.295702.4256-67
0.1276-78
1.5780-86
3.3818-25
76 8.2031-41
0.4315-19
5.3021-33
0.41227- 0.00526-29
0.6502-10
35
0.12381190.121123.56978.38190
390
707
496arbitrage
23.178Do any triangular
opportunities exist among these
251deviations from the theoretical cross
currencies? (Assume that any
rates of 5 points or less are due to transaction costs).
How much profit could be made from a $5 million transaction
associated with each arbitrage opportunity?
112
Intl.fin.
Questions
1. Discuss the forex market structure in India.
2. What risks confront the forex dealers and how
3.
4.
5.
6.
113
Intl.fin.
Questions
6. An investor wishes to buy euros spot @ $0.9080
114
Intl.fin.
Questions
8. As a foreign exchange dealer at Sumitomo Bank
you have a customer who would like spot and 30day forward Yen quotes on Australian Dollars.
Current market rates are:
Spot 30-day
101.37-85/US$1 1513
A$1.2924 44/US$1
2026
a) What bid and ask Yen cross rates would you quote
on spot Australian dollars?
b) What outright Yen cross rates would you quote on
30-day forward Australian dollars?
c) What is the forward premium or discount on buying
30-day Australian dollars against yen delivery?
115
Intl.fin.
116
Intl.fin.
117
Intl.fin.
Crisis in Thailand
Worlds fastest growing economy till 1997
Grew faster than any other country over 1985
94
Thai consumers spent freely and saved less
Result upward pressure on local interest rates
and prices of real estate and products
Thai Baht was linked to U.S. dollar till July 1995
and therefore attracted foreign investments
because of high interest rates.
More funds available to Thai banks were lent to
the real estate sector based on the previous
success of the developers
118
Intl.fin.
>>Crisis in Thailand
Thailand was a house of cards waiting to collapse
Large inflow of funds led to lower interest rates
Thai government borrowed heavily to improve
Intl.fin.
120
billion
On August 5 1997 IMF and other countries
agreed to provide a $16 billion rescue
package
In return Thailand agreed to reduce its
budget deficit, prevent inflation from rising
above 9% and increase taxes
Many banks folded up
Intl.fin.
The crisis spread throughout Southeast
Intl.fin.
122
Intl.fin.
Chaebols
collapsed,
Currency
depreciated
IMF rescue
package of $55
billion
- 0%
41%
Hong
Kong 0%
38%
-37%
123
Intl.fin.
Singapore
- 15%
-84%
Taiwan
-20%
-37%
How Interest Rates Changed between June 1997(.) and June 1998
S.Korea
(14)/17%
(7)/12%
(11)/24%
124
Intl.fin.
Singapore
(3)/7%
Indonesia
(16)/47%%
(7)/8
%
(7)/11%
%
Taiwan
(5)/7%
Hong Kong
(6)/10%
Philippine
s
(11)/14%
Sources of International
Liquidity
Monetary gold held by the authorities as a
125
financial asset
SDRs (Value of SDR determined daily by the
IMF on the basis of a basket of currencies, with
each currency assigned a weight)
Reserve position in the fund (difference
between each members quota plus other
claims on the fund less the Funds holdings of
that members currency).
Foreign exchange comprising monetary
authorities claim on non-residents in the form
of bank deposits, Treasury Bills, Short and longterm government securities, without regard as
Intl.fin.
to whether the claim is denominated in the
126
Intl.fin.
Intl.fin.
Bulldog Bonds,
Euro Bonds: Euro dollar, Euro Yen and Euro Pound
Bonds
Instruments in the Equity Market: ADR / GDR
128
Intl.fin.
129
Intl.fin.
130
Intl.fin.
Intl.fin.
Intl.fin.
international banks.
For GDRs, the investors are mostly
institutions and high net worth individuals.
For ADRs, it is the institutional investors or
HNIs through the Qualified Institutional
Buyers.
Intermediaries:
Lead Managers, Co-lead Managers,
Intl.fin.
Functions of Intermediaries
1. Lead and Co-lead Managers:
Undertaking due diligence
Preparing the offer memorandum
Marketing the issues, including the road
shows
Sometimes there could be more than one
lead manager to ensure successful launch.
One of the lead manager will run the books
(sending out invitations, allotting Bonds / DRs
etc.) for the issue.
2. Underwriters: Taking on the risk of
Intl.fin.
Functions of Intermediaries
3. Agents & Trustees: The issuer of the Bonds
136
Intl.fin.
Functions of Intermediaries
6. Depository Bank: Responsible for
Intl.fin.
company.
6. Regulatory aspects: Various approvals required from
different authorities.
7. Disclosure requirements.
8. Investment climate International liquidity, country risk.
138
Intl.fin.
139
Stage
a. Initial
decision
i. Meeting between
issuer and lead
manager planning the
issue.
ii. Issue structure
finalized in
conformity with the
domestic regulatory
environment.
iii. Draft documentation
iv. Due diligence process
v. Board meeting and
share holders
approval
vi. Fixing various parties
to the issue.
Intl.fin.
Time in
weeks
1 and 2
Time in
weeks
3 and 4
c. Pre-launch formalities
d. Launch of issues
140
Intl.fin.
141
Intl.fin.
Time in
weeks
INTERNATIONAL DEBT
MARKETS
Debt markets and instruments
142
Intl.fin.
143
Intl.fin.
borrower:
A variety of different maturities,
Repayment structures and
Currencies of denomination.
144
Intl.fin.
145
Intl.fin.
at face value.
These are unsecured bonds
Bonds issued in the Euro-market are called
Euro Bonds.
Interest on the bonds are benchmarked to
LIBOR
Redemption of Straights is done by bullet
payment
No tax deduction at source on the income
from these bonds.
Can also be issued as Zero Coupon Bonds
146
Intl.fin.
years.
Conventionally the Bonds are called the
Notes and the margin will be above 6
months LIBOR for euro dollar deposits.
Procedure for issue:
The mandated bank forms a syndicate group
The lead bank is responsible for credit
stock exchanges.
Bond issue procedures generally end with tombstone
advertisements.
Clearing arrangements:
Euro Bonds are generally handed over to either
fungible
and non-fungible
accounts for concluding transactions between parties.
Euroclear handles trades on fungible basis, whereas
Cedel permits both procedures.
individual securities are not provided)
148
Intl.fin.
149
Intl.fin.
150
Intl.fin.
.Euro Notes:
Euro Notes (EN) are different from syndicated bank
Intl.fin.
Intl.fin.
Intl.fin.
60s.
Period: 7 to 15 years
RoI: Floating rate linked to 3 or 6 months LIBOR.
Currency: Denominated generally in US$, JPY, Euro, SFR .
Amortization: Half-yearly installments with 2 3 years
grace period.
Simplest way of raising foreign currency resources.
Documentation: Information Memorandum and loan
agreement from the lead manager.
Underwriting: Yes, by a management group assembled by
the lead bank, including itself.
Comparative Analysis of Global Financial Markets.xlsx plu
s Comparative Analysis of Financial Instruments.xlsx
154
Intl.fin.
Intl.fin.
Intl.fin.
Intl.fin.
Intl.fin.
Intl.fin.
External Commercial
Borrowings (ECBs)
160
Intl.fin.
Meaning of ECBs
ECB refers to commercial loans in the form
of:
Bank loans,
Buyers credit,
Suppliers credit,
Securitized instruments (e.g. floating rate
Routes to ECBs
ECB can be accessed under two routes:
(i) Automatic Route and
(ii) Approval Route
Pricing?
All-in-cost ceilings:
Purpose of ECBs
ECB can be raised for import of capital goods for new
projects, modernization/expansion of existing
production units in:
a) Industrial sector including small and medium
enterprises (SME),
b) Infrastructure sector [power, telecommunication,
railways, roads including bridges, sea port and
airport, industrial parks, urban infrastructure
(water supply, sanitation and sewage projects),
mining, exploration and refining and cold storage
or cold room facility] and
c) Specified service sectors, like hotel, hospital,
software
Purpose of ECBs
d) Overseas Direct Investment in Joint
ECB Pricing
The all-in-cost ceilings for ECB are reviewed from time to
time.
The following ceilings are applicable up to September 30,
2012 and subject to review thereafter:
* for the respective currency of borrowing or applicable
benchmark
In the case of fixed rate loans, the swap cost plus the
margin should be the equivalent of the floating rate plus
the applicable margin.
Prepayment of ECBs
Prepayment of ECB up to USD 500 million
APPROVAL ROUTE
APPROVAL ROUTE
Eligible borrowers:
On lending by the EXIM Bank for specific purposes
Banks and financial institutions which had
Average Maturity
Period
benchmark
In the case of fixed rate loans, the swap cost plus the margin
should be the equivalent of the floating rate plus the applicable
margin.
187
Intl.fin.
Cost-related motives:
1.
2.
3.
4.
5.
188
Intl.fin.
189
Expected
Cash Flow
(marks)
Exchange
Rate (marks
to U.S. dollar)
Expected
Cash Flow
(U.S. dollars)
0
-1,500,000 2.50
-600,000
1
500,000
2.54
2
800,000
2.59
3
700,000
2.65
4
600,000
2.72
Net Present Value
190
Intl.fin.
Present Value
of Cash Flows
at 18%
-600,000
196,850 166,822
308,880 221,833
264,151 160,770
220,588 113,777
=
63,202
Intl.fin.
Intl.fin.
Intl.fin.
NPV Method
The
194
Intl.fin.
NPV Calculation
195
NPV Calculation
+ + - = {(3,000,000/1.10)} + {3,500,000/} + {(2,000,000 +
as k decreases.
2. Profitability index (PI): It is the ratio between the
present value of the future cash flows and the initial
investment.
PI = } ]
Substituting the figures given in the previous example,
we get: 7,873,778 / 5,000,000 = 1.57
The project may be accepted because PI is more than 1
196
Intl.fin.
IRR
is the discount rate equating the present value
of future cash flows and the initial investment.
For accepting a project, IRR should be greater
than the hurdle rate.
Expressed as an equation:
] - = 0
The project will be acceptable if IRR is greater
than the required rate of return.
Based on the previous example, IRR is 40%. Since
the required rate of return is 10% the project
would be acceptable.
197
Intl.fin.
198
Intl.fin.
199
Intl.fin.
200
Intl.fin.
Intl.fin.
that is chosen.
Project size and life
Differences in cash flows
When are the NPV & IRR reliable?
1. If projects are compared using the NPV , a discount rate
Intl.fin.
Theories of FDI
1. FDI moves from capital-rich countries to capital-scarce countries
2.
3.
4.
5.
6.
7.
8.
203
Intl.fin.
Intl.fin.
Intl.fin.
approval rules
3. Introduce extra territoriality provisions to interfere with
foreign subsidiaries
The host country government may insist on:
1. Appointing government representatives on the
Intl.fin.
207
Intl.fin.
Intl.fin.
Structure of WTO
209
Intl.fin.
WTO
The Ministerial Conference (MC) is the supreme
authority.
Its secretariat is headed by a Director General
appointed by the MC.
Takes decisions on all matters under any of the
multilateral trade agreements.
The General Council, composed of
representatives of all the members is a trade
policy review body and also a dispute settlement
body.
The three sub-councils operate under the General
Council.
210
Intl.fin.
WTO Agreement
I.
(TRIMS)
II.
Rights
Copy rights and other rights
Trademarks
Geographical indications
Industrial designes
Patents
Integrated circuits and
Trade secrets
211
Intl.fin.
Intl.fin.
International Cartels
Formation of a cartel is an attempt to reap
Intl.fin.
OPEC
Has 11 oil producing countries as members
(Saudi Arabia, Iraq, Kuwait, UAE, Iran, Venezuela, Libya,
Nigeria, Algeria, Indonesia & Qatar, in the decending
order of crude reserves)
Intl.fin.
Intl.fin.
Intl.fin.
Intl.fin.
218
Intl.fin.
Doha Conference
13th session of UNCTAD held from 21- 26
Intl.fin.
220
Intl.fin.
and export.
Sources of finance: Banks and Fis.
Mode of finance:
Fund-based and
Non fund-based
221
Intl.fin.
Export Finance
Export of goods and services play an
222
Cheap and
Intl.fin.
Export Finance
Pre-shipment and Post-shipment credit
Pre-shipment credit:
Packing credit
Advance against cheques / drafts received as advance payment.
Packing Credit:
Loan or advance granted to exporter for purchase of raw materials /
processing / packing based on confirmed orders or letters of credit
Quantum of finance: Generally up to fob value of goods.
Exception: Exports covered by incentives and backed by Export
Production Guarantee from ECGC.
Period of finance: Up to 180 days but can be extended up to 360
days if necessary.
Interest rate: Banks base rate minus 2.5% up 180 days and
normal rate thereafter.
Liquidation: By submission of export bills or from EEFC balances
Packing Credit is also available in foreign currency for cash exports
at internationally competitive interest rates.
224
Intl.fin.
Export Finance
Post-shipment finance:
Need for post-shipment finance?
Mode of finance:
Purchase/Discount/Negotiation of bills
Advance against export bills sent for collection
Advance against cash incentives / Duty Drawbacks etc.
225
Intl.fin.
Export Finance
Forfaiting
A mechanism of discounting export
Intl.fin.
Export Finance
Rediscounting export bills abroad:
An additional source of finance available to
exporters
Envisages banks rediscounting export bills in
the overseas market by making
arrangements with overseas agency / banks
by way of a line of credit
Interest rate: Linked to 6 months LIBOR rate
for the currency concerned.
227
Intl.fin.
228
Intl.fin.
229
Export Credit
Services:
1. Projects:
. Suppliers /
Buyers credit
. Pre-shipment
credit
. Guarantees
2. Products:
. Line of credit
. Pre-shipment
credit
. Post-shipment
credit
Intl.fin.
3.
Services:
. Suppliers credit
Value added
services:
1. Export
marketing
services
2. Multilateral
funded projects
3. Joint-venture
fecilitation
4. Consultancy
support
5. Workshop /
seminars
Advisory
services
230
Intl.fin.
Bill of Lading
2. Airway Bill
3. Post Parcel Receipt
1.
Acceptances
231
Intl.fin.
Bill of Exchange
232
Intl.fin.
Export Invoice
233
Intl.fin.
Packing List
234
Intl.fin.
FORM SPECIMEN.docx
235
Intl.fin.
INTERNATIONAL CASH
MANAGEMENT SYSTEM
236
Intl.fin.
management
Effective and fast collection of cash resources and
Optimum utilization and conversion of funds
237
Intl.fin.
year
Generate maximum possible return by investing all
the cash resources optimally
Judicious management of liquidity requirements
Minimize transaction costs and currency exposures
Optimally use the hedging techniques to minimize
the foreign exchange exposure
Achieve maximum utilization of transfer pricing
mechanism to enhance the profitability and
growth of the firm.
238
Intl.fin.
239
risks
3. Minimize the overall cash
requirements of the company as a
whole without disturbing the
smooth operations of the
subsidiaries
4. Minimize transaction costs
Intl.fin.
5. Achieve full benefits of economies
strategy
4. Netting
5. Transfer Pricing
240
Intl.fin.
Means adopted:
Remittance through SWIFT
Same day value credits
Monitoring through corporate treasury workstations
Pre-authorised payment up to a certain limit
241
Intl.fin.
Intl.fin.
Intl.fin.
Intl.fin.
Case Study
Multinational Industries Co. is an
Intl.fin.
246
Total Inflow
Total
Outflow
US
dollars
$42,000,000
$20,000,000
German
Marks
DM15,000,00
0
DM10,000,00
0
French
Francs
FFr.10,000,00
0
FFr.80,000,00
0
British
Pounds
24,000,000
15,000,000
Intl.fin.
US Dollars
German
Marks
French
Francs
British
Pounds
247
Intl.fin.
Spot Rate
(``)
42.50
22.50
One year
forward
rate(``)
43.20
23.25
6.60
6.00
66.90
67.10
Intl.fin.
rupees:
USDoll
ar
D.
Marks
French
Frs.
British
249
Intl.fin.
(Amounts in millions)
Inflo
w
Outflo
w
Net
flow
Rate
Sprea
d
42
20
22
0.70
Net
Exp
osur
e in
```
15.4
15
10
0.75
3.75
10
80
(70)
(0.6)
42
24
15
0.2
1.8
250
Intl.fin.
Intl.fin.
Netting:
Involves highly coordinated
international interchange of raw
materials, parts, subassemblies, and
finished parts among the various
units of an MNC, with many affiliates
both buying and selling to each other.
They are accompanied by heavy
volume of inter affiliate fund flows.
252
Intl.fin.
transactions
Reduces the need for foreign exchange
conversion and the exchange loss.
Besides administration costs, transaction
costs on these fund flows may vary from
0.25% to 1.5% of the volume of funds
involved.
Helps in improved cash flow forecasting
Netting cash flows is a means of reducing
credit exposure to counter parties.
253
Intl.fin.
multilateral.
Bilateral: Only two parties - parent and the
subsidiary
Multilateral: Parent and several affiliates
Multilateral system requires centralized
system of communication and discipline on
the part of the subsidiaries.
By multilateral netting big MNCs can
eliminate 50% or more of their inter
company transactions.
254
Intl.fin.
Intl.fin.
Intl.fin.
257
Payment
Net
Receipt
France
200
240
Canada
180
130
50
U.K.
210
160
50
Japan
190
250
Net
Payment
(40
60
Intl.fin.
Intl.fin.
Intl.fin.
Subsidia
ry y
Consolidated
subsidiaries
Sales
400
700
1100
Less cost of goods sold
220
400
620
Gross profit
180
300
480
Less operating expenses
80
100
180
EBIT
100
200
300
Interest expense
10
30
40
EBT
90
170
260
Taxes (50% for X and 20% for
45
34
79
Y)
45
136
181
EAT
The sales level of X matches the cost of goods sold of Y and hence it
can be inferred that the entire sales of X are to Y. When sales of X
are reduced from $400,000 to $320,000, this would affect the cost of
goods sold of subsidiary Y by the same amount and the EAT would
respectively be $5,000, $200,000 and $205,000. As a result, the
incidence of tax would come down from $79,000 to $55,000!
261
Intl.fin.
Questions
1. How can a MNC implement leading and
262
Intl.fin.
263
Intl.fin.
Introduction
BoP crisis in 1991
Process of liberalization
Article Viii of IMF Convertibility of current
264
Intl.fin.
Objectives of FEMA
Consolidate and amend the law relating
to foreign exchange:
To facilitate external trade and
payments
Promoting orderly development and
maintenance of foreign exchange
markets in India.
Approach of FEMA is radically different
from FERA change from conservation
to facilitation and control to regulation.
265
Intl.fin.
Intl.fin.
FEMA
FEMA is a civil law.
Facilitate external trade and
payments and maintenance
of forex markets in India
Violation of FEMA is a civil
offence.
Offences under FEMA are
compoundable.
Stay of more than 182 days
is the criteria for determining
the residential status of a
person.
These provisions have been
considerably liberalized in
FEMA.
Almost all current account
tractions are free.
transactions;
Control over realization of export proceeds;
Dealing in foreign exchange through
Authorized Dealers;
Adjudication of offences;
Appeal provisions including special director
(appeals) and appellate tribunal; and
Directorate of Enforcement
267
Intl.fin.
268
Intl.fin.
Intl.fin.
form)
Currency or trade controls
Changes in tax or labor laws
Regulatory restrictions etc.
International economic environment is heavily
Intl.fin.
loans and
Interest rates to demand on these loans.
271
Intl.fin.
Intl.fin.
273
Intl.fin.
employees
Volatile business cycles
Uncertain cash flows
274
Intl.fin.
Intl.fin.
same, a nation with more natural resources is a better bet than one
without natural resources. But other things are not always the same.
This is due to the quality of human resources and the degree to which
these resources are put to their most efficient use South Korea and
Taiwan Vs Mexico or Argentina).
Adjustment to external shocks:
Ability of a country to withstand unforeseen shocks.
Vulnerability of external shock varies from country to country with some
276
Intl.fin.
Techniques to assess CR
1. Debt-related factors:
Debt / GDP
Debt / foreign exchange receipts (Important ratio
277
Intl.fin.
solvency)
Interest payments / foreign exchange receipts (liquidity)
Debt-service ratio (relates debt-service requirements to
export income)
Short-term debt to total exports
Imports / GDP (sensitivity of domestic economy to
external development)
Net interest payment / exports
Current account balance / GNP (countries with large
current account deficit are usually less creditworthy)
Techniques to assess CR
2. Balance of Payments (BoP)
Under or over valuation of exchange rate (on
Intl.fin.
Techniques to assess CR
3. Economic Performance:
GNP or GDP / Per capita (measures the level of
development of a country)
Gross investment / GDP (called propensity to invest
ratio, captures the countrys prospects for future
growth. Higher the ratio, higher the potential
economic growth)
Inflation (change in consumer prices as an annual
average in % - measures the quality of economic
policy)
Money supply (serves as an early indicator for
future inflation)
Gross domestic savings / Gross National Product
279
Intl.fin.
Techniques to assess CR
4. Political Instability:
Political protest, demonstrations, strikes, riots,
assassinations etc.
Successful / unsuccessful coups
Raters of CR:
Two magazines Institutional Investor and Euromoney
Intl.fin.
Intl.fin.
Questions
1. What are the indicators of country risk? Of
2.
3.
4.
5.
282
country health?
What are the applications of country risk
analysis? Give examples to illustrate your
answers.
Briefly explain the various techniques to assess
country risk.
Why is country risk analysis is important for a
MNC?
How can exposure to country risk be reduced by
a MNC in the long run? Why country risk
analysis is not always accurate?
Intl.fin.