International Finance-Nijay Gupta

8/8/2019 International Finance-Nijay Gupta

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International Finance (IF) -OverviewFoundations of IF Management : -G

lobalization and the Multinational FirmInternational Monetary SystemBalance of Payments

The Market for Foreign ExchangeInternational Parity Relationships andForecasting Foreign Exchange Rates


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International Finance (IF) -OverviewW orld Financial Markets andInstitutions : -International Banking and Money Market International Bond market/Equity Market Futures and Options of Foreign Exchange

Currency and Interest Rate SwapsInternational Portfolio Investments


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International Finance (IF) -OverviewForeign Exchange Exposure andManagement :

Management of Credit ExposureManagement of Economic Currency/CountryExposure

Management Transaction/Product ExposureManagement of Translation & Settlement Exposure


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International Finance (IF) -OverviewFinancial management of the Multinational Firm :

Foreign Direct/FII Investments and Cross-Border

AcquisitionsInternational Capital Structure and the Cost of CapitalInternational Capital BudgetingMultinational cash Management

Export and ImportsInternational Tax Environment Corporate Governance around the world .


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International Finance

G lobalization and the Multinational Firm,Exchange Rate History

Currency Demand and SupplyBalance of Payments


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G lobalization and the Multinational FirmDeclining trade barriers, Collapse of Communist powerin Eastern Europe, move toward free market economiesby China and Latin America changes in communication,

information and transportation technologies haveglobalized and integrated world economy IF differs from domestic finance due to Foreignexchange & political risks, market imperfections andexpanded opportunity set (firms gaining from greater

economies of scale and deployment of assets on globalbasis)by using proper tools and instruments.Goals for IF - Maximization of Shareholders worth andneed for Corporate Governance.


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G lobalization and the Multinational FirmMNC s produces goods in one country, raise financefrom different countries and sell in other countries.G

lobalization of the World Economy Emergence of G lobalized Financial Markets, Advent of the Euro,Trade Liberalization (WTO, NAFTA, EU) andEconomic Integration (MNC s taking comparativeadvantage over another country (Theory of comparative advantage) due to their controllingcapital and know-how i.e. money & technical know-how power).


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Need & Importance of IFInternational Trade & Trade Settlement inForeign Exchange

G lobalization & Liberalization by countriesIntegration of Financial Markets with thedevelopment of new financial instruments,liberalization of regulations governing thefinancial markets and increased crosspenetration of foreign ownershipCover Trade & Forex Risk with newinstruments & Products


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Basic Ingredient of IFSame that of WTO i.e. due to free flowsbetween countries on account of :

Trade Trade Finance ProductsCapital Financial Markets and Instruments

Arbitrage Interest Rate between different

markets and different countriesMovement of People - Need for MoneyTransfer G enuine/Non- Genuine


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Trade Theories, Developments,

Barriers and RegulationsTheory of Absolute Advantage One countrymay be more efficient in producing a

particular good than another country and that country may be capable of producing someother good more efficiently than the first oneTheory of Comparative Advantage Both

countries enjoy comparative advantage in at least one of the products and to be seen fromthe point of Perfect competition, Productivity,Full employment, Mobility and Technology.


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Developments, Barriers and

RegulationsG rowth/Developments of International TradeRisks involved in International Trade

Emergence of Trading Blocks Free Trade Area,Custom Union, Common Market, Economic Union,NAFTA, ASEAN, SAARC, The European UnionTrade Barriers Tariff Custom/import duty,taxes/vat Non-Tariff Barriers Quota, Embargo,

Subsidies to local goods. Then Technical Barriers,procurement policies, international price fixing andExchange Control Regulations etc

Various Regulations to Trade FEMA, Exim Policy etc


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International Trade Finance in

India Risk/ExposureRisk in Export-Import BusinessExposure on:Buyer/Seller Credit, Capital, Capacity, Character andConditions of businessCountry Risk Political Risk, War or War like situation,Internal Disturbance & Govt. PolicyExchange Rate Risk Price/Volatility Risk Translation/-Transaction Risk Product Risk - CultureOperation Risk, Settlement Risk Interest Rate Risk Inflation, Economic conditions/exposure


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India- ECONOMIC SCENARIOF orex Reserves touches USD 229.00 BioGood F orex inflow by Exporters/ECBs/ F IIs/-F DIs leveraging on capital market and lessoutflow by ImportersRupee remained between 40.90-40.95

Inflation around 4.00%F orward premium around 1.00% for 1 year Libor at 5.50% p.a. for 3 to 6 months


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International Trade Finance in India- F INANCINGMECHANISM & CORRESPONDENT BANKSACCOUNTS

Permitted currencies for Payment(Trade/Investments)

Collection, Purchase, Discounting or Negotiationof Export Documents

Nostro AccountsVostro AccountsACU Dollar AccountF oreign Currency Accounts for Residents: EEFC ,R F C account and R F C (Domestic) account


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India- INCOTERMS ICC PARISMost commonly used Terms of Shipment are:F OB - SHIP, AIR, RAIL( F OR), TRUCK( F OT)

All cost till the time goods are kept ONBOARD ship/air/rail/truck are borne by theexporter CF R:-F OB PLUS the freight for the VoyageCIF :-CF R PLUS the Insurance for the Voyage


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India- INCOTERMS ICC PARISOther Incoterms not much in use:F AS : F ree Along-side Ship (loading/unloadingexpenses not included)CIF C: Cost, Insurance, F reight & CommissionDAF : Deliver at F rontiers

DDP: Delivered Duty PaidICC, Paris have now grouped these Incoterms asC, D, E and F .


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India- TERMS O F PAYMENTSADVANCE PAYMENT : By way of Swift/TT/DD/Cheque /TCs /CN etc

DP SIGHT/COD/CAD: Delivery of Documentsagainst PaymentDA USANCE/CREDIT/TERMDelivery of Documents against acceptance.Maximum credit can be allowed upto 180 daysfrom the date of shipmentLetter of CreditConsignment & Deferred Payment


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International Trade Finance in India-TERMS O F PAYMENT-LCLC is a sort of Guarantee issued by a Bank, on

behalf of the Buyer (applicant) favouring thesupplier (Beneficiary), undertakes to pay byauthorizing another bank (Negotiating Bank) to

pay on complying with the Terms & Conditionsmentioned therein.LC is also known as Documentary Credit as Banks

deals in Documents and not in goodsEach LC should mention that This LC is subjectto UCPDC publication no. 600, (2007 Revision)ICC guidelines to be operative


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International Trade Finance in India- TYPES O F

DOCUMENTARY CREDITS/LCS

REVOCABLE: Which can be cancelled by theapplicant without the consent of beneficiary

IRREVOCABLE: Which can not be cancelled or amended without the consent of beneficiaryIrrv. CON F IRMED: Which has been confirmed

by advising, another bank in the same country or another countryIrrv. TRANS F ERABLE: Which is transferred bythe Advising Bank at the request of Beneficiary tothird party


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International Trade Finance in India- TYPES O F DOCUMENTARY CREDITS/LCS

Irrv. Back to Back: Wherein another Lc isestablished by beneficiary on security of main LC

Irrv. Revolving: Wherein the credit available getsre-instated after utilization of the amount, Can beCumulative or Non-CumulativeIrrv.Standby: Used for transactions in US in placeof Guarantee for payment of Loan/lease etc


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International Trade Finance in India- TYPES O F DOCUMENTARY CREDITS/LCS

Irrv. Deferred Payment: Wherein the payments aremade in Installments and deferred over one year

Irr. Red Clause: Wherein the payment is made inadvance through an LC mechanism by the buyers

bank against the Indemnity & undertaking by theBeneficiary to export the goodsIrr. Restricted: Wherein the Lc is restricted for negotiation to a particular bank


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International Trade Finance in India-CHECKLIST ON RECEIPT O F LC

Name & Address of the Applicant & Beneficiary& Amount

Should be in English language onlyDescription of goods should be as per LCTerms of Shipment/Payment/ReimbursementMode of Transport, Part/Trans-shipment

Restricted or confirmed, charges thereonInspection & other Terms & Conditions matcheswith that of the Performa Invoice or ContractShipment/ Expiry date and Negotiation Period


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International Trade Finance in India-EXPORT/IMPORT F INANCE SCHEME

Common Scheme for all types of Exporters in allthe Banks in India

Scheme guided by RBI in its Monetary PolicyMoney given at Concessional Rate of Interest atPre-shipment & Post Shipment stage to meetShort-Term Working Capital.

Repayment of Loan/credit from Overseas onlyBanks are partly Refinanced by RBI & this ranksfor Priority Sector F inance of Banks


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PRE-SHIPMENT CREDIT: (RUPEES/ F C)Upto 180 Days : Not exceeding PLR

minus 2.5%Beyond 180 to 270 days: Not exceeding PLR

plus 0.5%PCF C upto 180 days: Not exceeding

LIBOR plus 1.00%PCF C 181 to 365 days: Not exceeding

LIBOR plus 3.00%


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POST SHIPMENT CREDIT (RUPEES/ F C)On DP Bills upto NTP : Not exceeding PLR

minus 2.5%

On Usance Bills:upto 90 days : Not exceeding PLR minus2.5% (PLR -4.50% for SME)

Beyond 90 to 6 months: Not exceeding PLR plus 0.5%

Bills Reds. Scheme : Not exceeding LIBOR plus 1.00%

IMPORTERS are not given any concessional F inance, however theytake benefit through Buyers Credit from overseas Banks/Institutions


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International Trade Finance in India-

IMPORTS - PAYMENTSAdvance payment beyond USD 100,000 or 15%of the amount for Import of Capital goods,requires guarantee from an reputed InternationalBank outside India. Ads now free to decide their own policy based on Importers past relationship.Remittance against import bills should be madewithin 6 months.

Interest on import bills upto 6 months can be paidupto LIBOR/Prime rate of the country. Beyond 6month, payment of interest under suppliers creditrequires RBI approval


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INTERNATIONAL F ACTORINGF actoring is purchase of EXPORT receivable(with or without recourse) on an ongoing basis.

The management, collection & administration istaken over by the factor for exports on openaccounts termsF inance is made available upto 90% of the invoicevalue

Offered by Global Trade F inance a subsidiary of Exim Bank in India, Canfactors & HSBC F actorsetc


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INTERNATIONAL F OR F AITINGF orfaiting is purchase of medium to long-termexport receivables backed by a LC or bankers

acceptance from the buyers bank at a discount ona without recourse basisExim Bank and Authorized Dealers offers this

product to exporters for a minimum amount of USD 50,000/-RBI allows banks to pay forfaiting charges inadvance


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F ACTORING : F OR F AITINGSuited for on goingopen a/c sales not

backed by LC or accepted Bills of ExchangeProvide short-termcredit upto 180 days

Single transactions backed by LC or a

Bank Guarantee

F or long-term creditupto 10 yeas, thoughavailable for Shortterm too


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International Monetary SystemIt s a system where Intl payments are made, movement of capital accommodated and exchange rates of currenciesdeterminedIt went through 5 stages Bimetallism (coinage in silver & goldlead to G resham s law for fixing exchange ratio of 2 metals)),classical gold standard (exchange ratio decided on gold contentsof currencies), interwar period (no clear rule lead to 44 nationsmeeting in 1944), Bretton Woods system (established a parvalue in relation to USD which was fully convertible to gold) andflexible exchange rate regime (replaced Bretton Woods due tospectacular rise & fall of USD in 1980).1987 G -7 countries agreed for Managed-float system for jointlyintervening in Forex market to cover over- or undervaluation of currencies.


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International Monetary System1979 EEC launched European Monetary System (EMS) to establish

zone of monetary stability in EuropeEMS are ECU (European Currency Unit basket) and ERM (ExchangeRate Mechanism) instruments based on parity grid that member

countries required to maintain for EMS accounting.1999 11 countries adopted common currency called Euro. G reeceadopted in 2001. Euro -12 helps reduced transactions cost, eliminationof exchange rate uncertainty and development of continentwide capitalmarketsEuropean Monetary Union (EMU) common monetary policy for 12 eurocountries formulated by ECB located at Frankfurt. European System of

Central Banks (ESBS) implements monetary policy of EMU in 12 eurocountriesEMU members prefer Fixed Exchange rate whereas US & Japan preferFlexible exchange rates. Choice between two involves trade-off between national policy autonomy and international economicintegration


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Balance of Payments

Current Account

Capital Account Official Reserve Transactions


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Quick vocab review - BOPCredit : any money flowing into the country islisted on balance of payments as a credit

ExportsForeigners investing in domestic real or financialassets

Debit : any money flowing out of the country islisted on balance of payments as a debit

ImportsDomestic citizens investing in foreign real or financialassets


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International Finance

A country s b alance of payments summarizes alleconomic transactions that occur during a given timeperiod between residents of a country and residents

of other countries.Balance of payments statements measure a flow becausethey summarize transactions in a given time period (year).Transactions that don t involve money are included.(Example : Food sent by world hunger organizations would

be included.) Accounts are maintained according to double-entry bookkeeping. (Debits- payments from us to the rest of the world,Credits payments by the rest of the world to us


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C omponents of Balance of Payment Accounts

Current account balance : Balance on goods and services The section of acountry s balance of payments account that measures the difference in value between acountry s exports of goods and services and itsimports of goods and services. (Includes incomeearned from foreign assets owned by Indiansminus income earned from India s assets ownedabroad.)Unilateral transfers payments of gifts and grantsamong countries (India has negative net unilateraltransfers since World War II)


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Implications of C urrent Account

Deficit (i.e. trade deficit)Is a trade deficit financed by a capitalaccounts surplus bad?

The trade deficit as an automaticstabilizerHow could the trade deficit beremoved?

Exchange rate devaluationEconomic recession


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Current account Includes all transactions involving goodsand services, as well as transfersbetween residents of different countriesHere, India typically runs deficit

Exports < imports (deficit)

Net unilateral transfers mostly deficit


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C omponents of Balance of

Payment Accounts (cont.)Capital account The record of a country sinternational transactions involving purchases orsales of financial and real assets (borrowing, lending,and investments).Official reserve transactions account The section of a country s balance-of-payments account that reflectsthe flow of gold, Special Drawing Rights, and

currencies among central banks A negative current account will be offset by a positivecapital account if exchange rates are flexible (nointervention of official reserves)


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Capital account Calculates foreign investment

Foreigners purchases of India s financialassets or real assets (India credit)India purchase of foreign financial assetsor real assets (India debit)


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Exchange Rate History

Gold Standard

Bretton WoodsInternational Monetary Fund


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G old standardCurrency of each country could beredeemed directly for a fixed amount of gold

Problems with commodity money : subject to forces of supply and demand

New gold discoveries caused inflationCountry s money supply strongly affectedby its international balance of payments


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Bretton WoodsForeign currencies were linked to U.S.dollar for exchange ratesU.S. dollar was fixed to goldForeign currencies could be exchangedto dollars, which could then be

exchanged for goldCreation of the International MonetaryFund (IMF)


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Currency appreciationIf U.S. $ appreciates relative to theGerman mark, 1 $ will now buy moremarks, or it will take more marks toexchange for 1 U.S. dollar

Originally : 1 $ = 2.2965 G erman marks1 G erman mark = 0.4355 U.S. $

After $ appreciation : 1 $ = 2.50 G ermanmarks1 G erman mark = 0.40 U.S. $


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Currency depreciationIf U.S. $ depreciates relative to theGerman mark, 1 $ will now buy fewermarks, or it will take less marks toexchange for 1 U.S. dollar

Originally : 1 $ = 2.2965 G erman marks1 G erman mark = 0.4355 U.S. $

After $ depreciation : 1 $ = 2.00 G ermanmarks1 G erman mark = 0.50 U.S. $


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Other terminologyCurrency devaluation : foreign exchangebecomes more expensive; domesticcurrency becomes weaker (relative toother currencies)Currency revaluation : foreign exchange

becomes less expensive; domesticcurrency becomes stronger (relative toother currencies)


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Relationship Between TradeBalance and Currency Value

How does an appreciation or

depreciation of the dollar affect our imports and exports?


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Net export function - Holds constant Home Country price levelPrice levels in foreign countriesHome Country interest ratesInterest rates in foreign countriesForeign income levels

U.S. dollar/INR exchange rates


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Indian interest ratesCapital account includes purchase of both financial and real assets

Increase in Indian interest rates relative tointerest rates in other countries makeinvestment in India relatively moreattractive to foreign investorsThis is counted as a credit for the Indiacapital account


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Interest rates in foreign

countriesRemember that capital account does includefinancial (interest earning) assets

Increase in interest rates in foreign countriesrelative to interest rates in India makes foreigninvestment relatively more attractive to foreignand domestic investors

India investors to send money abroadThis is counted as a debit for the India capitalaccount


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Foreign income levelsIncrease in income will increase demand

This does not only increases demand for domestic

goods and services, but also for foreign goods andservices (imports)This will potentially increase India exports

A decrease in income (in foreign countries)

will reduce demand for goods and services(both domestic and imported)


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Currency depreciationINR now buys fewer units of a foreigncurrency

Indian goods now relatively less expensivefor foreigners, so exports increaseForeign goods now relatively moreexpensive for domestic consumers, so

imports decreaseIncreases India s net exports (exports imports)


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Purchasing Power Parity

What is the general idea?


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The general ideaThe exchange rate between 2 countries willadjust to reflect the differences in the price

levels between the 2 countries, so that thesame amount of money should allow you tobuy the same amount of goods / services ineither country

If a country has a high price level, its currency willbe cheaperIf a country has a low price level, its currency willbe more expensive


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The general idea (cont.)If a country has a high price level

Exports will fall (currency demand decreases)

Imports will rise (currency supply increases)Currency depreciates

If a country has a low price levelExports will rise (currency demand increases)Imports will fall (currency supply decreases)Currency appreciates


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Determinants of ForeignExchange Rate

Foreign exchange is needed to carry out foreigntransactionsThe exchange rate is the price of one country s

currency measured in terms of another country scurrencyCurrency depreciation lowers the price of yourcurrency to foreigners (and lowers the price of yourexports and raises the price of imports)Currency appreciation increases the price of yourcurrency to foreigners (and increases the price of your exports and lowers the price of imports)


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Flexi b le and Fixed Exchange

RatesFlexible exchange rates Rates determined by theforces of supply and demand without government intervention

Fixed exchange rates Rates pegged within a narrowrange of values by central banks ongoing purchasesand sales of currenciesThe Current System : Managed Float- an exchange

rate system that combines features of freely floatingrates with intervention by central banks (to moderatefluctuations in exchange rates).The ideal system would foster international trade,lower inflation, and promote a more stable economy.


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The For eign Exc hange Ma rk etThe F unctions & Structure of the F orex MarketF oreign ExchangeTypes of TransactionsThe Spot Market

Spot Rate QuotationsThe Bid-Ask SpreadSpot F X TradingCross Exchange Rate QuotationsArbitrageSpot F oreign Exchange Market Microstructure

The F orward MarketSettlement Dates

Quotes for Various Kinds of Merchant TransactionsThe Indian ScenarioConvertibility, Exchange ControlThe F EDAI Rules Regarding Inter-bank DealingsF orex Dealing Room Operations


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S truc tur e of the For ex Ma rk etDecentralized, over-the-counter market, also known

as the 'interbank' market

Main participants: Central Banks, commercial andinvestment banks, hedge funds, pension funds,corporations & private speculatorsThe free-floating currency system began in 1973,and was officially mandated in 1978Online trading began in the mid to late 1990's


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S truc tur e of the For ex Ma rk etT r ading H ours

24 hour marketSunday 5pm EST through F riday 4pm EST. Rollover at 5pm ESTTrading begins in New Zealand, followed by Australia, Asia, theMiddle East, Europe, and America

S izeLargest market in the world$ 2 trillion average daily turnover, equivalent to:15 times the average daily turnover of global equity markets

Nearly 50 times the average daily turnover of the NYSE

The spot market accounts for about one-third of daily turnover


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S truc tur e of the For ex Ma rk etMaj or Ma rk et s

The US & UK account for more than 50% of turnover Major markets: London, New York, Tokyo

Trading activity is heaviest when major markets overlap Nearly two-thirds of NY activity occurs in the morning hourswhile European markets are open

T r adingAn estimated 95% of transactions are speculative

More than 40% of trades last less than two daysAbout 80% of trades last less than one week Brokers research: 90% of traders lose money, 5% break even, 5%make money


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S t ruc tur e of the For ex Ma rk et -

Cou nt ry wi se t ur noverCurrency Percentage ShareUSD 88.7EURO 37.2JPY 20.3GBP 16.9CHF 6.1AUD 5.5CAD 4.2Others 21.1Total 200.0


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S t ruc tur e of the For ex Ma rk et -

Cou nt ry Pai r -wi se t ur noverCurrency Percentage Share

EURO/USD 28

USD/JPY 17GBP/USD 14

AUD/USD 5USD/CH F 4

USD/ CAD 4EURO/JPY 3

Others 25Total 100


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A rou nd-the- clock FX tr ading

0

5,000

10,000

15,000

20,000

25,000

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Aver age El ectro ni c Co nvers ions Pe r H our

Gr eenwi ch Mean Time

Tokyoopens

Asiaclosing

10 AMIn Tokyo

Afternoonin America

Londonclosing

6 pmIn NY

Americasopen

Europeopening

LunchIn Tokyo


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W orld FX transactions

USD 2 trillion per day

spot33%

forward11%gap

6%

FX sw aps50%


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FX ma rk et in the U. S . is the m ost

acti ve ma rk et in the U. S600 billion turnover per day , in 2006Comparisons with U.S. asset markets:

10 times the turnover of U.S. govt. bonds 50 times the turnover of NYSE stocks

Comparisons with real activity in U.S.: 10 times U.S. daily GDP 30 times U.S. daily exports + imports


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P r ima ry fu nctions of FX Ma rk etCurrency conversions associated withinternational payments processProvision of credit to clients(also part of international payments process)Managing exchange rate risk


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S t ruc tur e of FX Ma rk et ( r etai l level)

Interbank mkt($/INR or F C)

domestic ($/INR) foreign ( F C)

Exchange-tradedfutures & options (notIn India)

central bank

firms

investors

for. firms

for. central bank

for. investors


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S t ruc tur e of FX Ma rk et: inte rb an k

(wh olesa le) levelBanks trade with each other

in response to the retail orders they receive to manage their own accounts

Banks trade directly with other banks indirectly through F X brokers


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FX ma rk et

dom. bank

Corp.order for.

bank

dom. bank

for. bank

F X broker

Corp.order

Corp.order

Corp.order

domestic($/INR)

foreign(F C)

$/INR or /FC


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D ir ect vs. brok er ed inte rb an k tr ade sD ir ect dea lingBanks face another banks bid-ask spread, at which they can transactimmediatelyB rok er ed t r ade sGet best price of all posted buys/sells 56% of all dealers trades are with other dealers 31% are with other financial institutions

(brokers, mutual funds, ...) 13% are with non-financial customers

66% of all trades are with foreign counterpartiesMuch (56%) of F X trading is in the interbank (wholesale) market


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However, the retail orders are the important onesthat determine exchange rates

Interbank traders are intermediaries(market makers)

temporarily take positions intra-daily, butwork hard to zero out their positions regularlyand by the end of the day


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FO R EX Ma rk et Pa r ticipant sThe F OREX market is a two-tiered market:

Interbank Market (Wholesale)About 700 banks worldwide stand ready to make a market inF oreign exchange.

Nonbank dealers account for about 20% of the market.There are F X brokers who match buy and sell orders but do notcarry inventory and F X specialists.

Client Market (Retail)Market participants include international banks, their customers,nonbank dealers, F OREX brokers, and central banks.


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Corr espondent Ban k ing Re lati onship sLarge commercial banks maintain demand depositaccounts with one another which facilitates the efficientfunctioning of the forex market.

International commercial banks communicate with oneanother with:

SWI F T: The S ociety for W orldwide I nterbank F inancial T elecommunications.CHIPS: C learing H ouse I nterbank P ayments S ystemECHO E xchange C learing H ouse L imited, the firstglobal clearinghouse for settling interbank F OREXtransactions.


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FOREIG N EXCHANG E MARKETPRICES AND NEWS - LI F E BLOOD

FI R E - LITTLE IS GOOD BUT MUCH IS BAD

MARKET MOVERSTRADERS

HEDGERSARBITRAGERSSPECULATORS


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G LOBAL MARKET MOVERSOIL PRICES

GROUP O F SEVEN G 7

GLOBAL STOCK MARKETS {DOW JONES, NIKKEI,HANG SENG, F TSE, DAX 30, BSE, NSE, OTC}

BALANCE O F TRADE

WAR OR THREAT O F WAR

VALUE O F DOLLAR


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PEOPLE MARKET MOVERSPRESIDENT O F U.S.

CHAIRMAN O F F EDERAL RESERVE

PRIME MINISTER O F U.K.

CHANCELLOR O F EXCHEQUER

INDIAN P.M / F .M / RBI GOVERNOR

ECB PRESIDENT

SUMMIT/TRADE TALKS


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MONETARY AND FINANCIAL MARKET

MOVERSINTEREST RATES

SHORT TERM/LONG TERMYIELD CURVEBASE RATEF ED F UNDS RATE/DISCOUNT RATE

INF LATION AND MONEY SUPPLYTOO MUCH O F MONEY CHASING TOO F EW GOODSOPEN MARKET OPERATIONSTAXATION - HIKES AND CUTS

LEADING INDICATORS


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SPECIAL FEATURES OF FX MKTMANAGED F LOATF LOW DRIVEN

TRADE F LOWSCAPITAL F LOWSOPTIONS HEDGING

REER / RBI EAR MONTH END SYNDROMEGLOBAL DOLLAR VALUEIMPACT O F US DATA RELEASEINF LUENCE O F NDF MARKET


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CAPITAL FLOWSF II F LOWS

FDI

FLOWS

F CCB / ECB F LOWS

NRI REMITTANCEF CNR(B) DEPOSITS

NRE RUPEE DEPOSITS REMITTANCES


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The Spot Ma rk etSpot Rate Quotations - SPOT USD INR, SPOT CROSSESThe Bid-Ask SpreadSpot F X tradingCross RatesSWAP USD INR POSITION TRADINGIN AND OUT TRADINGMARKET MAKERSMARKET USERSF UNDAMENTAL ANALYSISTECHNICAL ANALYSIS


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Spot Rate Q uo tati ons Spot Rate

Q uo tati onsDirect quotation

the U.S. dollar equivalent

e.g. a Japanese Yen is worth about a penny =$.01/yen

Indirect Quotation

the price of a U.S. dollar in the foreign currency= Y100/$e.g. you get 100 yen to the dollar


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Spot Rate Quotations

The dir ect quote for British poundis:

1 = $1.5627

Country

USDequivFriday

USD equivThursday

Currency perUSD Friday

Currency perUSD Thursday

Argentina(Peso) 0.3309 0.3292 3.0221 3.0377

Australia(Dollar) 0.5906 0.5934 1.6932 1.6852

Brazil (Real) 0.2939 0.2879 3.4025 3.4734

Britain (Pound) 1.5627 1.566 0.6399 0.6386

1 MonthForward 1.5596 1.5629 0.6412 0.6398

3 MonthsForward 1.5535 1.5568 0.6437 0.6423

6 MonthsForward 1.5445 1.5477 0.6475 0.6461

Canada (Dollar) 0.6692 0.6751 1.4943 1.4813

1 Month

Forward 0.6681 0.6741 1.4968 1.4835


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Spot Rate Quotations

Note that the

direct quoteis thereciprocal of the indirectquote:

6399.15627.1 !

1.49751.51060.66780.6626 MonthsForward

1.48881.5020.67170.66583 MonthsForward

1.48351.49680.67410.66811 Month Forward

1.48131.49430.67510.6692Canada (Dollar)

0.64610.64751.54771.54456 MonthsForward

0.64230.64371.55681.55353 MonthsForward

0.63980.64121.56291.55961 Month Forward

0.63860.63991.5661.5627Britain (Pound)

3.47343.40250.28790.2939Brazil (Real)

1.68521.69320.59340.5906 Australia (Dollar)

3.03773.02210.32920.3309 Argentina (Peso)



USD equivThursday

USD equivFridayCountry


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The B id- Ask Sp r eadThe Bid price is the price a dealer is willingto pay for a currency

The Ask price is the amount the dealer offers to sell you a currency. Its the pricethe dealer wants for the sale of currency

Bid-Ask Spread = [Ask price - Bid price] >0


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Spot FX tr adingIn the interbank market, the standard sizetrade is about U.S. $10 million.

A bank trading room is a noisy, active place.The stakes are high.

The long term is about 10 minutes


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Spot For eign Exc hange Mi cros truc tur e

Market Mi cros truc tur e are the mechanics of how amarketplace operates.Spot mkt Bid-Ask spreads in the:

increase with F X exchange rate volatility anddecrease with dealer competition.

Private information is an important determinant of spotexchange rates. - Mkt adjusts to econ info in 1min.- 1/3 of traders claim adjustment < 10 sec- Central bank intervention does not work; it increasevolatility.


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The For wa r d Ma rk etF orward Rate QuotationsLong and Short F orward PositionsF orward Cross Exchange RatesSwap TransactionsF orward PremiumA forward contract is an agreement to buy or sellan asset in the future at prices agreed upon today .

If you have ever had to order an out-of-stock textbook, then you have entered into a forwardcontract.


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For wa r d Rate Q uo tati onsThe forward market for F OREX involvesagreements to buy and sell foreign currencies in

the future at prices agreed upon today.Bank quotes for 1, 3, 6, 9, and 12 month maturitiesare readily available for forward contracts.Longer-term swaps are available.


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Q uo tati ons

Clearly themarket

participantsexpect that the

pound will beworth l ess indollars in sixmonths.

1.49751.51060.66780.6626 MonthsForward

1.48881.5020.67170.66583 MonthsForward

1.48351.49680.67410.66811 Month Forward

1.48131.49430.67510.6692Canada (Dollar)

0.64610.64751.54771.54456 MonthsForward

0.64230.64371.55681.55353 MonthsForward

0.63980.64121.56291.55961 Month Forward

0.63860.63991.5661.5627Britain (Pound)

3.47343.40250.28790.2939Brazil (Real)

1.68521.69320.59340.5906 Australia (Dollar)

3.03773.02210.32920.3309 Argentina (Peso)



USD equivThursday

USD equivFridayCountry


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For wa r d Rate Q uo tati ons

Consider the example from above:

for GBP, the spot rate is$1.5627 = 1.00While the 180-day forward rate is

$1.5445 = 1.00Whats up with that?


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L ong and Shor t For wa r d P ositi ons

If you have agreed to sell anything (spot or forward), you are short .

If you have agreed to buy anything (forward or spot), you are long .If you have agreed to sell F X forward, you areshort.If you have agreed to buy F X forward, you arelong.


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SWA P S/ For wa r d P r emi umA swap is an agreement to provide a counterparty with

something he wants in exchange for something that

you want.Swap transactions account for approximately 56 percent of interbank F X trading,whereas outright trades are 11 percent.

F orward Premium is just the interest rate differential

implied by forward premium or discount.


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Co nver ti b ilit y-Def initi on

Government restrictions can often result in acurrency with a low convertibility. F or example, agovernment with low reserves of hard foreigncurrency often restrict currency convertibility

because the government would not be in a positionto intervene in the foreign exchange market (i.e.revalue, devalue) to support their own currency if and when necessary


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R upee Co nver ti b ilit y

The Indian Rupee is1) for all intents and purposes, fully Convertible tothe US$ on the Trade Account and Current

Account. This means Indians can buy US$ for their Trade, Travel, F ees, Education, Interest,Dividend payments etc. US Dollars can also beconverted into Rupees

2) largely, NOT convertible to US$ on the CapitalAccount, especially when the flow of capital isfrom India to outside.


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R upee Co nver ti b ilit y

However, degrees of convertibility have been brought in. F or instance,

- Indian companies can invest in/ set upsubsidiaries abroad. Limits are placed on theamount of investment- Indian mutual funds, since last year, have beenallowed to invest in overseas markets, though we

doubt if activity has picked up on this front- Dividend and Interest payments to investorsabroad are unhindered


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R upee Co nver ti b ilit yF low of Capital from outside India (investments into India) areunencumbered from the "convertibility" point of view.

Investors may need to garner various necessary permissions asrequired to invest in the equity market, debt market or to set upgreenfield projects or buy over existing companies. These are,essentially, outside the ambit of "convertibility"Indian Rupee is not legally pegged to the Dollar. It is markettraded currency, though the trading itself is controlled byvarious measures. Technically, the Indian Rupee is in a"Managed F loat" or "Dirty F loat", like the Yen.


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Exc hange Co nt rolIntroduced during post-WW II periodMore stringent in post-independence eraF ERA 1948, MORE powers in 1973( Rigid import controls, highest duties, industrial policytowards import substitution, foreign investment discouragedetc. C L O SE D ECO NO MY )

1991 BOP crisis Policy shiftsAugust 1994Current account convertibility1999 F EMA


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For ex Dea ling R oom O pe r ati ons

Objectives of Dealing RoomAffording the best possible customer serviceManaging the banks foreign currency exposures

Generating profit for the bank Ensuring the compliance of relevant regulations

ParticipantsOrganizations

Commercial banksCentral banking authorityBrokers


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Indian RegulationsBrokers role is to bring market participants togetherBrokers do not buy or sell on their own account Brokers not allowed to as principals or maintaining foreigncurrenciesBrokers notes to be received promptly and acted upon on thesame day by dealers

Nominations of deals not done by them not permittedSpread of brokersDuty separation for dealers


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Dealing Process

Customer Bank BranchDealingRoom

Front Office

Mid-Office

Back Office

Domestic market

G lobal Market

Front Office: Actual dealingMid-Office: Riskmanagement,accounting and MISBack Office: Settlement,Reconciliation, complianceand accounting


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Regulatory RequirementsDaily F x turnover and Gaps position and Cash BalanceMonthly statement in USD denomination

Gap Limits, Aggregate gap limit (AGL) approvedMaximum AGL on any dayVaR approvedMaximum VaR on any day during the monthTRADING LIMITSDAYLIGHT LIMITSOVERNIGHT LIMITSSTOP LOSS LIMITS

CREATING AND MONITORING MISMATCHESEXPORT AND IMPORT TRANSACTIONSGENUINE MISMATCHESDELIBERATE MISMATCHES


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F ront Office: Confirmation, stamped agreement, P/Levaluation monthly report, gold and recordmaintenancePolicy prescriptions

Strategy formulationConcentration limits

Risk processesTask delineationInternal accounting/reportingSecrecy issues


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Managing Ri sksOpen positionMaturitymismatch

Credit risk OperationalRisk Legal Risk

SovereignRisks

Day light over night and cu t lossIG L, M onth ly L imit s, AG L, et c.

Cou nt ry /grou p , curr en cy limit sDuty segr egati on , proc esses, et c

Re sponsib ilit y f ixati on , su pp or ts, et c.Ex te r na l data , m onit or ing , et c.

Rate Me chani sm


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Transaction Buying Selling

Spot TT Base 48.5500Less [email protected]% 0.0380Spot TT 48.5120

Base 48.7000Add [email protected]% 0.0731Spot TT 48.7731

F orward TT Base 48.5500Add Premium 0.1500Less [email protected]% 0.0389F orward 48.6611

Base 48.7000Add Premium 0.2000Add [email protected]% 0.0734F orward 48.9734

Bill Base 48.5500Premium 0.4000

Less [email protected]% 0.0734Bill 48.8766

Base 48.7000Add [email protected]% 0.0731

Add [email protected]% 0.0975Bill 48.8706

TC Base 48.7500Less Margin@1% 0.4875TC 48.2625

TT Selling 48.7641Add [email protected]% 0.2438Add Commission@1% 0.4900

TC 49.4979


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MANAGING FOREX TRADING DESK

ANALYSING AND INTERPRETING THE DATADATA IN LINE WITH THE MARKET EXPECTATIONHOW MUCH IS ALREADY DISCOUNTED?

NO REACTIONF

ROM THE MARKET PRICED INDATA GOOD OR BADARE THERE ANY SEASONAL ADJUSTMENTS?ECONOMIC DATA VIZ., INDUSTRIAL PRODUCTION,EXPORT AND IMPORT, MONEY SUPPLY, RETAIL SALESMAY BE IN F LUENCED BY SEASONAL F ACTORS


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MANAGING FOREX TRADING DESK

RIF LE APPROACHR - READ

I INTERPRETF F ORM THE VIEWL GO LONG OR SHORT

E EXIT AT THE OPPORTUNE OR APPROPRIATE TIME


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INR DISCOUNT & PREMIUMIN THE INDIAN F OREX MARKET F ORWARD DI FFF ERENTIAL

NOT LINKED TO THE INTEREST RATE DI FF ERENTIALMULTIPLICITY O F INTEREST RATESADMINISTERED INTEREST RATESRESTRICTIVE MONEY MARKET CONDITIONS

DEMAND AND SUPPLY F ACTORS DOMINATEPERCEPTION O F THE CURRENCY DEPRECIATION OR APPRECIATION O F INR CENTRAL BANKS PARTICIPATIONMONEY MARKET CONDITIONS ADVANCE TAX OUTL F OWS,F CNR(B), EE F C AND ECB F UNDS

MONETARY ANDF

ISCAL POLICYINF LUENCE O F NDF MARKET


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MANAGING FOREX TRADING DESKSOME TRADING MAXIMSWHEN YOU HAVE A POSITION F ORGET YOUR EMOTIONSTREND IS YOUR F RIEND DONT F IGHT THE TREND

CONTRARIAN VIEW MAY WIN BUT NOT ALWAYSTHE F EAR O F LOSS IS MORE THAN THE LOSSWHEN IN DOUBT GET OUTWHEN THE ONLY THING LE F T IS HOPE YOU ARE SITTINGWITH THE WRONG POSITION

TRADING DISCPLINE IS NOT ONLY IN CUTTING LOSSESBUT ALSO IN TAKING PRO F ITSTHERE IS MORE TO LI F E THAN TRADING


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F EMA ACT 1999 Defines F oreign Exchange as F oreign Exchange means &includes:

a) All deposits, credits and balances payable in foreign currency, and anydrafts, travellers cheques, letters of creditand bills of exchange, expressed or drawn in Indian currency and payable inany foreign currency.

b) Any instrument payable at the option of the drawee or holder, thereof or any other

party thereto, either in Indian currency or inforeign currency, or partly in one and partly inthe other.


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FX RatesWhat is Exchange Rate ?Exchange Rate is a rate at which one currency can

be exchanged into another currency. In other words it is value one currency in terms of other.say:

US $ 1 = Rs.45.18This rate is the conversion rate of every US $ 1 toRs. 45.18

F t D t i i g E h g


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Factors Determining Exchange

Rates(a ). Fu ndamenta l Rea sons:

- Ba lan ce of Pa yment sur p lus lead s to stro nge r curr en cy.- Eco nomi c Gro wth Rate s High/ L ow g ro wth r ate.- F isca l / M oneta ry Policy- de f icit f inan cing lead s to dep r eciati on of curr en cy.- Inte r est Rate s curr en cy with highe r inte r est wi ll app r eciate in the shor tte r m.- P oliti ca l Issu es P oliti ca l sta b ility lead s to sta bl e r ate s

(b) . Te chni ca l Rea sons- Gov er nment Co nt rol can lead t o un r ea listi c va lu e.- Fr ee flo w of C apita l fro m lowe r inte r est r ate t o highe r

inte r est r ate s.(c). Spe cul ati on highe r the spe cul ati on highe r the vol ati lity in r ate s(d ) Developments a b road

Methods of Quotation


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Methods of Quotation

Method IOne Orange = Rs 2One Apple = Rs 2.50

Method IIRs. 10 = 5 OrangesRs. 10 = 4 Apples

Price under b oth the methods is the same though expressed differentlyPrice under b oth the methods is the same though expressed differently

MethodMethod - - IIDIRE CT (F C fixed)DIRE CT (F C fixed)USD 1 = Rs 45.18USD 1 = Rs 45.18GBP 1 = Rs.85.99GBP 1 = Rs.85.99EUR 1 = Rs 57.92EUR 1 = Rs 57.92

MethodMethod - - IIIIINDIRE CT ( H C fixed)INDIRE CT ( H C fixed)Rs 100 = USD 2.2133Rs 100 = USD 2.2133Rs 100 = GBP 1.1629Rs 100 = GBP 1.1629Rs 100 = EUR 1.7265Rs 100 = EUR 1.7265

W ith Effect from 02.08.1993, all exchanges are quoted in DirectMethod


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Understanding Tw o W ay Exchange Quotes

In Forex markets , there are t w o w ayquotes i.e. b oth b uying and sellingrates are given.1 USD = INR 45.16/ 18BUYING RATE $/RE = RE 45.16SELLING RATE $/RE = RE 45.18

In the a bov ementi oned q uo te ,lowe st i s ma rk et buy ing r ate and highe st i s ma rk et selling r ate .

Understanding Two Way Exchange Quotes


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Understanding Two Way Exchange Quotes

B U Y I N G R A T E

C H F 1 .2 5 7 0

S E L L I N G R A T E

C H F 1 . 2 5 7 3

U S D 1 = C H F 1 . 2 5 7 0 / 7 3

O ne of the f eat ur es of the FX ma rk et s is that thi s is the

nea r est for m of pe rf ect ma rk et s existing t oda y.

O ne of the r ea sons wh y thi s is so is that p r ices a r e a lwa ysQ uo ted a s T W O WA Y QU O T E S

U d di E h R


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Unde rs tanding Exc hange Rate s

Dollar/Swiss F rancs -- USD/CH F Note the order of the currenciesUSD comes before the CH F

The first currency($) - Base currencySecond currency (CH F ) - Terms currency

It is important to remember that Bid & Offer intrading always refers to the BASE CURRENCY .

Understanding Exchange Quotes


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In the F X market, Time is of great importance.

Therefore, there are short forms for everything.While quoting, the dealers use only the third & fourthdecimals.USD/CH F 1.2540 / 45USD/INR 45.1675 / 00GBP/USD 1.8000 / 10

BIG F IGURE

In a live dealing scenario dealers would quote only40/45 , 75/figure , figure/10 and the market assumesthat all players already know the BI G FIG URE


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Calculating Cross RatesIndia i s a ma rk et ma k er for Indian R upeeDoll a r / R upee t r ading ( the f irs t q uo te s) sta r t in the M um bai Ma rk etBUT W H AT AB O UT O TH E R C URR E NC IE S ?W H E R E DO R AT E S FO R C H F , G BP , E UR E T C CO M E FR O M? H O W AR E TH E Y C AL C ULA T E D?

A C H F/RUP EE R AT E IS A C R O SS OF DO LLA R/RUP EE & DO LLA R /C H F.DO LLA R / RUP EE = . /

DO LLA R / C H F = . /

C H F / RUP EE = . /In othe r wor ds, . / . = . AND45 . 5 / . 445 = .


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Calculating Cross RatesIndia i s a ma rk et ma k er for Indian R upeeDoll a r / R upee t r ading ( the f irs t q uo te s) sta r t in the M um bai Ma rk etBUT W H AT AB O UT O TH E R C URR E NC IE S ?W H E R E DO R AT E S FO R C H F , G BP , E UR E T C CO M E FR O M? H O W AR E TH E Y C AL C ULA T E D?

A C H F/RUP EE R AT E IS A C R O SS OF DO LLA R/RUP EE & DO LLA R /C H F.DO LLA R / RUP EE = 45 . /

DO LLA R / C H F = . 570 / 73

C H F / RUP EE = 35 . / 4In othe r wor ds, 45 . / . 570 = 35 . AND45 . / .. 573 = 35 . 4


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Forex market conventionsStandard nomenclaturesConcept of value date

Dealing and settlement locationsStandard ways of quoting

Direct QuoteIndirect QuoteExchange rate quote is always given as a number of units of the quoted currency per unit of the basecurrency eg. USD/INR


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Forex market conventions-contdExample of a Standard Quotation

USD/CH F Spot: 1.4550/1.4560

The left-side price is the bid i.e the dealer will buy 1USD and the bid rate for USD is CH F 1.4550. Hisoffer or ask rate for one USD is CH F 1.4560 i.e hewould be paid CH F 1.4560 for 1 USD sold.

F or most currencies quotations the base currencyis the dollar. The major exceptions areEUR,GBP,AUD and NZD


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Types of transactionsReady or Cash value todayTomorrow or tom-value tomorrow

Spot transactions two business days after trade dateF orward transactions- any value date

beyond spotSwap transaction combination of spot andforward


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Types of Transaction: Value Date ConceptDue to vastness of the market and origin of transactions and settlements may take

place at different time zones, most of times deal dates and settlement datediffers. Market uses different terminology which are used universally to avoidconflict.

T ype of T XN Date of Dea l Valu e Date

C ash/Read y 15 .11 . 006 15 .112 006W edne sda y W edne sda y

T O M 15 .11 .2006 16 .11 .06W edne sda y Th urs da y

Spot 15 .11 .2006 17 .11 .06W edne sda y Fr ida y

For wa r d 15 .11 .2006 A ny da y af te r 17.11 .06W edne sda y


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Types of Transaction: Value Date ConceptDue to vastness of the market and origin of transactions and settlements may take placeat different time zones, most of times deal dates and settlement date differs. Market usesdifferent terminology which are used universally to avoid conflict

Type of TXN Date of Deal Value DateCash/Ready 17.11.06 17.11.06

F riday F ridayTOM 17.11.06 20.11.06

F riday MondaySpot 17.11.06 21.11.06

F riday Tuesday

F orward 17.11.06 Any day after F riday 21.11.06


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Forward RatesWhat is a F orward Rate ?Rate agreed for settlement on an agreed date in thefutureAll rates are derived from Spot ratesF orward rate is the spot rate adjusted for the

premium / discount

F orward Rate = Spot Rate + / - premium or discount


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Premium/Discount F orward price = Spot price plus or minus forwardmargin.Premium forward value of currency is higher than spot rate. A currency with lower rate of interest is said to be at premium in the forwards.F orward margins added to spot rate.Discount forward value of currency is lower than spot rate. A currency with higher rate of interest is said to be at discount. F orward marginsdeducted from spot rate


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Derivative InstrumentsDerivatives instruments are management toolsderived from underlying exposures (Assets) suchas Currency, Commodities, Shares, Bonds or anyother indices, used to reduce or neutralize theexposure on the underlying contracts.Derivatives could be Over the Counter (OTC) i.e.

made to order or Exchange Traded F acilitieswhich are standardized in terms of quantity,quality, start & ending dates .


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What is an FX OptionAn F X option contract gives the buyer (or holder) theright, but not the obligation, to:

Buy R upee s, in the case of a R upee ca ll/ Dolla r pu t opti on ,again st D ollars (or s ell R upee s again st Dolla rs in the case of aR upee p u t/D olla r c a ll o pti on );For a p r edete r mined q uantit y of R upee s;A t a p r edete r mined f ixed p r ice (the str ik e or exerc ise p r ice);O n (i f Euro pean style) o r u nti l (if Ame r ican style) a f ixedfu tur e date ;

For a p r emi um ( opti on p r ice) neg otiated at the time of dea ling .

H d FX O ti Diff f


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How does an FX Option Differ from a

ForwardConsider an exporter who expects to receive $1MN in 3months.The exporter can go in for

F orward contract or Option contractF orward contract performance is obligatory on the

for buyer and seller.*Option contract performance is not obligatory for for option holder.

Suppose , exporter goes for option contract. He will agree to sell$1 mn after 3 months. On due date, depending upon $/RE r ate , hewi ll de cide t o exerc ise the opti on or not .

International Finance-Nijay Gupta

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