International finance management research study

International Finance Management

Finance Management Topic

Subin Umar Rahman S3 MBEM

International Finance Management P a g e | 1

Project Finance Management Nov 2012

CONTENTS

General ......................................................................................................................... 3

Evolution of International monetary systems ................................................................ 3

1. The Gold Standard .......................................................................................................... 3

The Collapse of Gold Standard- reasons ............................................................................ 4

The Bretton Woods Era ...................................................................................................... 4

The International Bank for Reconstruction and Development (IBRD) ............................... 4

International Monetary Fund (IMF) ................................................................................... 5

The End of the Bretton Woods System .............................................................................. 6

Post Bretton Woods System & the Floating Rate Era ........................................................ 7

Concepts of Globalization and MNCs ............................................................................. 7

The Growth of International Trade .................................................................................... 8

Multi-National Corporations ............................................................................................ 11

Important International Players in Global Finance .......................................................... 13

International Finance Markets: Foreign Exchange Market ............................................ 14

Organisation of Foreign exchange market ....................................................................... 14

Foreign Exchange Transactions ........................................................................................ 15

Exchange Rates ................................................................................................................. 15

Exchange Rate Quotes ...................................................................................................... 15

Exchange Rate Systems .................................................................................................... 15

Triangular Arbitrage .......................................................................................................... 15

International Money Market ............................................................................................ 16

International Credit Market ............................................................................................. 16

Syndicated Loans .............................................................................................................. 16

International Stock Markets ............................................................................................. 17

Methods Used for International Investment ................................................................... 17

Balance of Payment .................................................................................................... 18

International Trade Flows ................................................................................................. 19

Factors Affecting International Trade Flows .................................................................... 19

International Capital Flows ............................................................................................... 19

Agencies That Facilitate International Flows .................................................................... 19



Asian Development Bank ............................................................................................ 20

General ............................................................................................................................. 20

ADB’s window of operation .............................................................................................. 21

Instruments to assist PPP projects ................................................................................... 21

Pune Nirvana Hills Slum Rehabilitation Project- study ................................................. 22

Project Identification and Description .............................................................................. 22

Alignment with ADB Strategy and Operations ................................................................. 23

The Proposed ADB Assistance .......................................................................................... 24

Risks of the Project ........................................................................................................... 25

Budget for the Rehabilitation Plan ................................................................................... 25

References .................................................................................................................. 25

Books ................................................................................................................................ 26

Reports.............................................................................................................................. 26

Lectures ............................................................................................................................ 26

Websites ........................................................................................................................... 26



GENERAL

International finance is the branch of financial economics broadly concerned with monetary

and macroeconomic interrelations between two or more countries. International finance

examines the dynamics of the global financial system, international monetary systems,

balance of payments, exchange rates, foreign direct investment, and how these relate to

international trade.

Also referred as multinational finance, international finance is additionally concerned with

matters of international financial management. Investors and multinational corporations

must assess and manage international risks such as political risk and foreign exchange risk,

including transaction exposure, economic exposure, and translation exposure.

Some examples of key concepts within international finance are the Mundell–Fleming

model, the optimum currency area theory, purchasing power parity, interest rate parity, and

the international Fisher effect.

EVOLUTION OF INTERNATIONAL MONETARY SYSTEMS

The international monetary system establishes the rules by which countries value and

exchange their currencies. It also provides a mechanism for correcting imbalances between

a country’s international payments and its receipts. Further, the cost of converting foreign

money into firm’s home currency-a variable critical to the profitability of international

operations depends on the smooth functioning of the international monetary system.The

history of monetary system started when in ancient time (seventh century B.C.1) tribes &

city-states of India, Babylon & Phoenicia used gold & silver as media of exchange in trade.

The total history of international monetary system is discussed below in a chronological

order.

1. The Gold Standard

Meaning: Buying and selling of paper currency in exchange for gold on the request of any

individual of firm2. The theory of the gold standard rests on the idea that inflation is caused

by an increase in the supply of money, an idea advocated by David Hume, and that

uncertainty over the future purchasing power of currency depresses business confidence

and leads to reduced trade and capital3.

First to Adopt: In United Kingdom at 1821. It created a fixed exchange rate system because

each country tied the value of its currency.

Representative money and the Gold Standard protect citizens from hyperinflation and other

abuses of monetary policy, as were seen in some countries during the Great Depression.

However, they were not without their problems and critics, and so were partially

abandoned via the international adoption of the Bretton Woods System. That system

eventually collapsed in 1971, at which time all nations had switched to full fiat money.



The Collapse of Gold Standard- reasons

World War I

Post-War Conferences & Re-adaptation of Gold Standard

Implementation of Floating Rate System By Bank of England

Competitive Devaluation of Currencies & Increased Tariff Rate

Effect of beggar-thy-neighbor policies (World War 2

The Bretton Woods Era

Post-War Situation: World War II created inflation, unemployment and an instable political

situation. Every country was struggling to rebuild their war-torn economy.

Bretton Woods Conference: Not to repeat the mistakes that had caused World War II, to

promote worldwide peace & prosperity and to construct the postwar international

monetary system representatives of 44 countries met at a resort in Bretton Woods, New

Hampshire in 1944.

Conference has presented the world two historic agreements. These are as follows:

A. Agreement of conferees to renew the gold standard on a modified basis.

B. Agreement to create two new international organizations to assist the rebuilding of the

world economy and the international monetary system. These are

International Bank for Reconstruction and Development (IBRD)

International Monetary Fund (IMF)

The International Bank for Reconstruction and Development (IBRD)

The International Bank for Reconstruction and Development (IBRD) is the official name of

the World Bank. Established in 1945, the World Bank's initial goal was to help finance

reconstruction of the war-torn European economics. With the assistance of the Marshall

Plan, the World Bank accomplished this task by the mid-1950s. The Bank then adopted a

new mission—to build the economies of the world's developing countries. As its mission has

expanded over time, the World Bank created three affiliated organizations:

a. International Development Association (IDA)

b. International Finance Corporation (IFC)

c. Multilateral Investment Guarantee Agency (MIGA)

Together with the World Bank, these constitute the World Bank Group. The World Bankis

currently owned by the 185 member countries. The World Bank’s activities arefocused on

the reduction of global poverty, focusing on the achievement of theMillennium

Development Goals (MDGs), goals calling for the elimination of poverty andthe

implementation of sustainable development. United States is the bank’s largest

shareholder.



International Monetary Fund (IMF)

International Monetary Fund (IMF) was created to monitor and control the functioning of

the international monetary system. It is an international organization that oversees the

global financial system by observing exchange rates and balance of payments, as well as

offering financial and technical assistance. Its objectives are as follows:

i. To promote international monetary cooperation.

ii. To facilitate the expansion and balanced growth of international trade.

iii. To promote exchange stability, to maintain orderly exchange arrangements among

members, and to avoid competitive exchange depreciation.

iv. To assist in the establishment of a multilateral system of payments.

v. To give confidence to members by making the general resources of the Fund

temporarily available to them and to correct maladjustments in their balances of

payments.

vi. To shorten the duration and lessen the degree of disequilibrium in the interactional

balances of payments of members.

A Dollar-Based Gold Standard: The IMF and the World Bank provided the institutional

framework for the post war international monetary system. All countries agreed to peg the

value of their currencies to gold. However, only the United States pledged to redeem its

currency for gold at the request of a foreign central bank. Thus the U.S. dollar became the

key-stone of the Bretton Woods system.

In the early post war years, only the U.S. and Canadian dollars were convertible currencies,

that is, ones that could be freely exchanged for other currencies without legal restrictions.

Countries had faith in the U.S. economy and so were willing to accept U.S. dollars to settle

their transactions. As the British pound sterling had been in the nineteenth century, the U.S.

dollar became the preferred vehicle for settling most international transactions. The effect

of the Bretton Woods conference was thus to establish a U.S. dollar-based gold standard.

Under the Bretton Woods Agreement each country pledged to maintain the value of its

currency within ±1% of its par value. If the market value of its currency fell outside that



range, a country was obligated to intervene in the foreign-exchange market to bring the

value back within ±1% of par value. This stability in exchange rates benefited international

businesses, since the Bretton Woods system generally provided an assurance that the value

of each currency would remain stable.

Bretton Woods System as Adjustable Peg : The Bretton Woods system is oftendescribed as

using an adjustable peg because currencies were pegged to gold but thepegs themselves

could be altered under certain conditions. The arrangement of BrettonWoods System

worked well as long as pessimism about a country’s economy wastemporary. But, if a

country suffered from structural macroeconomic problems, majordifficulties could arise.

The End of the Bretton Woods System

Shortcoming of Dollar-Based Gold Standard Under Bretton Woods System &TriffinParadox:

The British and French central banks were a precursor to a run on the most important bank

in the Bretton Woods system—the U.S. Federal Reserve Bank. Ironically, the reliance of the

Bretton Woods system on the dollar ultimately led to the system's undoing. Because the

supply of gold did not expand in the short run, the only source of the liquidity needed to

expand international trade was the U.S. dollar. Under the BrettonWoods system, the

expansion of international liquidity depended on foreigners' willingness to continually

increase their holdings of dollars. Foreigners were perfectly happy to hold dollars as long as

they trusted the integrity of the U.S. currency, and during the 1950s and 1960s the number

of dollars held by foreigners rose steadily.

As foreign dollar holdings increased, however, people began to question the ability of

theUnited States to live up to its Bretton Woods obligation. This led to the Triffinparadox.

The paradox arose because foreigners needed to increase their holdings of dollars to finance

expansion of international trade. But the more dollars they owned, the less faith they had in

the ability of the United States to redeem those dollars for gold. The less faith foreigners

had in the United States, the more they wanted to rid themselves of dollars and get gold in

return. But if they did this, international trade and the international monetary system might

collapse because the United States didn't have enough gold to redeem all the dollars held by

foreigners. The shortcomings are listed below in brief-

Limited gold.

Liquidity problem.

Foreigners’ behavior of continuous increasing in dollar holding.

Foreigners’ less faith on United States.

Agreement to Create Special Drawing Rights (SDRs): To inject more liquidity into the

international monetary system while reducing the demands placed on the dollar as a

reserve currency, IMF members created the special drawing rights in 1967. SDR is a credit

granted by the IMF that can be used to settle official transactions among central banks. Thus

SDRs are sometimes called "paper gold". The value of an SDR is a function of the current

value of five different currencies from which it is comprised. They include the U.S. dollar, the

Japanese yen, the United Kingdom pound sterling, and the respective euro values of



Germany and France. An SDR's value is currently calculated daily as a weighted average of

the market value offive major currencies (U.S. dollar, German mark, French franc, Japanese

yen, andwas worth $1.54 in U.S. dollars.

Outcome of Creating SDRs: SDRs solved the liquidity problem for the international

monetary system, but if failed to solve the problem related to the glut of dollars held by

foreigners & faith. By mid-1971, the Bretton Woods system was tottering, the victim of fears

about the dollar's instability. In the first seven months of 1971, theUnited States sold one

third of its gold reserves15. It became clear to the marketplace that the United States did

not have sufficient gold on hand to meet the demands of those who still wanted to

exchange their dollars for gold.

Official Ending of Bretton Woods System: The Bretton Woods system officially endedwhen

in a dramatic address on August 15, 1971, President Richard M. Nixon announcedthat the

United States would no longer redeem gold at $35 per ounce.

Post Bretton Woods System & the Floating Rate Era

Most foreign currencies began to float, their values being determined by supply and

demand in the foreign-exchange market. The value of the U.S. dollar fell relative to most of

the world's major currencies. But the nations of the world were not yet ready to abandon

the fixed exchange-rate system.At the Smithsonian Conference in December 1971, central

bank representatives from the Group of Ten16 agreed to restore the fixed exchange-rate

system but with restructured rates of exchange between the major trading currencies. The

U.S. dollar was devalued to $38 per ounce but remained inconvertible into gold, and the par

values of strong currencies such as the yen were revalued upward. Currencies were allowed

to fluctuate around their new par values by =2.25%, which replaced the narrower ± 1.00%

range authorized by the Bretton Woods Agreement.

CONCEPTS OF GLOBALIZATION AND MNCS

The concept of globalization refers to the increasing connectivity and integration of

countries and corporations and the people within them in terms of their economic, political,

and social activities.Because of globalization, multinational corporations dominate the

corporate landscape. A multinational corporation (MNC) produces and sells goods or

services in more than onenation. A prototypical example is the Coca-Cola Company, which

operates in more than 200countries.

The link between a large European company and a large company from an

emergingeconomy is no coincidence. Recent years have seen strong growth in Brazil, Russia,

India,and China (sometimes called the BRICs). Today, the BRICs account for 15% of the

world’sgross domestic product (GDP) and more than 50% of the GDP of all emerging

countries.The international scope of business creates new opportunities for firms, but it also

poses many challenges. Globalization affects all aspects of society, but economically, two

main trends define it. First, countries continue to expand their trade in goods and services.

Second, countries continue to reduce their barriers to capital flows. We discuss each in turn.



The Growth of International Trade

Trade Liberalization

Beginning with the writings of David Ricardo in the 19th century, economists have known

that countries gain from trade if each nation specializes in the production of those goods

inwhich it has a comparative advantage. Even if one country is more productive at

producinga given item than other countries, it should still focus its production on those

goods in whichit is relatively most efficient, and doing so will make all trading partners

better off. There also appears to be a link in the data between trade and growth: More open

countries tend togrow faster. Unfortunately, many countries restricting international trade

through tariffs on imports, non-tariff barriers such as subsidies to local producers, quotas on

imported products, onerous regulations applying to imported products, and so

forth.Wacziarg and Welch (2008) pinpointed when various countries liberalized their trade

regimes—in other words, when the countries became open to trade. They looked at a

variety of criteria, including the extent of the countries’ tariffs and non-tariff barriers, and

state control on major export sectors. In 1960, only about 20% of countries were open to

trade. These countries included the United Kingdom and the United States, who had a long

tradition of openness to international trade, and many European countries that liberalized

in 1959 or 1960, after the creation of the European Economic Community(EEC) . The EEC set

out to establish free trade among a number of European countries, later turning into the

European Union. The idea that economies should be open to trade got a further boost in the

early 1980s, when Western governments started to deregulate their economies and

privatize government firms. More than 70% of countries open to trade by 2000.

International Efforts to Promote Free Trade

The General Agreement on Tariffs and Trade (GATT), signed in 1947, was designed to

encourage free trade between member states by regulating and reducing tariffs on

tradedgoods and by providing a common mechanism for resolving trade disputes. GATT

signatories occasionally negotiated new trade agreements to reduce tariffs, called

“Rounds,” to which countries would agree.The Uruguay Round, begun in 1986, established

the World Trade Organization (WTO) in 1995 to replace the GATT Treaty. GATT succeeded in

lowering trade barriers in a multilateral, worldwide way, but a number of important regional

trade agreements have slashed trade barriers even more in particular regions. The best

known of these regional agreements are the European Union (EU), the North America Free

Trade Agreement (NAFTA) ,Mercosur in South America, and the Association of Southeast

Asian Nations (ASEAN) .Maintenance, facilities management, and logistics—to specialist

firms to reduce costs. Today, outsourcing IT work to low-cost countries, such as India, has

become commonplace.These developments led to a new focus for trade policy: increasing

the internationaltradability of services.



The Growth in Trade

The evolution of trade openness dramatically increased trade flows between countries.

Onemeasure of trade openness is the sum of exports and imports in a given year divided by

ameasure of output, such as GDP presents some data on this relative size of thetrade sector.

Between 1985 and 2000, the trade sectors mostlygrew, especially in France, Germany, and

Australia, but over the past decade, only Germanyhas witnessed a substantial increase in its

trade sector. Of the countries shown, Germany isthe most open, with its trade sector

comprising 75% of GDP in 2009, while Japan is the leastopen, with trade comprising just

27% of its GDP.

In large, developing countries such as Brazil, India, and China witnessed increasesin the

relative size of their trade sectors. India’s trade sector evolved from less than10% of GDP in

1970 to over 45% in 2009. China’s trade sector nearly doubled between 1985and 2000 and

was over 50% of GDP in 2009. This increase reflects the major trade reformsChina

undertook during the 1980s and 1990s, including China’s accession to the WTO in2001. The

accession, in turn, led to a steady decrease in tariffs on imports. Because of itslarge size and

increased openness, China has become a major player in the world economy.

Although the global trend is toward freer trade, some countriesare clearly more open than

others. Many factors affect why, how much, and with whomcountries trade. For example,

countries that border oceans tend to trade more than inlandcountries. Large countries tend

to trade relatively less than smaller countries as evidencedby the U.S. numbers relative to

most other countries; and, indeed, China is a relative outlier.

The Globalization of Financial Markets

The globalization of financial markets and the profound changes they have undergone since

1980 have also dramatically changed how MNCs manage their business risks, improved their

access to foreign capital, and enhanced their ability to reduce financing costs. We provide a

short overview of the major developments.

Trends in Financial Openness

A country is financially open if it allows foreigners to invest in its capital markets and allows

its citizens to invest abroad. After World War II, most countries had controls or restrictions

in place that prevented the free flow of capital across borders. However, in the 1980s, many

developed countries began liberalizing their capital markets. For example, Japan started to

liberalize in 1984; in Europe, the movement toward the Single Market forced many

countries to abolish their capital controls, with France abolishing capital controls in 1986,

Italy in 1988, and Belgium in 1990. In the late 1980s and during the 1990s, many developing

countries began a financial liberalization process, relaxing restrictions on foreign ownership

of their assets and taking other measures to develop their capital markets, often in tandem

with macroeconomic and trade reforms. These developments created a new asset class in

which to invest: emerging markets.

A Global Financial Crisis

From 2007 through 2010, the world witnessed a full-blown financial crisis that started in the



United States and led to a global recession, the longest and deepest in the postwar era. We

will discuss a number of important economic crises in this book, but the scale and the depth

of this recent crisis raise deep issues about the functioning of the global financial system,

making it deserve special attention. The following figure depicts how a financial crisis

typically unfolds, consisting of rapidly falling asset prices and financial institutions that

become insolvent or are hit by liquidity crises.

Suppose asset prices fall. Consumers are now less wealthy and spend less. Firms may have a

harder time financing themselves because the value of their collateral drops, causing them

to invest less. As financial institutions take losses, aggregate lending to both consumers and

firms is reduced as well, causing them to spend less. Both chains of events reduce aggregate

output and lead to layoffs. The bad economic conditions feed back into asset prices and the

health of financial institutions through several channels. It entails in turn reduce asset prices

further. Increased uncertainty about the economic and financial future may make

companies delay investments and further reduce output. Facing defaults on their loans,

caused by the bad economic conditions, and perhapsbecause of their direct exposure to

asset prices, certain financial institutions may also curtail lending and perhaps even go

bankrupt. Once depositors and investors are sufficiently worried about the health of their

financial institutions, a liquidity crisis may erupt. In a liquidity crisis, a financial or other

institution does not have enough liquid assets to make the payments it has promised. It may

be solvent—that is, its assets may exceed its liabilities—but if counterparties who are

worried about its solvency insist on immediate payment, the institution is forced to sell

liquid assets at fire-sale prices. This may push the institution into insolvency and freeze up

the markets in which the institution plays a big role.



Multi-National Corporations

A multinational corporation (MNC) consists of a parent company in the firm’s originating

country and the operating subsidiaries, branches, and affiliates it controls both at home and

abroad. The United Nations refers to such firms as transnational corporations to emphasize

that the operation and ownership of these enterprises is spread throughout the world.Many

MNCs initially start out simply as exporting or importing firms. Later, an MNC may use many

methods to expand and spread out such as

Licensing in which the MNC gives local firms abroad the right to manufacture the company’s

products or provide its services in return for fees, typically called royalties. It doesn’t require

much investment while expanding globally but can be difficult for licensing firms to maintain

their product quality standards.

Franchising involves somewhat more involvement. Here, the firm provides a specialized

sales or service strategy,offers support at various levels, and may even initially invest in the

franchise in exchange for periodic fees. E.g. McDonald’s is the best-known franchising firm.

Joint Venture is another way to penetrate foreign markets where, a company that is jointly

owned and operated by two or more firms. For example, Walmart, the gigantic U.S. retailer,

set up a joint venture with India’s Bharti Enterprises in 2007 to start a chain of wholesale

cash-and-carry stores in India.

MNCs also enter foreign markets by setting up production and distribution facilitiesabroad

either by acquiring or merging with foreign companies or by simply establishing new

operations in the countries (in what are called greenfield investments ). These latter

categories constitute the bulk of foreign direct investment (FDI).

Goals of an MNC

The appropriate goal of the management of any corporation, including a multinational

corporation, is to maximize shareholder wealth. They maximize shareholder wealth by

making investments in projects whose returns are sufficiently large to compensate its

shareholders, through dividends and capital gains, for the risk involved in the projects.

Investment Time Horizon

Stakeholder Alternative

Agency Theory and Corporate Governance

Corporate Governance around the World

When reviewed of corporate governance and control, five ways of overcoming agency

problems are examined. The pros and cons of the different approaches are discussed.

An Independent Board of Directors

Concentrated Ownership

Executive Compensation

Shareholder Activism and Litigation

Hostile Takeovers



Foreign direct investment (FDI) in MNCs

It occurs when a company from one country makes a significant investment that leads to at

least a 10% ownership interest in a firm in another country. The outstanding stock of FDI

was estimated to be worth around $18 trillion in 2009 and has grown 30-fold between 1980

and 2009.

Between 1980 and 2000, the FDI>GDP ratio essentially grew by a factor of 10 in both

developed countries (from 1% to 9%) and in developing countries (from 0.4% to 4.3%). Over

the last decade, FDI flows stalled, and they decreased during the global crisis. Although

FDI inflows and outflows relative to GDP between 1980 and 2009 for developed countries, for

developing countries, and for two countries in Asia (Japan and China)



much was made of Japan’s international investments in the 1980s, it now has a lower

FDI>GDP ratio than China, whose FDI flows have grown quickly. There is another notable

difference between the two countries. Japan’s FDI outflows are about six times as large as

FDI inflows to Japan. In contrast, China’s inflows in 2009 were twice as large as its outflows.

Overall, the United States remains the country with the largest dollar amount of FDI inflows

and outflows.An important part of FDI involves international mergers and acquisitions

(M&A), in which a corporation in one country merges with or acquires a corporation in

another country.

Important International Players in Global Finance

In the course of its international business activities, an MNC may need financing from

aninternationally active bank, use economic information provided by an international

organization, operate within a regulatory framework set by local governments or

international institutions, and deal with investor relations in several countries. Some of

these international players in finance are mentioned below.

International Banks

International Institutions

o The International Monetary Fund (IMF)

o The World Bank

o Multilateral Development Banks (MDBs)

o The World Trade Organization (WTO)

o The Organization for Economic Cooperation and Development (OECD)

o The Bank for International Settlements (BIS)

o The European Union (EU)

Governments

Individual and Institutional Investors

o Individual Investors

o Institutional Investors

o Sovereign Wealth Funds

o Hedge Funds and Private Equity Firms



INTERNATIONAL FINANCE MARKETS: FOREIGN EXCHANGE MARKET

The foreign exchange market allows for the exchange of one currency for another. Large

commercial banks serve this market by holding inventories of each currency, so that they

can accommodate requests by individuals or MNCs. Individuals rely on the foreign exchange

market when they travel to foreign countries. The exchanges of money occur in the foreign

exchange market. Because different countries use different kinds of money, the

globalization process of the past 30 years has led to spectacular growth in the volumes

traded on this market.The institutional structure allows corporations, banks, international

investors, and tourists to convert one currency to another.At the core of the foreign

exchange market are traders at large financial institutions. For one currency to be

exchanged for another currency, there needs to be an exchange rate that specifies the rate

at which one currency can be exchanged for another.The system used for exchanging

foreign currencies has evolved from the gold standard, to an agreement on fixed exchange

rates, to a floating rate system.

Organisation of Foreign exchange market

The foreign exchange (sometimes abbreviated “forex”) has the customers of the foreign

exchange dealers buy and sell foreign currencies. These customers are the multinational

corporations that market goods and services throughout the world and the institutional

investors and money managers that invest capital or speculate throughout the world.



Foreign Exchange Transactions

The “foreign exchange market” should not be thought of as a specific building or location

where traders exchange currencies. Companies normally exchange one currency for another

through a commercial bank over a telecommunications network. The most common type of

foreign exchange transaction is for immediate exchange at the so-called spot rate. The

market where these transactions occur is known as the spot market.

If a bank begins to experience a shortage in a particular foreign currency, it can purchase

that currency from other banks. This trading between banks occurs in what is often referred

to as the interbank market. Within this market, banks can obtain quotes, or they can contact

brokers who sometimes act as intermediaries, matching one bank desiring to sell a given

currency with another bank desiring to buy that currency. About 10 foreign exchange

brokerage firms handle much of the interbank transaction volume.

Exchange Rates

An exchange rate is the relative price of two monies, such as the Japanese yen price of the

U.S. dollar, the British pound price of the euro, or the Brazilian real price of the Mexican

peso. The contractual parties use abbreviations. In banking and commercial transactions, it

is important that all parties understand which currencies are being used. Hence, there is a

need for standardization of the abbreviations which is done by the International

Organization for Standardization.

Exchange Rate Quotes

Because exchange rates are relative prices, they can be expressed in two ways. Exchange

rates can be quoted in direct terms as the domestic currency price of the foreign currency or

in indirect terms as the foreign currency price of the domestic currency.

Exchange Rate Systems

Exchange rate systems can be classified according to the degree by which exchange rates

are controlled by the government. Exchange rate systems normally fall into one of the

following categories:

Fixed

Freely floating

Managed float

Pegged

Triangular Arbitrage

Triangular arbitrage is a process that keeps cross-rates (such as euros per British pound) in

line with exchange rates quoted relative to the U.S. dollar. A trader can conduct a triangular

arbitrage in many ways. For example, a trader might start with euros, buy pounds with the

euros, then simultaneously sell those pounds for dollars and sell those dollars for euros.

Inother words, instead of exchanging just two currencies, the trader exchanges three

(hencetheterm “triangular” arbitrage). If the number of euros the trader has at the end of



these three transactions is greater than the number of euros at the beginning, there is a

profit.

If such transactions can be done profitably, the trader can generate pure arbitrage profits—

that is, earn risk-free profits. Obviously, in perfectly competitive financial markets, it is

impossible to earn arbitrage profits for very long. If the euro price of the pound were not

equal to the euro price of the U.S. dollar multiplied by the U.S. dollar price of the pound,

arbitrage activity would immediately restore equality between the quoted cross-rate and

the cross-rate implied by two dollar quotes:

Euros / Pound = Euros / Dollarx Dollars / Pound

International Money Market

In most countries, local corporations commonly need to borrow short-term funds to support

their operations. Country governments may also need to borrow short-term funds to

finance their budget deficits. Individuals or local institutional investors in those countries

provide funds through short-term deposits at commercial banks. In addition, corporations

and governments may issue short-term securities that are purchased by local investors.

Thus, a domestic money market in each country serves to transfer short-term funds

denominated in the local currency from local surplus units (savers) to local deficit units

(borrowers).The international money market includes large banks in countries around the

world. Two other important components of the international money market are the

European money market and the Asian money market.

International Credit Market

Multinational corporations and domestic firms sometimes obtain medium-term funds

through term loans from local financial institutions or through the issuance of notes

(medium-term debt obligations) in their local markets. However, MNCs also have access to

medium-term funds through banks located in foreign markets. Loans of one year or longer

extended by banks to MNCs or government agencies in Europe are commonly called

Eurocredits or Eurocredit loans. These loans are provided in the so called Eurocredit market.

The loans can be denominated in dollars or many other currencies and commonly have a

maturity of 5 years.

Syndicated Loans

Sometimes a single bank is unwilling or unable to lend the amount needed by a particular

corporation or government agency. In this case, a syndicate of banks may be organized.

Each bank within the syndicate participates in the lending. A lead bank is responsible for

negotiating terms with the borrower. Then the lead bank organizes a group of banks to

underwrite the loans. The syndicate of banks is usually formed in about 6 weeks, or less if

the borrower is well known, because then the credit evaluation can be conducted more

quickly.

International bonds are typically classified as either foreign bonds or Eurobonds. A foreign

bond is issued by a borrower foreign to the country where the bond is placed. For example,



a U.S. corporation may issue a bond denominated in Japanese yen, which is sold to investors

in Japan. In some cases, a firm may issue a variety of bonds in various countries. The

currency denominating each type of bond is determined by the country where it is sold.

These foreign bonds are sometimes specifically referred to as parallel bonds.

International Stock Markets

MNCs and domestic firms commonly obtain long-term funding by issuing stock locally. Yet,

MNCs can also attract funds from foreign investors by issuing stock in international markets.

The stock offering may be more easily digested when it is issued in several markets. In

addition, the issuance of stock in a foreign country can enhance the firm’s image and name

recognition there.

Methods Used for International Investment

For investors attempting international stock diversification, five common approaches are

available:

Direct purchases of foreign stocks

Investment in MNC stocks

American depository receipts (ADRs)

Exchange-traded funds (ETFs)

International mutual funds (IMFs)



BALANCE OF PAYMENT

A country’s balance of payments (BOP) records the value of the transactions between its

residents, businesses, and government with the rest of the world for a specific period of

time, such as a month, a quarter, or a year. Hence, the balance of payments summarizes the

international flows of goods and services and changes in the ownership of assets across

countries. There are two major BOP accounts: the current account and the capital account.

In recent years, most countries have renamed the capital account as the “financial account”

in order to comply with the recommendations of the International Monetary Fund (IMF).

Because the terminology capital account has a long tradition and continues to be used in the

financial press, we continue to use it here.

The current account records:

Goods and services transactions

Transactions associated with the income flows from the ownership of foreign assets

Unilateral transfers of money between countries

The capital account records the purchases and sales of foreign assets by domestic residents

as well as the purchases and sales of domestic assets by foreign residents.

{The definition of an asset is all inclusive: It encompasses both financial assets (bank deposits and

loans, corporate and government bonds, and equities) and real assets (factories, real estate,

antiques, and so forth)}

Balance of Payment follows a Double Entry Accounting System. Each transaction gives rise

to two entries: One entry is a credit, and the other entry is a debit of equal value. The rules

for determining credits and debits on the balance of payments are analogous to those in

financial accounting.

Credit transactions

Give rise to conceptual inflows or sources of foreign exchange

purchases of goods and assets by foreign residents from domestic residents are

credits because they are a source of foreign exchange

Increase the supply of foreign money in the foreign exchange market.

Debit transactions

give rise to conceptual outflows or uses of foreign exchange

purchases of goods and assets by domestic residents from foreign residents are

debits because they cause an outflow of foreign exchange

increase the demand for the foreign money in the foreign exchange market

Current Account Transactions- Every current account transaction can be considered to have

a corresponding flow of foreign money associated with it, and this flow of foreign money is

recorded as a capital account transaction.

Capital Account Transactions- Some capital account transactions arise naturally, as

demonstrated in the case of payment flows associated with current account



transactions.However, some transactions involve situations in which both entries are

recorded exclusively on the capital account.

Because the two major accounts of the balance of payments are the current account and

the capital account, we see immediately that a current account deficit must have a capital

account surplus as its counterpart. In other words, if we list credit items with a 1 + 2 and

debit items with a 1 - 2, we can add the accounts, and they must sum to zero:

Current account + Capital account = 0

International Trade Flows

Canada, France, Germany, and other European countries rely more heavily on trade than

the United States does. Canada’s trade volume of exports and imports per year is valued at

more than 50 percent of its annual gross domestic product (GDP). The trade volume of

European countries is typically between 30 and 40 percent of their respective GDPs. The

trade volume of the United States and Japan is typically between 10 and 20 percent of their

respective GDPs. Nevertheless, for all countries, the volume of trade has grown over time.

As of 2006, exports represented about 18 percent of U.S. GDP.

Factors Affecting International Trade Flows

Because international trade can significantly affect a country’s economy, it is important to

identify and monitor the factors that influence it. The most influential factors are:

Inflation

National income

Government policies

Exchange rates

International Capital Flows

One of the most important types of capital flows is direct foreign investment. Firms

commonly attempt to engage in direct foreign investment so that they can reach additional

consumers or can rely on low-cost labour. In 2006, the total amount of direct foreign

investment (by firms or government agencies all over the world) into all countries was about

$1.2 trillion. Exhibit 2.7 shows a distribution of the regions where the DFI was targeted

during 2006. Notice that Europe attracted almost half of the total DFI in 2006. Western

European countries attracted most of the DFI, but Eastern European countries such as

Poland, Hungary, Slovenia, Croatia, and the Czech Republic also attracted a significant

amount of DFI. This is not surprising since these countries are not as developed as those in

Western Europe and have more potential for growth. They also have relatively low wages.

The United States attracted about $177 billion in DFI in 2006, or 14 percent of the total DFI.

Agencies That Facilitate International Flows

International Monetary Fund

World Bank

Multilateral Development Banks (MDBs)

The World Trade Organization (WTO)



The Organization for Economic Cooperation and Development (OECD)

The Bank for International Settlements (BIS)

Asian Development Bank

ASIAN DEVELOPMENT BANK

General

ADB is a multilateral financial institution dedicated to reducing poverty in Asia and the

Pacific. It was established in 1966 and now owned by 63 member countries, of which 42 are

considered developing. It is headquartered in Manila, with 27 other offices around the

world and more than 2,000 employees from 50 countries. ADB provides financial assistance

to governments and to public and private enterprises. In the year 2004 the approvals

include: $5.8 billion in loans, equity investments, guarantees, and technical assistance.

Some of the important functions of ADB are

ADB catalyses and mobilizes the capital for the PPP project.

It leads private capital to development projects in countries or sectors with perceived

high risks (e.g. transition economies, small countries, frontier sectors).

Provides comfort to co-investors by taking the same risks through direct participation in

projects (i.e., being on the “same boat”).

Mitigates perceived risks through credit enhancement instruments such as guarantees.

Assures financial closure in critical infrastructure projects requiring large financing.

ADB’s value system

Better loan terms and financial structure to improve project’s viability.

Mutually beneficial concession contracts.

Improved environmental and social risk mitigation. enhanced public consultation.

Improved corporate governance in the project.

“Certification” of projects on issues of environmental protection, good governance, etc.

on the strength of ADB’s value system.

Some of the targeted Infrastructure Segments for ADB financing are

Power: generation, transmission, distribution, renewables.

Oil and gas: pipelines, terminals, distributions systems.

Transport: roads, bridges, ports, airports, rail transport systems.

Telecommunication: backbone networks, rural telecom.

Water: supply, distribution, wastewater treatment.

Urban services: waste management, mass rapid transit, and other transport systems.



Types of Infrastructure project that have been assisted are

Greenfield: start-up projects, including BOOs, BOOTs, BOTs and other similar

contractual structures.

Brownfield: expansion, rehabilitation, modernization of existing facilities with private

sector participation.

Privatization: state-owned utilities.

ADB’s window of operation

Public Sector Window

o Deals with the government

o Instrument: sovereign loans , technical assistance, guarantees

Private Sector Window

o Direct assistance to private enterprises

o Instruments: Equity investments, non- sovereign loans, guarantees, complementary

financing scheme

Instruments to assist PPP projects

o Equity investments

o Loans without sovereign guarantees

o Complementary financing scheme (CFS)

o Political risk guarantee (PRG)

o Partial credit guarantee (PCG)

o Sovereign loans to finance the host government’s equity in a PPP project, if needed.

ADB’s Initiatives in Local Currency Lending

Local currency financing is needed to mitigate the risk of currency mismatches.ADB can

issue its own local currency denominated bonds to generate local currency funds for on

lending to borrowers in the host country (e.g., India and Thailand).ADB can also generate

local currency funds via cross currency swaps in the market.ADB’s partial credit guarantee is

available to credit enhance local currency borrowings or bond issues by clients.

Single project exposure limit:

The lesser of $250 million or 25% of project cost.

This applies to the aggregate of equity investment, loan, PCG (present value), and PRG (risk

weighted).

PRG transaction limit:

Up to $250 million (or higher under special conditions);if without sovereign counter-

guarantee.

No pre-specified limit ;if with sovereign counterguarantee.

CFS / Guarantor of Record: no pre-specified limit.



PUNE NIRVANA HILLS SLUM REHABILITATION PROJECT- STUDY

Project Identification and Description

India suffers from an acute shortage of housing, estimated at 24.71 million housing units,

and Maharashtra has the greatest shortage at 3.72 million units.1 The problem will increase

due to rapid urbanization and population growth, amongst other factors. Given this

tremendous shortage of housing, substandard housing and slums are proliferating. The

Asian Development Bank (ADB) was approached by Deutsche Bank, a leading real estate

financing bank in India, to provide financing for this slum rehabilitation project. The project

is considered to be one of the best opportunities for ADB to support slum rehabilitation

because of its good location, high development impact, and strong sponsor, Kumar Urban

Development Limited (KUDL).

Design

Pune, the second-largest city in Maharashtra, has a population of approximately 5.5 million

people, of which about 32.5% to 40% live in slums. The project is situated on a prime piece

of real estate, advantageously located in the Kothrud area of southwest Pune, near the

Pune–Mumbai expressway. Residential housing is in short supply across the city and in

particular in the Kothrud area. The project represents one of a few new developments in

Kothrud, which also suffers from a lack of retail and office space.

The project covers a site of 76 acres and entails the in-situ rehabilitation of slum dwellings

and the development of mixed-use residential and office and retail space, which the sponsor

is entitled to sell at market prices. Currently a large number of slum households are living in

substandard conditions on the site. The sponsor will construct (i) multiple buildings to re-

house the slum dwellers, each building with 11 floors of 13 units each, and several

commercial spaces for small businesses that are operating in the slum area; (ii) residential

buildings with apartments, office space, and retail space; and (iii) amenities and

infrastructure for the use of the re-housed slum dwellers—housing society offices, a self-

employment center for women, playgrounds, daycare facilities, community and senior

citizen recreation centers, libraries, a primary and secondary school, and a park.

The project is expected to be constructed in 7 years, including a 4-year construction period

for the rehabilitation buildings that started in 2011. A phased approach is being used to

manage the construction and regulatory approval process and to minimize the need for

transit housing. During construction, the slum dwellers will either be moved into temporary

housing on the site or be paid a monthly rental allowance until they are moved into their

new, permanent housing. Additionally, for eligible and ineligible slum dwellers under the

SRS (para. 6), the developer will pay a moving allowance before the slum dwellers vacate

their homes, and when the slum dwellers move into their new apartments. The architect of

the commercially saleable portion of the project (the “free-sale” area) is P.G. Patki

Architects Pvt. Ltd., which has designed several well-known projects in India.



Operation and maintenance of the rehabilitation buildings is carried out by the housing

society, formed by the apartment owners, which will outsource such work to external

parties. The sponsor will deposit a fixed amount per slum household in an escrow account,

which is jointly managed by the SRA and the housing society. Interest earned from this is

expected to be sufficient to cover such costs. The households pay their own monthly

electricity and running-water costs. These costs are expected to be relatively low and, in

many cases, are already being borne by the households.

Alignment with ADB Strategy and Operations

Consistency with Strategy 2020

The project is consistent with ADB’s Strategy 2020, which promotes private sector

investment in the infrastructure sector, as well as an improvement in public health

standards. Strategy 2020 also states that ADB will continue to emphasize gender equality

and the empowerment of women as fundamental elements of achieving inclusive growth.

The project is expected to yield tangible benefits for women and empower them, e.g.,

through joint ownership of apartments and job and skills training. Also, under Strategy

2020, cities constitute a key focus, specifically in terms of promoting livable cities that are

socially inclusive. The project promotes, in an inclusive and innovative way, the private

sector’s participation in the slum rehabilitation sector.This is a sector which the government

has so far and can be expected to support only to a limited extent.

Consistency with Country and Sector Strategy

The project is consistent with the country partnership strategy (CPS) 2009–2012 for India.

The CPS aims to significantly strengthen ADB’s infrastructure activities and to encourage

innovative financing. The CPS further notes that ADB’s ongoing urban sector operations will

combine infrastructure development with targeted poverty reduction components. Finally,

the project is in line with ADB’s desire to undertake projects that have targeted poverty

reduction components and promote inclusive growth. The project is also consistent with

ADB’s strategies and plans for private sector development, poverty reduction, and urban

operations. The poverty reduction strategy supports the need to undertake sustainable

housing projects implemented by the private sector. ADB’s draft urban operations plan

states that ADB’s support for inclusive cities must include support to slum upgrading,

housing, land tenure, and development and housing finance.

Project Cost and Financing Plan

The project will be financed through sales advances, sponsor equity, and the remaining by a

combination of CCDs (compulsory convertible debenture) and debt from ADB;

FMO(NederlandseFinancierings-MaatschappijvoorOntwikkelingslanden N.V. (Netherlands

Development Finance Company)), (with participation from GuarantCo) and Deutsche Bank.

The debt investors will provide direct onshore loans to Kumar Sinew Developers Private

Limited (Project Company). FMO and GuarantCo have already funded the project through



CCDs and Deutsche Bank has provided debt. FMO and GuarantCo will further invest in the

form of debt, as Nonconvertible debentures (NCDs), and Deutsche Bank will provide further

debt.

Implementation Arrangements

The Proposed ADB Assistance

The Assistance

ADB proposes to provide the rupee equivalent of up to $35 million to the project in the form

of CCDs, which will be issued by KUL UDPL (issuer). CCDs have been used in the past by

foreign investors for slum rehabilitation projects, as well as for projects in other sectors.

The issuer is expected to pay to ADB and other CCD holders a fixed coupon amount, payable

quarterly. ADB is expected to have the right to nominate one director for appointment to

the board of the issuer. To facilitate exit arrangements, ADB will grant to the sponsor a call

option under which it will have an option to buy the CCDs, or on default, for a

predetermined amount that would both pay the amount invested by ADB and provide a

return on such investment. Should the sponsor not exercise the option, the CCDs will

automatically convert to shares of the issuer. The CCD investors may also force a conversion

if the issuer defaults on its CCD obligations.

Security-The OPCD (optionally convertible debenture) loan from the issuer to the project

company will be secured by a mortgage on land and buildings of the project at a minimum

collateral value in relation to the loan amount. Additional collateral satisfactory to the CCD

holders will be provided if the collateral value declines below a certain level. The value of

the collateral will be reviewed on a semi-annual basis by an internationally recognized

Aspects Arrangements

Regulatory framework Slum Rehabilitation Scheme and Slum Rehabilitation Authority of Pune.

Management Sponsor’s project management team.

Implementation Period

Multiple ADB CCD infusions expected to be made in 2012–2014.

Construction Arrangements

Kumar Sinew Developers is responsible for the supervision of the construction activities. Construction works will be competitively bid out on a turnkey basis to qualified contractors.

Revenue structure Revenue from pre-sales and sales of residential apartments and commercialspace, and from lease rentals of the retail space.

Operation and maintenance

Housing societies will be responsible for the operation and maintenance of the common areas of the buildings

Performance monitoring

Key performance indicators will be reported by KUDL as per ADB’s requiredinformation covenants. A semiannual market valuation of the proposed securitywillbe provided by an independent real estate consultant. An independentexternal consultant will monitor compliance with ADB’s Safeguard Policy Statement (2009).



independent real estate company and valuator. In addition, the OPCD loan will be secured

by a guarantee from the sponsor. All proceeds in an enforcement scenario will be shared

paripassu among Deutsche Bank, the NCD holders, and the OPCD holders. In an

enforcement situation, conversion to shares will thus give the CCD holders the ability to

enforce the project company’s obligations to repay the issuer’s OPCD loan and, if necessary,

to (i) exercise the security for the OPCD loan and (ii) call on the sponsor guarantee. In

certain circumstances, control of the issuer may also enable the investors to recover their

investments by selling the project company as a whole or by causing it to liquidate.

Value Added by ADB Assistance

ADB’s value addition to the project is expected to be the following:

(i) Funding for the real estate sector, particularly for slum rehabilitation projects, is not

readily available from commercial banks. The project will play a pioneering role in

demonstrating the commercial viability of slum rehabilitation projects undertaken through

the SRS(Slum Rehabilitation Scheme) in India, which may help to catalyze commercial bank

financing for future slum rehabilitation projects.

(ii) ADB’s participation will further strengthen the project through the application of ADB’s

social safeguards, gender and development targets, and environmental standards, which

are of particular importance.

Risks of the Project

Real Estate Market Risk

Project Risk

Sponsor Risk

Social Safeguards Risk

Regulation Risk

Reputational Risk

Corporate Governance Risk

Budget for the Rehabilitation Plan

The budget for the rehabilitation plan has been developed based on the number of eligible

and non-eligible families. The budget provides indicative costs (in Indian Rupees) for the

following options:

Option I: Cash Compensation at Replacement Value; and;

Option II: Low Cost Housing linked to the RAY (Rajeev AwazYojana);

Option III: Non-SRA/KUL allocated housing without FSI advantage.

REFERENCES



Books

1. International Financial Management Second Edition by Geert Bekaert and Robin

Hodrick

2. International Financial Management Ninth Edition by Jeff Madura, Florida Atlantic

University

Reports

1. The Future of the Global Financial System -A Near-Term Outlook and Long-Term

Scenarios:A World Economic Forum Report In Collaboration With Oliver Wyman

2. Infrastructure PPP Projects: Financing & Risk Mitigation Instruments of the Asian

Development Bank by Jean-Pierre Verbiest, Thailand Resident Mission ,Asian

Development Bank

Lectures

1. History of International Monetary System byMd. AzimFerdous, Dept. of

Management Studies, University of Dhaka

2. Lecture on Evolution of International Financial System by AkilaWeerapana

3. Global Financial System in Perspective

Websites

1. Rehabilitation Planning Document : Pune Nirvana Hills Slum Rehabilitation

Projecthttp://www.adb.org/sites/default/files/projdocs/2012/44940-01-ind-rp-

01.pdf

2. www.adb.org › › Projects › Documents

http://www.adb.org/sites/default/files/projdocs/2012/44940-01-ind-rp-01.pdf

http://www.adb.org/sites/default/files/projdocs/2012/44940-01-ind-rp-01.pdf

International finance management research study

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