Paper/Subject Code: 86002/Elective: Finance: International Finance
TYBMS SEM 6:
Finance:
International Finance
(Q.P. April 2024 with Solution)
Q.P. November 2019 with Solution
IMP write a short note with Solution
Note:
1) All questions are compulsory subject to internal choice.
2) Figures to the right indicate full marks.
3) Use of simple calculator is allowed
Q.1. (a) Multiple Choice Questions (any 8): (08)
(1) _______ is the branch of economics that studies the dynamics of exchange rates, foreign investments, and how these affect international trade.
(a) International Finance
(b) International Marketing
(c) International Economics
(d) International Monetary System
(2) The asset price at which the investor can exercise an option is called _______ price.
(a) Strike
(b) Spot
(c) Future
(d) Forward
(3) Currency that is used as a unit of account, medium of exchange and store of value not only for transactions within the country, but also for international public and private transactions, is called as _______ currency.
(a) Vehicular
(b) Home
(c) Variable
(d) Foreign
(4) BBC Global 30, S&P Global 100, S&P Global 1200 are examples of _______
(a) International Equity Benchmarks
(b) Yankee Stock Offering
(c) Cross Listing of Shares
(d) ADRs
(5) _________ is the risk of exchange rate that creates an impact on the market value of a company.
(a) Economic Risk
(b) Transaction Risk
(c) Translation Risk
(d) Liquidity Risk
(6) FOREX market facilitate the conversion of one currency into another i.e. payment between exporters & importers. This function of FOREX Market can be referred as _______
(a) Transfer of Purchasing Power
(b) Credit Function
(c) Hedging Function
(d) Risk Management Function
(7) ________ is the process of assessing, in a structured way, the case for proceeding with a project or proposal, or the project's viability.
(a) Project Appraisal
(b) Project Management
(c) Risk Mitigation
(d) Risk Management
(8) ________ offers foreign individuals and businesses little or no tax liability in a politically and economically static environment.
(a) Tax Haven
(b) Offshore Banking Unit
(c) FOREX Market
(d) Tax Neutrals
(9) _______ involves the simultaneous buying and selling of an asset in order to profit from small differences in price.
(a) Hedging
(b) Speculation
(c) Arbitrage
(d) Investing
(10) ________ Exchange Rate is a system where the currency price is set by the forces of forex market i.e. demand and supply of currencies.
(a) Flexible
(b) Fixed
(c) Managed Float
(d) Gold
Q.1.(B) State whether the following statements are True or False (any 7): (07)
1) Unilateral Transfers are recorded under Capital Account of BOP.
Ans: False
2) FEMA was replaced by FERA
Ans: True
3) NPV is a non-discounted technique of Capital Budgeting
Ans: False
4) If the Quote is given as USD-INR 83.1550-75; This quote is called as "Direct Quote" in New York.
Ans: True
5) India is a Tax Haven nation.
Ans: False
6) There is easy entry and exit in FPI.
Ans: True
7) To be cross-listed, a company must comply with the requirements of all the stock exchanges in which it is listed.
Ans: True
8) Changes in market inflation cause changes in currency exchange rates.
Ans: True
9) Call option gives the right to buy an asset at a fixed date and price.
Ans: True
10) Under Bretton Woods system, countries could use USD as a medium of exchange for international settlements.
Ans: True
Q.2.(A) Discuss the significance of International Finance in today's context. (08)
( B) What is Balance of Payments? How is it different from BOT? What is meant by Autonomous and Accommodating Transactions? (07)
The Balance of Payments (BOP) is a comprehensive record of all economic transactions between the residents of a country and the rest of the world over a specific period, typically a year. These transactions include trade in goods and services, capital flows, and financial transfers.
Components of BOP:
Current Account:
- Records transactions related to trade in goods and services, income receipts (such as dividends and interest), and unilateral transfers (like remittances and foreign aid).
Capital Account:
- Records capital transfers and the acquisition/disposal of non-produced, non-financial assets (e.g., patents, copyrights).
Financial Account:
- Records investments, loans, and changes in foreign exchange reserves.
Errors and Omissions:
- A balancing item to ensure that all recorded transactions sum to zero.
The BOP always balances theoretically, but individual accounts (current, capital, or financial) may show surpluses or deficits.
What is Balance of Trade (BOT)? How is it Different from BOP?
The Balance of Trade (BOT) is a subset of the BOP and refers specifically to the net difference between a country's exports and imports of goods (also known as visible trade).
Autonomous and Accommodating Transactions
1. Autonomous Transactions:
- These are transactions undertaken for their own economic interest, independent of the BOP status.
- They are motivated by profit or economic gain, such as:
- Exports and imports of goods and services.
- Foreign investments.
- Autonomous transactions occur in the current account and the capital account.
- They are often referred to as above-the-line items.
2. Accommodating Transactions:
- These transactions are undertaken to balance the BOP when there is a deficit or surplus in autonomous transactions.
- They are not driven by economic motives but aim to stabilize the BOP, such as:
- Borrowing from the International Monetary Fund (IMF).
- Using foreign exchange reserves.
- These transactions are part of the financial account.
- They are referred to as below-the-line items.
OR
(P) The following quote is given in Canada: ISGD = CAD 1.0110-85 (08)
1) In which country, the quote is "Direct"?
2) In which country, the quote is "Indirect"?
3) What is the Mid Rate?
4) What is Spread?
5) What is % Spread?
6) Calculate the inverse quote.
(Q) The following quotations are available in USA (07)
1 USD GBP 0.8350-0.8425
1 USDCAD 1.1125-1.1175
And the quotation available in Canada is: 1 GBP CAD 1.5550-1:5650
From the quotes given in USA, derive the quotation for 1 GBP in terms of CAD Compare the derived quotation with quotation available in Canada and identify if any arbitrage opportunity exists. (Assume Capital GBP 2 Million)
Q.3.(A) What are Eurobonds? Explain different types of Eurobonds. (08)
Eurobonds are a type of international bond issued in a currency different from the currency of the country or market in which they are issued. For example, a bond issued in Japan in US dollars is considered a Eurobond. Despite the name, Eurobonds are not restricted to Europe and can be issued anywhere globally. The term "Euro" in Eurobonds refers to their issuance in the international market rather than a specific location.
Features of Eurobonds:
- Issued in a foreign currency: They are denominated in a currency other than that of the country where the bond is issued.
- Marketed globally: These bonds are sold to investors in multiple countries, promoting global participation.
- Lack of regulatory restrictions: Eurobonds are less regulated compared to domestic bonds, making them attractive for issuers.
- Interest payments: Usually paid annually, and they often offer higher returns to compensate for currency and credit risks.
- Flexibility in structure: Eurobonds can be tailored to meet the needs of both issuers and investors.
Types of Eurobonds
- Fixed-Rate Eurobonds:
- These bonds have a fixed interest rate throughout their tenure.
- Interest payments (coupons) are made periodically, typically annually.
- Example: A US dollar-denominated Eurobond issued with a fixed coupon rate of 5%.
- Floating-Rate Eurobonds (FRNs):
- These bonds have a variable interest rate, which is tied to a benchmark rate like LIBOR (London Interbank Offered Rate) or SOFR (Secured Overnight Financing Rate).
- The interest rate is adjusted periodically, typically every 3 or 6 months.
- Example: A Eurobond with an interest rate of LIBOR + 1%.
- Zero-Coupon Eurobonds:
- These bonds do not pay periodic interest. Instead, they are issued at a discount to their face value and redeemed at par at maturity.
- Suitable for investors who prefer capital appreciation over regular income.
- Example: A Eurobond issued for $800 that matures at $1,000.
- Convertible Eurobonds:
- These bonds can be converted into equity shares of the issuing company at a predetermined conversion rate and time.
- They offer lower interest rates compared to non-convertible Eurobonds because of the conversion option.
- Example: A Eurobond issued at $1,000, convertible into 50 shares of the company at the holder's discretion.
- Exchangeable Eurobonds:
- These bonds allow investors to exchange them for equity shares of a company other than the issuer, usually a subsidiary or an affiliate.
- Example: A Eurobond exchangeable for shares of a subsidiary company.
- Callable Eurobonds:
- These bonds give the issuer the right to redeem the bond before its maturity date, typically at a premium.
- Beneficial for issuers if interest rates fall, allowing them to refinance at lower rates.
- Example: A callable Eurobond with a 10-year maturity but callable after 5 years.
- Putable Eurobonds:
- These bonds give investors the right to sell the bond back to the issuer at a predetermined price before maturity.
- Beneficial for investors if interest rates rise, as they can reinvest at higher rates.
- Example: A putable Eurobond maturing in 10 years but with a put option exercisable after 3 years.
- Dual-Currency Eurobonds:
- These bonds involve interest payments in one currency and principal repayment in another.
- Example: A Eurobond paying interest in US dollars but repaying the principal in euros.
- Perpetual Eurobonds:
- These bonds do not have a fixed maturity date, and the issuer may choose to redeem them at their discretion.
- They typically offer higher yields to compensate for the lack of maturity.
Significance of Eurobonds
- For Issuers:
- Access to a wider investor base.
- Diversification of funding sources.
- Less stringent regulatory requirements.
- For Investors:
- Opportunities to invest in foreign currencies.
- Portfolio diversification.
- Potential for higher yields.
Eurobonds remain a vital instrument in global finance, offering flexibility and benefits for both issuers and investors.
(B) What are Currency futures? How are they different from Currency forwards? (07)
Currency Futures are standardized financial contracts traded on organized exchanges, where parties agree to buy or sell a specific amount of a foreign currency at a predetermined exchange rate on a future date. These contracts are used to hedge against foreign exchange risk or to speculate on currency movements.
Features of Currency Futures:
Standardized Contracts:
- Fixed contract sizes, maturity dates, and settlement procedures.
- Example: A currency future might require trading in lots of 100,000 USD.
Exchange-Traded:
- Traded on organized exchanges like the Chicago Mercantile Exchange (CME) or Intercontinental Exchange (ICE).
- Transparent pricing and liquidity due to centralized trading.
Marked-to-Market:
- Gains and losses are calculated daily and settled through a margin account.
Delivery Date:
- Specific expiration dates (e.g., quarterly contracts).
Regulated:
- Subject to oversight by regulatory authorities, ensuring compliance and reducing counterparty risk.
How are Currency Futures Different from Currency Forwards?
Currency futures and currency forwards both serve the purpose of managing foreign exchange risk, but they differ in several key aspects:
|
|
Currency
Futures |
Currency
Forwards |
|
Market |
Traded on
organized exchanges. |
Traded
over-the-counter (OTC) between banks or firms. |
|
Standardization |
Standardized
contract terms (size, maturity, etc.). |
Customized
terms based on the needs of the parties. |
|
Settlement |
Daily
marked-to-market with margin requirements. |
Settled only
at maturity unless otherwise agreed. |
|
Counterparty
Risk |
Low; the
exchange acts as a clearinghouse. |
Higher;
depends on the creditworthiness of the parties. |
|
Liquidity |
High due to
centralized trading and standardization. |
Lower as
contracts are customized and private. |
|
Flexibility |
Limited to
fixed contract sizes and dates. |
Highly
flexible in terms of size, currency pair, and maturity. |
|
Purpose |
Often used by
speculators and retail investors. |
Primarily
used by businesses for hedging. |
|
Pricing
Transparency |
High due to
public trading on exchanges. |
Lower as
prices are privately negotiated. |
Example Comparison:
Currency Future:
- A trader buys a futures contract to purchase €100,000 at a rate of 1.10 USD/EUR for delivery in March 2025. The trade is facilitated on an exchange, and the margin account is adjusted daily.
Currency Forward:
- A business agrees with a bank to purchase €100,000 at a rate of 1.10 USD/EUR for delivery on March 15, 2025. The terms, including the exact amount and date, are customized.
OR
(P) Consider the following information: (08)
Spot CAD/SEK 7.8650 - 7,8700
1 Month Forward 50- 70
2 Month Forward 290 - 340
3 Month Forward 920 -1020
6 Month Forward 1500 -1600
Calculate 1 Month Forward, 2 Month Forward, 3 Month Forward and 6 Month Forward
CAD/SEK Rates.
(Q) Spot USD/INR 83.1525
3 Month Forward USD/INR 83.2525
Calculate 3 Months AFM and interpret the results.
Q.4.(A) What is FDI? What is FPI? How are they different from each other?
Foreign Direct Investment (FDI) refers to an investment made by a foreign entity (individual or company) directly into the business operations or assets of another country. FDI involves significant ownership, management, or influence over the enterprise and often includes acquiring physical assets or establishing a presence, such as a factory or subsidiary.
Characteristics of FDI:
- Long-Term Investment: Aimed at lasting interest in a foreign entity.
- Active Control: Involves significant influence or control over management.
- Examples:
- Building a manufacturing plant in a foreign country.
- Acquiring a substantial stake in a foreign company (usually >10% of shares).
What is FPI?
Foreign Portfolio Investment (FPI) refers to investments made by foreign investors in a country’s financial assets, such as stocks, bonds, mutual funds, or other securities. FPI is more of a passive investment and does not provide control over the business operations of the investee company.
Characteristics of FPI:
- Short-Term Investment: Focused on financial returns rather than operational involvement.
- No Control: Provides no significant influence or management participation.
- Examples:
- Purchasing shares of an Indian company listed on the stock exchange by a foreign investor.
- Investing in government or corporate bonds of another country.
|
|
FDI |
FPI |
|
Nature of
Investment |
Direct
investment in physical assets or a business. |
Passive
investment in financial assets. |
|
Control |
Involves
active control or significant influence. |
No control or
influence over operations. |
|
Time Horizon |
Long-term
commitment. |
Short-term,
liquid investments.. |
|
Risk |
Higher risk
due to active involvement and long-term exposure. |
Lower risk
due to diversification and liquidity. |
|
Regulations |
High due to
centralized trading and standardization. |
Relatively
less regulated. |
|
Impact on
Economy |
Boosts
infrastructure, technology, and job creation. |
Provides
liquidity to financial markets. |
|
Examples |
Setting up a
subsidiary, joint ventures, or acquiring ownership in foreign businesses. |
Buying
foreign stocks, bonds, or mutual funds. |
FDI vs. FPI: A Practical Example
- FDI: Toyota builds a manufacturing plant in the U.S., creating jobs and transferring technology.
- FPI: A foreign investor buys shares in Tesla but has no control over its operations.
(B) Discuss global money market instruments.
The global money market consists of short-term debt instruments used by governments, corporations, and financial institutions to manage liquidity and fund short-term needs. These instruments typically have maturities of one year or less and are highly liquid, low-risk, and widely traded in global markets.
Global Money Market Instruments
1. Treasury Bills (T-Bills):
- Issuer: Governments.
- Description: Short-term debt instruments with maturities typically ranging from a few days to one year. They are issued at a discount to face value and redeemed at par.
- Example: U.S. Treasury Bills, Indian T-Bills.
- Features:
- Highly secure due to government backing.
- No interest payments; returns come from the difference between purchase price and face value.
2. Commercial Paper (CP):
- Issuer: Corporations.
- Description: Unsecured, short-term promissory notes issued by companies to meet working capital needs. Typically issued for maturities of up to 270 days.
- Example: CP issued by multinational corporations like IBM or General Electric.
- Features:
- Higher returns than government securities.
- Risk depends on the creditworthiness of the issuing company.
3. Certificates of Deposit (CDs):
- Issuer: Banks and financial institutions.
- Description: Time deposits with a fixed maturity and interest rate. CDs are tradable in secondary markets, providing liquidity.
- Example: Eurodollar CDs issued by international banks.
- Features:
- Secured by the issuing bank.
- Typically offer higher interest rates than savings accounts.
4. Bankers’ Acceptances (BAs):
- Issuer: Commercial banks.
- Description: Time drafts guaranteed by a bank, often used in international trade. The bank's guarantee makes them low-risk instruments.
- Example: Used by exporters and importers to secure trade transactions.
- Features:
- Liquid and tradable in secondary markets.
- Short maturities, typically ranging from 30 to 180 days.
5. Repurchase Agreements (Repos):
- Issuer: Banks, financial institutions, or government entities.
- Description: Short-term agreements where one party sells securities to another with a promise to repurchase them at a pre-agreed price and date.
- Example: U.S. repo market used for overnight or term funding.
- Features:
- Collateralized by securities, reducing risk.
- Common in central bank operations to control money supply.
6. Eurodollar Deposits:
- Issuer: Banks outside the U.S. dealing in U.S. dollars.
- Description: Dollar-denominated deposits held in foreign banks or the foreign branches of U.S. banks.
- Example: Eurodollar accounts in London.
- Features:
- Not subject to U.S. banking regulations.
- Offer competitive interest rates.
7. Foreign Exchange Swaps:
- Issuer: Banks or multinational corporations.
- Description: A simultaneous agreement to exchange a specified amount of currency at the spot rate and reverse the transaction at a forward rate on a specific future date.
- Example: Used by companies for hedging short-term currency exposure.
- Features:
- Helps manage foreign exchange risk.
- Common in international money markets.
8. Euro Commercial Paper (Euro-CP):
- Issuer: Corporations or banks.
- Description: Short-term unsecured promissory notes issued in a currency different from the issuer's domestic currency.
- Example: A U.S. company issuing Euro-CP in euros.
- Features:
- Traded in international markets.
- Flexible maturities and lower borrowing costs compared to domestic markets.
9. Money Market Mutual Funds (MMMFs):
- Issuer: Financial institutions or asset management companies.
- Description: Investment funds pooling capital to invest in short-term money market instruments.
- Example: Funds investing in T-Bills, CPs, and CDs.
- Features:
- Provide diversification and liquidity to investors.
- Often used as a safe investment during market uncertainty.
Significance of Global Money Market Instruments
- Liquidity Management: Provide governments, corporations, and banks with access to short-term funding.
- Safe Investment Options: Offer low-risk returns for investors seeking capital preservation.
- Facilitate International Trade: Instruments like BAs and foreign exchange swaps streamline cross-border transactions.
- Central Bank Operations: Instruments like repos are used by central banks to regulate liquidity and implement monetary policy.
- Global Integration: Eurodollar deposits and Euro-CPs promote cross-border capital flows and international financial market integration.
OR
(P) Given: (07)
Spot AUD/JPY 99.1575
AUD Interest Rate - 0.75% p.a.
JPY Interest Rate = 1.50% p.a.
Calculate three month forward AUD/JPY rate
(Q) From the following data, find the best alternative for investing INR 5 Million for a temporary period of 3 Months. Exchange rates are against INR. (08)
|
|
Currency |
Spot Rate |
3 months
forward rate |
Interest
rate |
|
1 |
USD |
83.5650 |
83.5950 |
5% pa |
|
2 |
EUR |
90.1225 |
90.0550 |
3% pa. |
|
3 |
GBP |
102.5650 |
102.5750 |
4% pa |
Q.5.(A) What are the Benefits towards Parties doing Business Internationally? (08)
Engaging in international business offers several advantages to companies, governments, and individuals. These benefits are essential for fostering global economic integration and growth. Below are the key benefits for the parties involved in international business:
1. Access to Larger Markets
- Benefit: By doing business internationally, companies can tap into new, larger markets, which may not be available within their domestic borders.
- Example: A company in India can sell products to consumers in Europe, North America, and other parts of the world, significantly expanding its customer base.
2. Economies of Scale
- Benefit: Expanding internationally allows businesses to increase production, leading to economies of scale. The more products or services a company produces and sells, the lower the per-unit cost.
- Example: A manufacturer producing goods in large quantities for international markets can spread fixed costs (e.g., machinery, research and development) over a larger output, reducing costs and improving profitability.
3. Increased Revenue Opportunities
- Benefit: International business opens up new revenue streams, especially if the domestic market is saturated or growing slowly.
- Example: A tech company selling software globally can earn substantial revenue from markets in North America, Europe, and Asia, diversifying its income sources.
4. Diversification of Risk
- Benefit: Operating in multiple countries can help mitigate risks. If one market faces economic downturns, other international markets may provide a buffer.
- Example: A clothing retailer in the U.S. can offset losses from reduced demand in the domestic market by increasing sales in markets like Asia or Latin America.
5. Access to Resources and Raw Materials
- Benefit: Companies can access raw materials, labor, and resources that may not be available domestically or that can be sourced at a lower cost in other countries.
- Example: A car manufacturer based in Germany might source cheaper steel or parts from China, reducing production costs.
6. Innovation and Learning Opportunities
- Benefit: Exposure to different cultures, technologies, and business practices can foster innovation and lead to the development of new ideas, products, and services.
- Example: A company operating in both the U.S. and Japan may learn about advanced manufacturing techniques and apply them to its operations in other markets, increasing productivity and competitiveness.
7. Competitive Advantage
- Benefit: International expansion may give companies a competitive edge over rivals that limit their operations to a single domestic market. It also provides access to the latest technology, production techniques, and business strategies from different parts of the world.
- Example: A company operating in emerging markets may gain early access to fast-growing segments and capitalize on the untapped market potential before competitors.
8. Better Talent Pool
- Benefit: International business allows companies to access a global talent pool, hiring employees with unique skills, experiences, and expertise from different countries.
- Example: A multinational technology company can hire engineers, designers, and developers from around the world, benefiting from a diverse range of perspectives and expertise.
9. Political and Economic Stability
- Benefit: Operating in multiple countries can help businesses protect themselves from political or economic instability in any one country. Some countries may provide better business environments or favorable tax regimes.
- Example: A company may set up operations in politically stable countries with attractive tax policies to safeguard its investments.
10. Brand Recognition and Reputation
- Benefit: International operations can enhance a company’s brand image and reputation, making it a global name. Global recognition often leads to increased trust and customer loyalty.
- Example: A company like Coca-Cola or Apple has established its brand as a symbol of quality worldwide, which increases demand across many different markets.
11. Improved Supplier Relationships
- Benefit: Engaging in international business allows companies to build relationships with foreign suppliers, which can lead to better pricing, quality, and availability of goods and services.
- Example: A retailer sourcing products from various countries can negotiate favorable terms with suppliers, diversifying its supply chain and increasing reliability.
12. Enhanced Cultural Understanding
- Benefit: Companies involved in international business often develop a deep understanding of diverse cultures, which helps in tailoring products, marketing strategies, and customer service to meet the specific needs of different markets.
- Example: A fast-food chain might adjust its menu in different countries, offering local flavors that cater to cultural preferences (e.g., a vegetarian menu in India).
13. Expedited Growth and Global Networking
- Benefit: International business encourages fast growth as companies expand and collaborate with foreign partners, creating a broader network of business connections globally.
- Example: A small company in the U.S. might partner with an Asian distributor to expand quickly into the Asian market, leveraging their local expertise.
14. Foreign Exchange Earnings
- Benefit: Conducting international business provides companies with opportunities to earn foreign currency. This can be beneficial for countries and companies as it helps build foreign exchange reserves and strengthens the local currency.
- Example: A U.S. company that sells goods to Japan in yen benefits from holding a stable supply of yen, which can be exchanged for dollars.
15. Better Access to Financing
- Benefit: International operations may give companies access to financing options that are not available domestically. For example, they might receive international investments or access capital markets in other countries.
- Example: Large multinational corporations may have access to international bond markets to secure better financing rates.
(B) Ms. Gurneer is planning to buy a machine which would generate cash flow after taxes as follows: (07)
|
Year |
0 |
1 |
2 |
3 |
4 |
|
CFAT in USD |
(1,00,000) |
24,000 |
32,000 |
60,000 |
32,000 |
If discounting rate is 10%, is it worth to invest in machines.
|
Year |
1 |
2 |
3 |
4 |
|
Discount Factor |
0.909 |
0.826 |
0.751 |
0.683 |
OR
Q.5. (P) Write Short Notes on (any three) (15)
1) Fixed Vs. Flexible Exchange Rate System
The exchange rate system is a crucial aspect of a country's monetary policy, determining how its currency is valued relative to other currencies. Broadly, exchange rate systems can be categorized into fixed and flexible (or floating) systems, each with its own set of advantages and disadvantages.
Fixed Exchange Rate System
A fixed exchange rate system (also known as a pegged exchange rate system) is one in which a country’s currency value is tied or pegged to the value of another major currency, like the U.S. dollar, euro, or a basket of currencies, or sometimes to a commodity such as gold.
How It Works:
- The government or central bank intervenes in the foreign exchange market to maintain the currency's value at a fixed rate.
- If the currency value deviates from the peg, the central bank buys or sells its own currency or foreign reserves to maintain the target exchange rate.
Example:
- The Hong Kong Dollar (HKD) is pegged to the U.S. Dollar (USD).
- The Saudi Riyal (SAR) is pegged to the U.S. Dollar (USD).
Advantages of Fixed Exchange Rate:
Stability and Predictability:
- Fixed exchange rates reduce exchange rate risk for international trade, which can encourage foreign investment and economic growth.
- Businesses and investors can plan ahead more effectively, knowing the exchange rate won’t fluctuate dramatically.
Control of Inflation:
- Countries with a stable and credible anchor currency (e.g., U.S. dollar) can keep inflation under control by linking their currency to a stable one.
Investor Confidence:
- Stable exchange rates foster confidence in foreign investors and businesses, leading to more foreign direct investment (FDI).
Disciplined Monetary Policy:
- Governments must maintain reserves to support their currency, which can help maintain fiscal discipline and reduce the likelihood of excessive government spending.
Disadvantages of Fixed Exchange Rate:
- Central Bank Intervention:
- Maintaining the fixed rate requires frequent intervention in the currency markets, which may deplete a country’s foreign exchange reserves if demand for the currency fluctuates greatly.
- Limited Monetary Policy Control:
- A country has less flexibility in setting its domestic interest rates because it needs to align with the country whose currency it is pegged to.
- It may not be able to adjust its monetary policy effectively to suit domestic economic conditions.
- Vulnerability to External Shocks:
- Countries with fixed exchange rates are vulnerable to external shocks, like changes in the value of the anchor currency or shifts in global economic conditions, that might force painful adjustments.
- Speculative Attacks:
- If investors believe the currency is overvalued or undervalued, they may engage in speculative attacks, forcing a devaluation or forcing the country to abandon the peg.
Flexible (Floating) Exchange Rate System
A flexible exchange rate system (also known as a floating exchange rate system) is one in which the value of a currency is determined by market forces—supply and demand—without direct government or central bank intervention. The exchange rate fluctuates freely based on factors such as economic conditions, interest rates, inflation, and political stability.
How It Works:
- The value of the currency is allowed to fluctuate in the foreign exchange market.
- Central banks may intervene occasionally to stabilize the currency or meet certain macroeconomic objectives, but this is typically not as frequent as in a fixed system.
Example:
- The U.S. Dollar (USD), Euro (EUR), and Japanese Yen (JPY) are examples of currencies with flexible exchange rates.
Advantages of Flexible Exchange Rate:
- Monetary Policy Flexibility:
- Central banks have more autonomy in adjusting interest rates and controlling inflation based on domestic economic needs.
- Automatic Adjustment Mechanism:
- The exchange rate can automatically adjust to changes in economic conditions, such as inflation or trade imbalances. For example, if a country faces a trade deficit, the currency will likely depreciate, which can make exports cheaper and imports more expensive, improving the trade balance.
- No Need for Large Reserves:
- Unlike fixed systems, countries with a flexible exchange rate do not need to hold large reserves of foreign currency to maintain the exchange rate.
- Reduced Risk of Speculative Attacks:
- Since the currency is allowed to float freely, it’s less likely to be subject to speculative attacks, which are common in fixed exchange rate systems.
Disadvantages of Flexible Exchange Rate:
- Volatility and Uncertainty:
- Exchange rate fluctuations can create uncertainty for businesses involved in international trade and investment, making it harder to predict costs, profits, and cash flows.
- Inflationary Pressure:
- Countries with floating currencies can face inflation if their currency depreciates significantly, raising the cost of imported goods and services.
- Negative Impact on Trade:
- A rapidly depreciating currency may increase the cost of imports, potentially harming businesses reliant on foreign goods and causing domestic inflation.
- Investor Concerns:
- Exchange rate volatility can discourage foreign investment in countries with unstable currencies.
2) ADRs Vs. GDRs.
ADRs (American Depository Receipts) and GDRs (Global Depository Receipts) are both financial instruments used by companies to list and trade their shares on foreign stock exchanges. However, there are key differences between the two in terms of their geographical focus, usage, and structure.
1. What Are ADRs (American Depository Receipts)?
ADRs (American Depositary Receipts) and GDRs (Global Depositary Receipts) are financial instruments that allow investors to trade foreign stocks in domestic markets. Here’s a comparison:
1. ADRs (American Depositary Receipts)
- Issued In: The United States
- Listed On: U.S. stock exchanges (NYSE, NASDAQ) or traded over-the-counter (OTC)
- Regulatory Body: Subject to SEC regulations
- Currency: USD
- Purpose: Allows U.S. investors to invest in foreign companies without dealing with foreign exchanges
- Example: Alibaba’s ADR trades on the NYSE instead of a Chinese exchange
2. GDRs (Global Depositary Receipts)
- Issued In: Multiple global markets (outside the U.S.)
- Listed On: European and Asian exchanges (London Stock Exchange, Luxembourg Stock Exchange, Singapore Exchange, etc.)
- Regulatory Body: Varies by country (not SEC-regulated)
- Currency: Can be USD, EUR, or other major currencies
- Purpose: Enables companies to raise capital in multiple international markets
- Example: A Russian company issuing GDRs in London to attract global investors.
3) Foreign Exchange Dealers Association of India
The Foreign Exchange Dealers Association of India (FEDAI) is a self-regulatory organization (SRO) established in 1958 with the primary objective of promoting a healthy and transparent foreign exchange market in India. It plays a vital role in regulating and overseeing the activities of foreign exchange dealers and ensuring smooth operations in the foreign exchange market in India.
Objectives and Functions of FEDAI:
Standardization of Practices:
- One of the main roles of FEDAI is to standardize the practices and operations of the foreign exchange market in India. This includes setting guidelines for foreign exchange dealers, ensuring compliance with exchange rate policies, and promoting consistency in transactions.
Regulation of Foreign Exchange Market:
- FEDAI works closely with the Reserve Bank of India (RBI) and other financial authorities to ensure the proper functioning of the foreign exchange market. It aims to safeguard the interests of the dealers and their clients by ensuring that the transactions are conducted fairly and in line with RBI’s regulations.
Issuing Guidelines:
- FEDAI issues operational guidelines to its member banks and other financial institutions involved in the foreign exchange business. These guidelines help maintain transparency, enhance the integrity of the market, and reduce risks associated with currency transactions.
Training and Capacity Building:
- It also plays a role in training foreign exchange professionals through workshops, seminars, and certification programs. This helps improve the overall understanding of market practices, regulatory changes, and developments in the global foreign exchange environment.
Monitoring and Surveillance:
- FEDAI monitors foreign exchange transactions conducted by its members to ensure adherence to the guidelines and regulations. It takes necessary actions in case of any violation of the set standards or market manipulation.
Providing a Platform for Members:
- FEDAI offers a platform for foreign exchange dealers to communicate, collaborate, and address common challenges. This network helps in the dissemination of information and updates related to forex markets, and it acts as a mediator between the RBI and market participants.
Dispute Resolution:
- FEDAI also helps resolve disputes that may arise between its members or between members and clients. It acts as an arbitrator in cases of disagreements regarding foreign exchange transactions.
Enhancing Market Liquidity:
- By facilitating smoother transactions and creating a more transparent environment, FEDAI contributes to enhancing liquidity in the Indian foreign exchange market. This helps in stabilizing exchange rates and reduces volatility.
Collaboration with Other International Bodies:
- FEDAI collaborates with international bodies like the International Chamber of Commerce (ICC), International Monetary Fund (IMF), and other global foreign exchange market regulators to align Indian practices with international standards.
Membership:
- FEDAI's membership includes Indian banks, foreign banks operating in India, and financial institutions involved in foreign exchange trading. These members are required to comply with FEDAI’s guidelines and the regulations set by the RBI.
Role of FEDAI in Foreign Exchange Market:
Market Stability:
- FEDAI plays a crucial role in maintaining the stability of the Indian foreign exchange market. It works with the RBI to ensure that foreign exchange transactions are conducted smoothly, and that the market is not subject to speculative activities that could lead to sharp currency fluctuations.
Exchange Rate Management:
- Through its collaboration with the RBI, FEDAI helps in the management of exchange rates by encouraging the use of best practices in the market. It supports efforts to limit volatility and control excessive speculation in the forex market.
Promoting a Transparent Market:
- FEDAI ensures that market participants adhere to fair practices by standardizing terms and rates for various foreign exchange transactions. This transparency helps maintain the confidence of domestic and foreign investors in the Indian forex market.
Supporting RBI’s Monetary Policies:
- FEDAI assists in the implementation of the Reserve Bank of India's monetary policy, especially in relation to foreign exchange control, intervention in the forex market, and managing India’s foreign exchange reserves.
Types of Foreign Exchange Transactions Overseen by FEDAI:
- Spot Transactions: The immediate exchange of one currency for another at the current exchange rate.
- Forward Contracts: Agreements to exchange currency at a future date, often used to hedge against currency risk.
- Swap Transactions: The exchange of currency between two parties, with a simultaneous buy and sell agreement.
- Options: Contracts that give one party the right but not the obligation to exchange currencies at an agreed-upon rate in the future.
- Derivatives: Instruments used to hedge against currency risks.
4) PPP Theory
Purchasing Power Parity (PPP) is an economic theory and a fundamental principle in international finance that asserts that in the absence of transportation costs and other trade barriers, identical goods or services in different countries should have the same price when expressed in a common currency. Essentially, PPP suggests that exchange rates between two countries should adjust so that the same basket of goods costs the same in both countries when measured in a common currency.
The Core Idea of PPP:
Law of One Price: According to PPP, the law of one price holds, which means that identical goods should sell for the same price in different countries when expressed in a common currency. If the prices differ, arbitrage opportunities arise, where people buy goods where they are cheaper and sell them where they are more expensive, bringing prices into alignment.
Exchange Rate Adjustment: PPP suggests that exchange rates will adjust to reflect the relative price levels between two countries. If one country experiences higher inflation than another, the currency of the country with higher inflation should depreciate relative to the other country's currency to maintain price parity.
Types of PPP:
Absolute PPP:
- This version of PPP asserts that the exchange rate between two currencies is equal to the ratio of the price levels of a fixed basket of goods between the two countries. It implies that the cost of a basket of goods should be the same in both countries when expressed in a common currency.
Relative PPP:
- Relative PPP is a more widely used version. It focuses on the rate of change in the price levels (inflation rates) rather than the absolute price levels. Relative PPP suggests that changes in the exchange rate over time are equal to the differences in inflation rates between two countries. If one country has higher inflation than another, its currency is expected to depreciate by the same percentage.
Assumptions of PPP Theory:
- No Transaction Costs: The theory assumes that there are no costs involved in the exchange of currencies or transportation of goods across borders.
- Perfect Substitutes: The goods or services being compared are perfect substitutes in both countries (the same quality and type).
- Free Trade: There are no trade barriers such as tariffs or quotas between the countries.
Applications of PPP:
Exchange Rate Forecasting: PPP is often used by economists and analysts to predict long-term exchange rate movements. According to PPP, if a country experiences high inflation, its currency should depreciate relative to another country with lower inflation.
International Comparison of Living Standards: PPP is also used to compare the standard of living between different countries by adjusting for differences in price levels. For example, the World Bank and International Monetary Fund (IMF) use PPP to compare GDP across countries to account for variations in price levels.
Macroeconomic Policy: Policymakers may use PPP as a tool to assess the impact of inflation rates on exchange rates and plan for future currency adjustments.
Limitations of PPP Theory:
While PPP theory is helpful in understanding exchange rate movements over long periods, it has several limitations:
- Market Imperfections: In reality, there are transaction costs, tariffs, shipping costs, and other barriers that prevent the law of one price from holding in practice.
- Non-traded Goods and Services: PPP assumes the same basket of goods can be purchased in different countries, but some goods and services (such as housing or healthcare) are non-traded and thus cannot be included in a global basket.
- Short-Term Variations: PPP is more effective for long-term exchange rate predictions, as short-term fluctuations in exchange rates can be influenced by speculative trading, political events, or other factors not captured by PPP.
- Differences in Consumer Preferences: The PPP theory assumes that consumers in different countries have the same preferences and consumption patterns, which may not always be the case.
5) Euro credit
Eurocredit refers to loans or credit facilities that are provided by international financial institutions or banks to borrowers in various countries, but denominated in a currency other than the currency of the country where the loan is being made. This term specifically relates to loans issued in Eurocurrency markets (i.e., outside the control of domestic monetary authorities), which are usually in Eurodollars (U.S. dollars deposited outside the U.S.) or other major currencies like the Euro, Yen, or Swiss Franc.
Eurocredits are typically short- to medium-term loans granted to governments, financial institutions, or corporations, and they can be either floating-rate or fixed-rate loans, often with relatively favorable terms compared to domestic credit markets.
Characteristics of Eurocredits:
Eurocurrency Market:
- The term Eurocredit originates from the Eurocurrency market, where financial institutions lend and borrow funds in currencies (such as the U.S. dollar, Euro, British pound) that are deposited outside the country of the currency's origin. These loans and deposits are typically offered by banks that operate in countries other than the one where the currency is legally issued.
Currency Denomination:
- Eurocredits can be denominated in any major currency. The term Eurocredit is primarily associated with Eurodollar loans, which are U.S. dollar-denominated loans made in markets outside the U.S., but can also refer to loans in other currencies (such as Euro, Yen, or Sterling), hence Eurocredit is a broad term for international loans denominated in any foreign currency.
Credit Facility:
- Eurocredits are typically revolving credit lines or term loans issued by international banks or consortia of banks. These facilities are extended to borrowers who may be multinational corporations, government bodies, or large financial institutions.
Interest Rates and Terms:
- Eurocredits are often short-term loans, generally with maturities ranging from one month to five years. The interest rates are typically based on the LIBOR (London Interbank Offered Rate) or EURIBOR (Euro Interbank Offered Rate), plus a margin that reflects the credit risk of the borrower.
Syndicated Loans:
- Eurocredits are often syndicated, meaning that a group of banks or financial institutions come together to provide the loan, thereby sharing the risk of lending. This allows banks to lend larger amounts of money while reducing their individual risk exposure.
No Domestic Regulations:
- Eurocredits are issued outside the jurisdiction of any single country’s central bank. This means the loans are not subject to domestic regulatory controls and often provide more flexible and competitive terms for borrowers. This allows companies and governments to raise capital at more attractive rates than might be available in their domestic markets.
Types of Eurocredits:
Eurodollar Credits:
- These are loans denominated in U.S. dollars but made by banks outside the U.S. Eurodollar loans are the most common form of Eurocredit.
Euroloan:
- Euroloan refers to a Eurocredit loan that may be denominated in currencies other than the U.S. dollar, such as the Euro, British pound, or Swiss franc. Euroloans are especially common in Europe, where borrowers may prefer loans denominated in Euros.
Eurobond Credit:
- A form of Eurocredit raised through the issuance of Eurobonds in international markets, which can be denominated in multiple currencies. The Eurobond market is a way for companies and governments to issue debt securities outside their own country, often at favorable terms.
Advantages of Eurocredits:
Diversification of Funding Sources:
- Eurocredits allow borrowers to tap into the global capital markets, providing an alternative to domestic credit markets. This is especially valuable for companies or governments that are looking to diversify their sources of financing.
Lower Borrowing Costs:
- Because Eurocredits are often offered by a group of international banks, they may offer more competitive interest rates than loans obtained from domestic lenders. The flexibility of the Eurocurrency market can also lead to lower costs for borrowers.
Increased Flexibility:
- Eurocredits can be structured with flexible terms, including the ability to choose between floating or fixed interest rates, repayment schedules, and currencies, allowing borrowers to tailor the loan to their specific needs.
Avoidance of Domestic Regulations:
- Since Eurocredits are not subject to the regulations and restrictions of the domestic banking system, they may offer more favorable terms, such as higher loan amounts, fewer restrictions on the use of funds, and fewer regulatory hurdles.
Disadvantages of Eurocredits:
Currency Risk:
- Borrowers who take out loans in a foreign currency are exposed to foreign exchange risk. If the value of the currency in which the loan is denominated rises relative to the borrower’s home currency, the cost of servicing the loan increases.
Interest Rate Risk:
- If the Eurocredit is tied to a floating interest rate (e.g., LIBOR or EURIBOR), the borrower faces the risk of rising interest rates, which could increase the cost of borrowing.
Limited Regulation:
- While the lack of regulation might benefit borrowers in terms of flexibility, it can also expose them to greater risk, as there are fewer safeguards in place to protect the parties involved.
Example of Eurocredit:
Imagine a multinational corporation based in India looking to borrow funds in U.S. dollars for a short-term project. The corporation may approach a group of international banks that participate in the Eurodollar market to issue a Eurocredit loan. This loan would be denominated in U.S. dollars, but the banks providing the credit are based in markets outside the United States, and the loan would be governed by international financial regulations rather than Indian or U.S. domestic laws.
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Elective: HRM in Global
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Elective: Retail Management (CBCGS) |
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Elective: Indirect Tax (CBCGS) |
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Elective: Marketing of Non-Profit
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Elective: Indian Ethos in
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