International finance

            I. Why International Financial Management?

1.      globalization

Implication of globalization

·         Companies to become globally competitive

·         Firms should understand the complexities of markets and economies

·         The firms should be able to anticipate international events like recession and its impact on the firm thus enabling the firm to “Maximize profits from opportunities and minimize losses from events”

2.      Integration of financial markets

Integration of financial markets mean

·         Freedom and opportunity to raise funds from and to invest anywhere in the world

·         Through any type of investment

·         The degree of freedom differs across countries but the trend is towards giving more freedom

·         Anything happening anywhere in the world affects the other countries due to “TRANSMISSION EFFECT”

·         Greater the integration, stronger the effect

Reasons for integration

·         Improvement in technology

·         Increase in inflation levels making financial assets more dearer ie the interest yield tends to increase with inflation levels

·         Liberalization

·         Increase in penetration of foreign ownership

·         Benefits of integration

·         Faster transfer of resources from surplus to deficit

·         Quicker cashing in on the opportunities with high yield

·         Better consumption pattern for all people

·         Government too gets funds for investment

·         Risk very well diversified

3.      Companies becoming International

More and more companies are becoming international and those companies that are already into international business are expanding to more countries, because of liberalization and globalization. Thus the firms in order to  be successful, need to understand the global events and markets more precisely to reap profits.

II How does IFM help firms?

1.      The scope of IFM includes the following, thus enabling the firms to beat the competition arising in a globalized world.

2.      Scope of IFM – Forex risks and political risks

-          Expanded opportunity sets

-          Market Imperfections – ( Trade barriers including legal restriction, excessive transaction cost, information asymmetry, discriminatory taxation ) because of which MNCs have production facilities overseas.

           New Trends in Global economy

·         Emergence of Globalized financial markets

·         Emergence of Euro as a global currency

·         Trade liberalization and economic integration

·         Large scale privatization

INTERNATIONAL MONETARY SYSTEM

            International business transactions create obligations which have to be settled through money

            A payment system for settling international financial obligations involving different currencies, is needed for smooth functioning of the global economic system, this is known as International Monetary System.

Main aim of international Monetary system is to maintain stability in the exchange rate and to promote free flow of trade and finance

IMF – International Monetary Fund, IBRD or World Bank, International Development Association, Multilateral Investment Guarantee Agency, IFC, Interntional Centre for Settlement of Investment Disputes (ICSID) ,ADB are some of the funding and multilateral agencies in the world.

International Monetary system of the past

Self Sufficiency Stage

Barter System

Bi –Metallism

Gold Standard

Gold Exchange

Fixed Exchange rate system

Bretton Woods Agreement

Flexible Exchange Rate system

Different Exchange Rate systems

Broadly classified in to three – Fixed, Float, Hybrid

Under Fixed Exchange rate system – Currency Board, Target Zone Arrangement, Monetary Union,

Under Flexible Exchange rate system – Managed /dirty float and Free float

Under Hybrid – Crawling Peg

REFER : Eprahim Clark

BALANCE OF PAYMENTS

• Summarized record of different types of economic transactions that had occurred during a specified period (usually an accounting year) between the residents of a country and rest of the world.
• It is also known as the summary of international transactions
• It shows the balance of international payments
• It has two sub-accounts namely Current Account and Capital Account

Current account

Summary of flow output of funds between one specified country and all other countries due to the purchase of goods and services or the provisions of income on financial assets.

            Capital Account

Represents a summary of the flow of funds resulting from the sale of assets between one specified country and all other countries over a specified period of time

For ruling refer IFM by Kevin

FOREIGN EXCHANGE MARKET AND MECHANISMS

1. The exchange rate between two currencies is the number of units of one currency per unit of the other currency
2. it is the ratio of exchange between the two currencies
3. the expression of this ratio or the rate of exchange is known as the foreign exchange quotation

There are two types of quotations

1. Direct and Indirect

Direct method expresses the number of units of home currency required to buy one unit of foreign currency

Indirect quote expresses the number of foreign currency required to buy one unit of home currency

2. The exchange rate is expressed upto four decimals in India and the last decimal is known as points

If ER moves from 46.5125 to 46.5128 then the rate is said to have moved by 3 points

3. Bid and Offer rate

Foreign exchange dealers usually quote 2 prices, one for buying and the other for selling. The buying rate is known as Bid rate and the selling rate is known as offer rate

The difference between the offer rate and the bid rate is called as Bid-offer Spread

Spread Percentage = ((Ask- Bid) / Ask ) * 100

4. Spot and forward Rates and markets

Spot market is a place where the transactions are settled immediately or after 2 days. The date on which it is settled is called as Value date

Spot can be either spot, cash or Tom. In tom contracts, the value date is tomorrow, and in cash transactions, value date happens to the same date

In forward market, parties enter into answer forward forex contract. A Forward foreign Exchange contract is an agreement between two parties to exchange one currency for the other at some future date, with the Exchange rate, delivery date and the quantity being fixed at the time of agreement

Spot rate is determined in the spot market

5. Forward premium and forward discount

The difference between forward exchange rate and the spot exchange rate is called as forward rate differential

Example Spot rate = 1 USD  = Rs 46.28

      3 month forward = 1 USD = Rs 46.40

Here the Forward rate > Sport rate, so more INR is required to buy USD, so USD is said to have appreciated and INR is said to have depreciated

Forward Premium (discount) = (n day forward rate- spot rate ) / (Spot Rate ) ) * 360 /n

When less quantity of INR (Home currency ) is required to buy 1 USD (foreign currency) then the home currency is said to trade at a forward discount

6. Forward rate Quotations

Spot Rate and Forward Rate differentials are quoted separately.

Forward Premium points have to be added to the spot rate to calculate the forward rate and

Forward discount points is to be deducted from the spot rate to calculate the forward rate

7. Cross rates

1. Exchange rates need not be available for all the currencies due to limited demand
2. in such cases, home currency should be first converted into foreign currency and then it is converted into the desired currency

1 USD = Rs 40/.30

1USD = Can$ 0.76/0.78

Ask rate for Can$/INR = RS 40.30 / Can$ 0.76  = Rs 53.03

Bid Rate for Can $ = Rs 40.00 / Can $ 0.78 = Rs 51.28

So 1 Can $  = Rs 51.28/53.03

8. American quote Vs European Quote

-          A quote can be classified into American or European if any one of the currency is in dollars,

-          AQ is the number of dollars expressed per unit of any other currency

-          EQ is the number of any other currency expressed in terms of unit of dollars

9. Inverse quote

-          For every quote (A/B) there is an inverse quote (B/A)

-          Where A is being bought and sold for currency Ball

-          Thus it is the reciprocal of the original quote

-          Euro /$ = 1.6688/1.6693

-          Then $/Euro = (1/1.6688 ) / (1/1.6693) or 0.5990/0.5992

         

10. Cross rate or Synthetic rate calculation formula

 A, B and C are three currencies

Then

Synthetic (A/C) quote (Bid) = A/B (bid) *  B/C (ask)

Synthetic (A/C) Ask quote = A/B (ask) * B/C (bid)

For inverse quotes

Synthetic (A/C) Bid = (A/B) Bid * 1 /  (B/C) ask

Synthetic (A/C) Ask = (A/B) Ask * 1 / (C/B) Bid

11. Participants in the market

Arbitrageurs

Speculators

Brokers

Dealers

Bankers – Market makers

Authorized money changers

Hedgers

9 Levels of Indian forex market

Wholesale or interbank market

Retail Market or Merchant market

12. Types of Account

Vostro

Nostro

Loro

13. FEDAI, FEMA , FERA, EEFC
14. Bill rates