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International finance
1.1.1. Meaning of International Finance
International finance is the branch of economics that studies the dynamics of exchange rates,
foreign investment, and how these affect international trade. It also studies international projects,
international investments and capital flows, and trade deficits. It includes the study of futures,
options and currency swaps. Together with international trade theory, international finance is also
a branch of international economics.
International finance is the examination of institutions, practices, and analysis of cash flows that
move from one country to another. There are several prominent distinctions between
international finance and its purely domestic counterpart, but the most important one is exchange
rate risk. Exchange rate risk refers to the uncertainty injected into any international financial
decision that results from changes in the price of one country's currency per unit of another
country's currency. Examples of other distinctions include the environment for direct foreign
investment, new risks resulting from changes in the political environment, and differential
taxation of assets and income.
1.1.2. Nature of International Finance
International finance is a distinct field of study and certain nature set it apart from other fields.
The important distinguishing nature of international finance is explained below
1) Foreign Exchange Risk: An understanding of foreign exchange risk is essential for managers
and investors in the modern day environment of unforeseen changes in foreign exchange
rates. In a domestic economy this risk is generally ignored because a single national currency
serves as the main medium of exchange within a country. When different national currencies
are exchanged for each other, there is a definite risk of volatility in foreign exchange rates.
The present International Monetary System set up is characterized by a mix of floating and
managed exchange rate policies adopted by each nation keeping in view its interests. In fact,
this variability of exchange rates is widely regarded as the most serious international financial
problem facing corporate managers and policy makers.
2) Political Risk: Another risk that firms may encounter in international finance is political risk.
Political risk ranges from the risk of loss (or gaih) from unforeseen government actions or
other events of a political character such as acts of terrorism to outright expropriation of
assets held by foreigners. MNC must assess the political risk not only in countries where it is
currently doing business but also where it expects to establish subsidiaries.
3) Expanded Opportunity Sets: When firms go global, they also tend to benefit from expanded
opportunities which are available now. They can raise funds in capital markets where cost of
capital is the lowest. In addition, firms can also gain from greater economies of scale when they
operate on a global basis
4) Market Imperfections: The final feature of international finance that distinguishes it from
domestic]
lntri
finance is that world markets today are highly imperfect. There-are profound differences
among nations] laws, tax systems, business practices and general cultural
environments. Imperfections in the world]
. financial markets tend to restrict the extent to which investors can diversify their portfolio.
Though there are | risks and costs in coping with these market imperfections, they also offer
managers of international firm ] abundant opportunities
2) The acquisition of
funds, and 31 the
allocation of finds.
However, each of these three functions shares most principles of global finance and their
relationships. Seven important principles of global finance are as follows
1) Risk-Return Trade-off: The maximization of stockholders wealth depends on the trade-off
between risk I and profitability. Generally', the higher the risk of a project, the higher is the
expected return from the j project. For example, if anyone is offered a chance to invest in a
project which offers an extremely high I rate of return, you should immediately suspect that
the project is very risky. The risk-return trade-off does | not apply to 100 per cent of all cases,
but in a free enterprise system, it probably comes close. Thus, the | financial manager attempt
to determine the optimal balance between risk and profitability that will | maximize.
2) Market Imperfections: Perfect competition exists when sellers of goods and services have
complete freedom of entry into and exit out of any national market. Under such conditions,
goods and services would be mobile and freely transferable. The unrestricted mobility of
goods and services creates equality in costs j and returns across countries. This cost-return
uniformity everywhere in the world would remove the incentive for foreign trade and
investment.
3) Portfolio Effect (Diversification): The portfolio effect states that as more assets are added to a
portfolio, the risk of the total portfolio decreases. This principle explains much of the
rationale for large MNCs to \ diversify their operations not only across industries but also
across countries and currencies. Some MNCs, such as Nestle of Switzerland, have operations
in countries as varied as the United States, Japan, Hong Kong. France. Russia. Mexico,
Brazil, Vietnam, Nigeria and North Korea. Because it is impossible to predict which
countries will outperform other countries in the future, these companies are hedging their
bets".
4) Comparative Advantage: Comparative advantage states that trade between the two countries
can boost living standards in both. Trade allows countries to specialize in what they do best
and to enjoy a greater variety of goods and services. At the same time, companies earn
. 1) Access to capital markets across the world enables a country to borrow during tough times
and lend during good times.
12) It promotes domestic investment and growth through capital import.
3) Worldwide cash flows can exert a corrective force against bad government policies.
4) It prevents excessive domestic regulation through global financial institutions.
; 5) International finance leads to healthy competition and, hence, a more effective banking
system.
6) It provides information on the vital areas of investments and leads to effective capital
allocation.
I 7) International finance promotes the integration of economies, facilitating the easy flow of
capital. The free transfer of funds would eventually result in more equality among
countries that are a part of the global financial system.
8) International finance leads to healthy competition and, hence, a more effective banking
system.
F 9) It provides information on the vital areas of investments and leads to effective capital
allocation.
; 10) International finance promotes the integration of economies, facilitating the easy flow of
capital. The free transfer of funds would eventually result in more equality among
countries that are a part of the global financial system.
International business activities are affected by the international financial environment. For
example, a few years ago the financial crisis in the South-East Asian countries seriously
affected other financial markets in the rest of the world and international business activities
were consequently affected as well.
1) Foreign Exchange Market: The foreign exchange market is the place where money
denominated in one currency is bought and sold with money denominated in another
currency
2) Currency Convertibility: The discussion of the foreign exchange market was based on the
assumption that the currencies of various countries are freely convertible into other
currencies. This assumption is not valid. Many countries restrict the ability of residents and
non-residents to convert the local currency into foreign currency, making international
businesses more difficult.
A countrys currency is said to be freely convertible when the countrys government allows
both residents and non-residents to purchase unlimited amounts of foreign currencies with
the local currency. A currency is non-convertible when neither residents nor non-residents are
allowed to convert local currency into a foreign currency.
3) International Monetary System: Every country' needs to have its own monetary system and an
authority to maintain order in the system. Monetary system facilitates trade and investment.
India has its own monetary policy that is administered by the Reserve Bank of India.
Primarily, RBI aims at controlling inflation and money supply and maintaining an interest
rate regime that is helpful to economic growth.
4) Balance of Payments: Balance of Payments (BOP) is a statistical statement that
systematically summarizes, for a specified period of time, the monetary transactions of an
economy with the rest of the world. BOP data help measure financial transactions between
residents of the country and residents of all other countries. Transactions include exports and
imports of goods and services, income flows, capital flows, and gifts and similar one-sided
transfer payments.
International Financial System: The international financial system consists of the numerous
rules, customs, instruments, facilities, markets, and organizations that enable international
payments to be made and funds to flow across borders. In recent years, the international
financial system has experienced | tremendous growth. New financial instruments have been
created, and the volume of transactions has exploded. The dramatic metamorphosis of
international financial markets is driven by technological [ changes, the growth in world trade,
and the breakdown of barriers to financial (capital) flows
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
countrys international payments and its receipts. Further, the cost of converting foreign
money into firms home currency - a variable critical to the profitability of international
operations depends on the smooth functioning of the international monetary system.
An international monetary system is required to facilitate international trade, business, travel,
investment, foreign aid, etc. It is a complex system of international arrangements, rules,
institutions, policies in regard to exchange rates, international payments, capital flows. IMS
has evolved over time as international trade/flnance/business has changed, as technology has
improved, as political dynamics change, etc. For example, evolution of the European Union
and the euro currency impacts the IMS. International monetary system is an institutional
framework within which International payments are made, movements of capital an:
accommodated and ex-rates are determined.
The international monetary system has evolved over the course of centuries and defines the
overall financial environment in which multinational corporations operate. The international
monetary system consists of elements such as laws, rules, agreements, institutions, mechanisms
and procedures which affect foreig" exchange rates, balance of payments adjustments,
international trade and capital flows. This system will continue to evolve in the future as the
international business and political environment of the world economy continues to change.
The international monetary system plays a crucial role in the financial management of*
multinational business and economic and financial policies of each country
Evaluation monetary system
The history of monetary system started when in ancient time (7th century B.C.) tribes and citystates of India, Babylon, and Phoenicia used gold and silver as media of exchange in trade.
Evolution of the international monetary system can be analysed in four stages which are as
follows:
1.2.2.1.2.
standard, and a gold- exchange standard. Under a gold-bullion standard, gold coin neither
circulates as money nor is it used commercial bank reserves, and the government does not
coin gold. The monetary authority (treasury or cant bank) stands ready to transact with
private parties, buying or selling gold bars (usable only for import or export, not us domestic
currency) for its notes, and generally a minimum size of transaction is specified.
4) Gold Points and Gold Export/Import: A fixed exchange rate (the mint parity) for two
countries oh ik gold standard is an over-simplification that is often made but is misleading.
There are costs of importing or exporting gold. These costs include freight, insurance,
handling (packing and cartage), interest on mono committed to the transaction, risk
premium (compensation for risk), normal profit, any deviation oi purchase or snle price
from the mint price, possibly mint charges, and possibly abrasion (wearing out of removal
of gold content of coin should the coin be sold abroad by weight or as bullion).
Expressing tk expelling costs as the per cent of the amount invested (or, equivalently, as per
cent of parity), the product of 1/100'1' of these costs and mint parity (the number of units of
domestic currency per unit of foreic currency) is udded to mint parity to obtain the goldexport point the exchange rate at which gold - exported. To obtain the gold-import point,
the product of 1/100,h of the importing costs and mint park) is subtracted from mint parity.
Gold-Point Spread: The difference between the gold points is called the (gold-point) spread.
The safe points and the spread may be expressed as percentages of parity. Estimates of gold
points and spread involving centre countries are provided for the classical and interwar cold
did not contract the supply of money when the country incurred a gold outflow.
4) A gold standard restricts the Federal Reserve from enacting policies which significantly alter
the growth of the money supply which in turn limits the inflation rate of a country.
The extensive use of gold standards implies a system of fixed exchange rates. If all countries
are on a gold standard, there is then only one real currency, gold, from which all others derive
their value. The stability the gold standard cause in the foreign exchange market is often cited
as one of the benefits of the system
As countries began to recover from the war and stabilize their economies, they made several
attempts to return to the gold standard. The United States returned to gold in 1919 and the United
Kingdom in 1925. Countries such as Switzerland, France and Scandinavian countries restored
the gold standard by 1928.
The key currency involved in the attempt to restore the international gold standard was the pound
sterling which returned to gold in 1925 at the old mint parity exchange rate of $4.87/. This was
a great mistake since the United Kingdom had experienced considerably more inflation than the
United States and because UK had liquidated most of its foreign investment in financing the war.
The result increased unemployment and economic stagnation in Britain.
The pounds overvaluation was not the only major problem of the restored gold standard. Other
problems included the failure of the United States to act responsibly, the undervaluation of the
French franc and a general decrease in the willingness and ability of nations to rely on the gold
standard adjustment mechanism.
In 1934, the United States returned to a modified gold standard and the US dollar was devalued
from the previous $20.67/ounce of gold to $35.00/ounce of gold. The modified gold standard
was known as the Gold Exchange Standard. Under this standard, the US traded gold only with
foreign central banks, not with private citizens. From 1934 till the end of World War II, exchange
rates w'ere theoretically determined by each currencys value in terms of gold. World War II also
resulted in many of the world's major currencies losing their convertibility. The only major
currency that continued to remain convertible was the dollar.
Thus, the inter-war period was characterized by half-hearted attempts and failure to restore the
gold standard, economic and political instabilities, .widely fluctuating exchange rates, bank
failures and financial crisis. The Great Depression in 1929 and the stock market crash also
resulted in the collapse of many banks
1.2.2.3. Bretton
The depression of the 1930s, followed by another war, had vastly diminished commercial
trade, the international exchange of currencies and cross-border lending and borrowing.
Revival of the system was necessary and the reconstruction of the post-war financial
system began with the Bretton Woods Agreement that emerged from the International
Monetary and Financial Conference of the united and associated nations in July 1944 at
stable exchange rates, a small pool of lendable resources and the principle that the burden of
adjustment of payment imbalances should fall primarily on deficit countries.
1) Each nation should be at liberty to use macroeconomic policies for full employment.
1.2.2.3.3.
The Bretton Woods System worked without major changes from 1947 till 1971. During this
period, the fixed exchange rates were maintained by official intervention in the foreign exchange
markets. International trade expanded in real terms at a faster rate than world output and
currencies of many nations, particularly those of developed countries, became convertible.
The stability of exchange rates removed a great deal of uncertainty from international trade and
business transactions thus helping the countries to grow. Also, the working of the system
imposed a degree of discipline on the economic and financial policies of the participating
nations. During the 1950s and 1960s, the IMF also expanded and improved its operation to
preserve the Bretton Woods System. The system, however, suffered from a number of inherent
structural problems. In the first place, there was much imbalance in the roles and responsibilities
of the surplus and deficits nations. Countries with persistent deficits in their balance of payments
had to undergo tight and stringent economic policy measures if they wanted to take help from the
IMF and stop the drain on their reserves.
The basic problem here was the rigid approach adopted by the IMF to the balance of payments
disequilibrium situation. The controversy mainly centres on the 'conditionality issue, which
refers to a set of rules and policies that a member country is required to pursue as a prerequisite
to using the IMFs resources. These policies mainly try and ensure that the use of resources by
concerned members is appropriate and temporary. The IMF distinguishes between two levels of
conditionality, first was low conditionality where a member needs funds only for a short period
and second was high conditionality where the member country wants a large access to the IMFs
resources. This involves the formulation of a formal financial programme containing specific
measures designed to eliminate the countrys balance of payments disequilibrium.
Use of IMF resources, under these circumstances, requires IMFs willingness that the
stabilization programme is adequate for the achievement of its objectives and an understanding
by the member to implement it.
1.2.2.3.4.
VERSUS
non-
In long-run, Bretton Woods (gold-exchange system) was unstable. There was no way to:
1) Devalue the reserve currency ($) even when it was over-valued, or
2) Force a country to revise its ex-rate upward. A country could agree or be pressured into
devaluation, but there was no way to revalue a currency upward (appreciate through
concretionary policy).
1.2.2.4.
The exchange rate regime is the way a country manages its currency in respect to foreign
currencies and the foreign exchange market. It is closely related to monetary policy and the two
are generally dependent on many of the same factors. In other words, the concept of exchange
rate regime may be explained as the method that is employed by the governments in order to
administer their respective currencies in the context of the other major currencies of the world.
The foreign exchange market is pretty important in this case as well. Exchange rate regime has
often been likened to monetary policies and it may be concluded that both the processes are
actually dependent on a lot of similar factors.
There are two broad categories of exchange rate systems.
1) In one system, exchange rates are set purely by private market forces with no government
involvement. Values change constantly as the demand for and supply of currencies fluctuate.
2) In another system, currency values are allowed to change, but governments participate in
currency markets in an effort to influence those values.
1.2.2.5.
The fluctuating exchange rate regime, which is also referred to as the floating/flexible exchange
rate regime is one of several kinds or regime in which the value of a currency can fluctuate
according to movement; of she foreign exchange market. According to this system, exchange
rate fluctuates on a regular basis in response TO the changes n demand and supply forces in the
market. Some financial experts believe that the floating exchange rate regime is the more
appropriate choice to use because it docs not interfere with foreign trade, la fact, some economy
experts strongly believe that floating exchange rates are the better choice over fixed exchange
rates in most circumstances. For one thing, using the floating exchange rate regime, adjustments
are made automatically. Using floating exchange rates also makes i: possible for countries to
lessen shocks, as well as cycles for foreign business. In addition, the floating exchange rate
regime can eliminate the possibility of a country experiencing any type of crisis for balance of
payments.
fundamentals. As the structure of a nations economy changes and its trade relationships
and balances evolve the exchange rate itself should change. Flexible exchange rates allow
this to happen gradually and efficiently, but fixed rates must be changed administratively
- usually too late, too highly publicized and at too large a one-time cost to the nations
economic health.
1. Shock Absorption: A flexible rate acts as an absorber of shocks originating from other
countries. To a certain extent, it provides an automatic adjustment and insulation against
foreign disturbances.
2. Effectiveness of Monetary and Fiscal Policies: It increases effectiveness of monetary
policy for domestic stability which can be achieved with less forceful monetary and fiscal
measures.
3. BOP Adjustment: It helps in restoring balance of payments equilibrium.
4. Foreign Exchange Reserves: If the rate responds to market forces within limits, the
authorities need not intervene at all. And even if they do, they shall need comparatively
less of foreign exchange reserves to act as a buffer since such forces are usually selfregulatory.
5. No Need for International Management of Exchange Rate: Unlike fixed exchange rate
based on a metallic standard, floating exchange rates do not require an international
manager such as International Monetary Fund to look over current account imbalances.
Under the floating system, if a country has large current account deficits, its currency
depreciates.
6. No Need for Frequent Central Bank Intervention: Central banks frequently must
intervene in foreign exchange markets under the fixed exchange rate regime to protect the
gold parity, but such is not the case under the floating regime. Here there is no parity to
uphold.
7. No Need for Elaborate Capital Flow Restrictions: It is difficult to keep the parity intact
in a fixed exchange rate regime while portfolio flows are moving in and out of the
country. In a floating exchange rate regime, the macroeconomic fundamentals of
countries affect the exchange rate in international markets, which, in turn, affect portfolio
flows between countries. Therefore, floating exchange rate regimes enhance market
efficiency.
8. Greater Insulation from Other Countries Economic Problems: Under a fixed
exchange rate regime, countries export their macro economic problems to other countries.
Suppose that the inflation rate in the U.S. is rising relative to that of the Euro-zone.
the situation worse. For example, if the country suffers from higher inflation, depreciation
of its currency may drive the inflation
rate higher because of increased demand for its goods; however, the countrys current
account may also worsen because of more expensive imports.
Managed Float:
A managed float exchange rate system is an international financial arrangement, whereby central
banks intervene only periodically, not necessarily to support a country's currency, but rather to
stabilize volatile fluctuations in foreign exchange rates. A managed float is some times called a
"dirty float" because exchange Kites are free to fluctuate, but central banks are committed to
intervene under conditions of perceived instability. The central bank steps in to offset only so
much of a change in demand or supply to bring the exchange rate back into an acceptable "band"
or range of exchange rates.
In other words, a managed currency is an exchange rate that is basically floating in the foreign
exchange markets but is subject to intervention from time to time by the monetary authorities, in
order to resist fluctuations that they consider to be undesirable.
Normally the currency floats freely in the market - the value is determined by the forces of
supply and demand for a given currency. But the government and/or central bank of a country
may decide to use intervention in the currency market as a way of manipulating its value to
achieve given macroeconomic objectives.
For example, an attempt to bring about a depreciation to:
1) Improve the balance of trade in goods and services/improve the current account position.
2) Reduce the risk of a deflationary recession - a lower currency increases export demand and
increases the domestic price level by making imports more expensive.
3) To re-balance the economy away from domestic consumption towards exports and investment.
4) Selling foreign currencies to overseas investors as a way of reducing the size of government
debt.
Or to bring about an appreciation of the currency
1) To curb demand-pull inflationary pressures; and
2) To reduce the price of imported capital and technology.
2) The central bank may choose instead to change policy interest rates - e.g., raising interest
rates in a bid to attract short-term inflows of hot money into their domestic banking
system from overseas.
3) Although many currencies are officially free-floating it is not difficult to find examples of
central bank intervention.
In me pegged exchange rate regime, the value of the currency is pegged to some major
currency like U.S Dollar, Euro, or to a currency basket. The plus point of this system is that it
imposes monetary discipline a nation and checks inflation, whereas the minus point is that it
becomes very difficult Cot a smaller nation to maintain the peg if the currency comes under
speculative attack in the foreign exchange market White a pegged exchange rate regime is used
for a variety of reasons, it is most commonly associated with stabilizing currency value to the
other currency pegged to which makes investments and trades between the two countries more
predictable.
Advantages of Craw ling Pegged Exchange Rate
Following are the advantages of pegged exchange
rate:
1) The system potentially avoids the economic instability associated with the infrequent bin
discrete adjustment which characterize the fixed exchange rate, and
2) They reduce uncertainty due to volatility characterizing floating exchange rate.
Disadvantages of Crawling Pegged Exchange Rate
Sometimes it is difficult to realize in practice the above advantages if crawling pegged
exchange rate system generating substantial currency flows in anticipation of exchange rate
realignment. There flows might prompt monetary authorities to accelerate their currency
realignments, therefore creating an erratic adjustment process and exposing market operators
to unsystematic economic costs.
1.2.3.
The IMF currently classifies exchange late arrangement into eight separate regimes
1) Exchange Arrangements with no Separate Legal Tender: The currency of another
country circulates as the sole legal tender or the country' belongs to a monetary or
currency union in which the same legal tender is shared by the members of the union.
Examples included Ecuador, El Salvador and panama using the U.S. dollar and the 12
euro zone member countries (like France, Germany and Italy) sharing the common
currency, the euro.
2) Currency Board Arrangements: A monetary regime based on an explicit legislative
commitment to exchange domestic currency for a specified foreign currency at a fixed
exchange rate, combined with restrictions on the issuing authority to ensure the
fulfillment of its legal obligation. Examples includes Hong Kong fixed to the U.S.
dollar and Estonia fixed to the euro.
3) Other Conventional Fixed Peg Arrangement: The country pegs its currency
(formally* or de facto)'- at a fixed rate to a major currency or a basket of currencies
where the exchange rate fluctuates within a narrow margin of less than 1 per cent, plus
or minus, around a central rate. Examples include Morocco, Saudi Arabia and Ukraine.
4) Pegged Exchange Rates within Horizontal Bands: The value of the currency is
maintained within margins of fluctuation around a formal or de facto fixed peg that are
wider than at least 1 per cent, plus or minus, around a central rate. Examples include
Denmark, Slovenia and Hungary.
5) Crawling Pegs: The currency is adjusted periodically in small amounts at a fixed, proannounced rate or in response to changes in selective quantitative indicators. Examples
are Bolivia, Costa Rica and Tunisia.
6) Exchange Rates within Crawling Bands: The currency is maintained within certain
fluctuation margins around a central rate that is adjusted periodically at a fixed proannounced rate or in response to changes in selective quantitative indicators. Examples
are Belarus and Romania.
7) Managed Floating with no Pre-announced Path for the Exchange Rate: The
monetary authority influences the movements of the exchange rate through active
intervention in the foreign exchange market without specifying, or pre-committing to, a
pre-announced path for the exchange rate. Examples include Algeria, China, P.R.,
Czech Republic, India, Russia, Singapore and Thailand.
8) Independent Floating: The exchange rate is market determined, with any foreign c,
aimed at moderating the rate to change and preventing undue fluctuations in the
exchange, establishing level for it. Example* include Australia, Brazil, Canada, Korea,
Mexico Switzerland and the United States.
1,2.4.
Currency Board
A currency board is a monetary authority that issues notes and coins convertible into a foreign
anchor at a fixed exchange rate. The anchor currency is a currency chosen for its expected
stability, and international , acceptability. For most currency boards, the U.S. dollar or L.K.
Usually, the fixed exchange rate is set by law, ma> changes to "inc exchange rate very costly
for governments. Put simply, currency boards offer the strongest f of a fixed exchange rate
that is possible short of full currency union.
The commitment to exchange domestic currency for foreign currency at a fixed exchange rate
requires that die currency board have sufficient foreign exchange to honor this commitment.
This means that its holdings of foreign exchange must at least equal 100 per cent of its notes
and coins in circulation, as set by .aw A currency board can operate in place of a central bank
or as a parallel issuer alongside an existing central bank. Usually, a currency board takes over
the role of a central bank in strengthening the currency of a developing country.
By design, a currency board has no discretionary powers. Its operations are completely
passive and automatic. The sole function of a currency board is to exchange its notes and
coins for the anchor at a fixed rate. Unlike a central bank, a currency board does not lend to
the domestic government, to domestic companies, or to domestic tanks. In a currency board
system, the government can finance its spending only by taxing or borrowing, not by printing
money, and thereby creating inflation. This results from the stipulation that the backing of tie
domestic currency must be at least 100 per cent.
According to Williamson, Currency board is a monetary institution that issues base money
solely in exchange for foreign assets, specifically the reserve currency.
Currency boards can confer considerable credibility on fixed exchange-rate regimes. The
most vital contribution a currency board can make to exchange-rate stability is by imposing
discipline on the process of money creation. This results in greater stability of domestic
prices, which, in turn, stabilizes the value of the domestic currency. In short, the major
benefits of the currency-board system are as follows:
1) Making a nations currency and exchange-rate regimes more rule-bond and predictable.
2) Placing an upper bound on the nations base money supply.
3) Arresting any tendencies in an economy toward inflation.
4) Forcing the government to restrict its borrowing, to what foreign and domestic lenders are
willing to lend it at market interest rates.
5) Engendering confidence in the soundness of the nations money', thus assuring citizens and
foreign investors that the domestic currency can always be exchanged for some other
strong currency; and
6) Creating confidence and promoting trade, investment, add economic growth.
A currency board is a monetary institution that only issues currency to the extent that it is
fully backed by foreign rescues. In other words, a currency board is an extreme form of the
fixed exchange rate regime under which local currency is fully backed by the U.S. dollar or
any other chosen currency. Its major attributes include.
1) An exchange rate that is fixed not just by policy, but by law,
2) A reserve requirement to the extent that a countrys reserves are equal to 100 per cent of its
notes and coins in circulation.
3) Money supply and thus the amount of spending as well.
4) No central bank under a currency board system.
We use a more specific definition and state that a currency board is an establishment by law,
which covers the following issues:
1. The exchange rate is pegged to the anchor currency without the existence of a certain
fluctuation hand,
2. The monetary base is covered with at least 100% of foreign reserves (of the anchor
currency).
3. 'The currency board guarantees full convertibility.
1.2.4.2.
Foreign exchange market intervention is a monetary policy tool in which a central bank takes an
active participatory role in influencing the monetary fluids transfer rate of the national currency.
Central banks, especially those in developing countries, intervene in the foreign exchange market
in order to build reserves, stabilize the exchange rate, and to correct misalignments. The success
of foreign exchange intervention depends on how the central bank sterilizes the Impact of its
interventions, as well as general macroeconomic policies set by the government.
In other words, intervention in foreign exchange market can to an important tool for central
banks, particularly in developing countries. However, it can put the central bank's
credibility and scarce foreign exchange reserves at risk. Operational aspects of intervention,
including the timing* frequency, amounts, modalities of intervention, are among the most
important decisions taken by monetary authorities.
Reasons for Foreign Exchange Market Intervention
There are four broad based reasons why central banks Intervene In the foreign exchange market
1) Misalignment: Central banks intervene in the foreign exchange market to influence the level
of exchange rate. Usually* central banks believe that the market is driving the exchange rate
away from Its equilibrium* value and intervenes to break the momentum.
'.
2) Calming a Disorderly Market: Central banks intervene to calm the market and so it from
becoming disorderly. Rapid movement in the exchange rate may at times threaten the orderly
functioning of the market, leading to a widening of spreads and at times loss of liquidity. this
action serves to discourage the market from becoming one-sided.
3}Signaling/Accommodating Monetary Policy: Intervention may be used to signal future
changes to monetary policy or possibly calm expectations if monetary policy is changed
unexpectedly, which might otherwise lead to a loss in confidence and thereby induce an
unwarranted move in the exchange rate.
4) Reserve Building: Central banks intervene to maintain an inventory of net foreign currency
assets.
I.2.5.2.
and consequent accumulation or depletion of foreign exchange reserves of the Central Bank
requires large holding of the government securities (as often sterilization measures are
conducted through open market sale or purchase of the government securities) by the Central
Bank. The cost of conducting sterilization may thus be substantial.
market or in one country can have immediate effects on other countries and on the entire
international financial system. According to Alan Greenspan, These global financial
markets, engendered by the rapid proliferation of cross-border financial flows and
products, have developed a capability of transmitting mistakes at a far faster pace
throughout the financial system in ways that were unknown a generation ago.
1.3.2. Evolution of International Financial System
International financial system consists of international financial market, international financial
institutions and international financial instruments. It is divided into three sections:
1. Price Setting: The value of a pounce of gold or a share of stock is no more, and no less, than
what someone is willing to pay to own it. Markets provide price discovery, a way to
determine the relative values of different items, based upon the prices at which individuals
are willing to buy and sell them.
2. Asset Valuation: Market prices offer the best way to determine the value of a firm or of the
firms assets or property. This is important not only to those buying and selling businesses,
but also to regulators. An insurer, for example, may appear strong if it values the securities it
owns at the prices it paid for them years ago, but the relevant question for judging its
solvency is what prices those securities could be sold for if it needed cash to pay claims
today.
3. Arbitrage: In countries with poorly developed financial markets, commodities and currencies
may trade at very different prices in different locations. As traders in financial markets
attempts to profit from these divergences, prices move towards a uniform level, making the
1.5.1.
The Eurocurrency market consists of banks (called Euro banks) that accept deposits and
make loans in foreign currencies. A Eurocurrency is a freely convertible currency deposited
in a bank located in a country which a not the native county of the currency. The deposit can
be placed in a foreign bank or in the foreign branch! Of a domestic US bank.
In the Eurocurrency market, investors hold short-term claims on commercial banks which
intermediate to transform these deposits into long-term claims on final borrowers. The
Eurocurrency market is dominated US $ or the Eurodollar.
The Eurocurrency markets came into existence in late 50s when major European countries
greatly relaxed exchange control regulations and made their currencies convertible for nonresidents. Hence pound sterlingdeposits held by Banks in U.S.A. are called Euro-Sterling.
Deutsche mark held by banks in France is Euros j marks and so on. They are all Euro
currencies. Euro dollars are the main Euro currencies and are the most! 1 traded Currencies.
Hence Euro Currency market is known as Euro-dollar market.
The main difference between Euro markets and their domestic counterparts is that Euro markets
are free from! Regulations like cash reserves, deposit insurance, maximum ceiling on interest
etc., which effectively bring! H down the cost of funds. Similarly Eurobonds are free from
regulations like credit rating and disclosure normsthese differences account for Euro markets
occupying special place in the field of international finance
1.5.2.
4) Regulatory Authorities: Eurocurrencies are outside the direct control of the regulatory
authorities but still they are subject to indirect controls by authorities since all the
settlements in the currency have to take place in the country of issue.
5) Provide Free Access to New Entrants: Eurocurrency markets are highly sophisticated
and provide free access to new entrants. This resulted in competitiori of the highest
order and the players in the market Operate oh very thin margins. Margin means the
spread between the borrowing and lending interest rates.
6) Floating Interest Rate: Another interesting feature of Eurocurrencies markets is the
floating interest rate concept. Under this, the rate of interest on the borrowings and
lending are linked to a base rate called London Inter-bank Offered Rate (LIBOR). The
interest rate will be reviewed at periodical intervals, say 6 months and changed in line
with the LIBOR
1.5.3
Euro-Dollar Market
Euro-Dollar Market
borrowed by U.S. and foreign corporations for various purposes but especially to pay for
goods imported from the United States and to invest in U.S. security markets also. U.S.
dollars used as an international currency qr medium of exchange, and many Eurodollars
also used for this purpose. Eurodollars are usually held in Interest bearing accounts. The
interest rate paid on these deposits depends: llon the banks lending rate,
1.5.4.
The international money market is the market that handles the international currency transactions
between the various central banks of the nations. In the international money market, the
transactions are carried-out mainly in gold or in U.S. dollar. The international money market is
governed by the international monetary transactionsbetween various nations currency. The
international money market mainly handles the currency trading between the countries. The
trading of one countrys currency for another one is also named as the foreign exchange currency
trading or forex trading.
The basic performance of the international money market involves the money borrowing or
lending by a government or some large financial institutions. Unlike share markets, the
international money market dealswith much larger fund and the players of the market are big
financial institutes. The international money market allows investing in a less risk while the
return that comes from that is also less. The best way to invest in the international money market
is by money market mutual funds or treasury bills
The international money market takes care of the exchange rates on a regular basis. Currency
band, exchangerate regime, fixed exchange rate, linked exchange rate, and floating exchange
rates are some of the other indices that govern the international money market in a huge way.
most important international interest rates. Now most Eurocurrency transactions are priced in
terms of LIBOR plus a premium reflecting the risk of the arrangement, just as domestic loans are
priced in relation to prime
2. Euro Credits: The term Euro credit refers to loans in a currency that is not the lending banks
national currency. Euro credit loans are large and long-term, and usually only large corporations
and government agencies request them. Banks that extend these loans usually also participate in
the Eurocurrency Market, where they hold deposits in currencies other than the local currency.
The prefix euro is often used in finance to refer to funds in a foreign currency and has nothing
to do with Euro currency or European countries. A bank extends a euro credit loan when the loan
is not in the banks national currency loan ois extended in a country other bank than the one in
whose currency the loan is denominated. For example an American bank provides a loan
denomination in japan yen or Russian rubles for an company. Euro credit loans increased the
flow of capital between various countries and help governments to finance their investment
3. Euro Certificate of Deposit: Certificate of deposit is a certificate issued by a bank evidence
money and carries the banks guarantee for the repayment of principal and interest. Certificate are
negotiable instruments and are issued payable to bearer and are traded in the secondary
certificates of deposits are issued for a minimum denomination of U.S. dollar 50,000/- and for a
maxi period generally of 1 year. Certificates of deposits provide an excellent avenue to the
investors Eurocurrency market who would like to park their surplus in a high interest instrument
with Liquidity. For example, if a bank has surplus fund, which it would like to invest for a period
of say i it can buy a 4 C.D. for 3 months. If need be, the bank can sell the C. D. in the secondary
market and liquidate it
4. Euro Commercial Papers: Commercial paper is a short term unsecured promissory note that is
generally sold by large corporations on discount basis to institutional investors and other
corporates for maturities ranging from 7 to 365 days. Commercial paper is cheap and flexible
sources of fund for highly fated borrowers as it works out cheaper that bank loans. For an
investor it is an attractive short-term investment, which offers higher interest than bank deposits
5. Euro notes: Euro Notes are the notes of the euro, the currency of the euro zone. They have been
in circulation since 2002 and are issued by the European Central Bank (ECB). Each bearing the
signature of the President of the European Central Bank. Denominations of notes range from 5
to 500 and, unlike euro coins, the design is identical across the whole of the Eurozone, although
they are printed in various member states. Euro-notes encompass note-issuance facilities, those
that are underwritten, as well as those that are not underwritten
6. Floating Rate Notes: The floating-rate note is, as the name implies, an instrument whose interest
rate floats* with prevailing market rates. It pays a three or six months interest rate set above, at,
or below, LIBOR. This interest rate is reset every three or six months to a new level based on tlie
prevailing LIBOR level at the reset date. Floating Rate Notes (FRNs) are bonds that have a
variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a
spread. The spread is a rate that remains constant. Almost all FRNs have quarterly coupons, i.e.,
the pay out interest every three months, though counter examples do exist At tlie beginning of
each coupon period, the coupon is calculated by taking the fixing of the reference rate for that
day and adding the spread. A typical coupon would look like 3 months USD LIBOR -0.20%
7. Bankers Acceptances: This is an instrument widely used in the US money market to finance
domestic as well as international trade. In a typical international trade transaction, the seller
(exporter) draws
shipment, the exporter hands over the shipping documents and the letter of credit issued by the
importers bank to its bank. The exporter gets paid the discounted value of the draft. The
exporters bank presents the draft to the importers bank which stamps k as accepted. A
bankers acceptance is created.
International Bank Loans: International bank loans have traditionally been sourced in the
Eurocurrency
Markets. Eurodollar bank loans are also called Eurodollar credits or simply 'Euro credits'
There are two components of international bank loans
I.
Euro credits: Euro credits are bank loans to MNEs, sovereign governments, international
institutions, and banks denominated in Eurocurrencies and extended by banks in
II.
countries other than the country in whose currency the loan is denominated
Syndicated Credits: The syndication of loans has enabled banks to spread the risk of very
large loans among a number of banks. Syndication is particularly important because
many large MNEs need credit in excess of a single banks loan limit. A syndicated bank
credit is arranged by a lead bank on behalf of its client
2. Euro Notes Market: The Euro note market is the collective term used to describe short to
medium-termdebt instruments sourced in the Eurocurrency markets. The euro note market has
four main components
I.
Euro Notes: Euro notes ate like promissory notes issued by companies for obtaining
short-term funds. They are denominated in any currency other than the currency of the
II.
country where they are issued. They represent low-cost funding route
Euro Note Facilities: A major development in international money markets was the
establishment of facilities for sales of short-term, negotiable, promissory notes - Euro
notes. Among the facilities for their issuance were Revolving Underwriting Facilities
(RUFs), Note Issuance Facilities (NIFs), and Standby Note Issuance Facilities (SNIFs).
These facilities were provided by international investment and commercial banks. The
Euro note was a substantially cheaper source of short-term funds than syndicated loans,
because the notes were placed directly with the investor public, and the securitized and
underwritten form allowed the ready establishment of liquid secondary markets. The
III.
banks received substantial fees initially for their underwriting and placement services
Euro Commercial Papers: It is an attractive foam to short-term debt instrument. It is a
promissory note like the short-term Euro notes although it is different from Euro notes in
IV.
some ways. It is not underwritten, while the Euro notes are underwritten
Medium-Term Euro Notes: Medium-term Euro notes are just an extension of short-term
Euro notes as they fill the gap existing in the maturity structure of international financial
market instruments. They are a compromise between short-term Euro notes and longterm. Euro bonds as their maturity ranges from one year and five to seven years
3. Euro Bonds: Following are the important kinds of bonds which are being issued to mobilize debt
internationally
1. Straight Euro Bond: These bonds have fixed maturities and carry a fixed rate of interest Straight
Eurobond are repaid by amortization or in a lump sum at the maturity date. Straight Euro-bond
are technically unsecured (debenture) bonds because almost all of them are not secured by any
specify c property of the borrower. Because of this, bondholders become general creditors in the
event of d rail It. The lenders usually look to the nature of the borrowers assets, its earning
power, and its general credit strength
2. Convertible Euro-Bond: These bonds are convertible into parent common stock and have
become increasingly popular because tile market for straight Euro-bonds has weakened.
Convertible Euro-bonds provide investors with a steady income and an opportunity to participate
in rising stock prices. International investors are inflation-conscious; they prefer convertible
Euro-bonds witch maintain the purchasing power of their money
3. Bond with Warrants: Some Euro-bonds are issued with warrants. A warrant is an option to buy a
stated number of common shares at a stated price during a prescribed period. Warrants pay no
dividends, have no voting rights, and become worthless at expiration unless the pries of the
common stock exceeds the exercise price
4. Currency Option Bonds/Multiple Currency-Bonds: Currency option bond allows the bondholder
receive the interest payment and the principle in any of the currencies specified in the bond. The
bondholder can choose the currency of their coupon and principle from among the two or more
currencies specified in the bond at the pre-determined exchange rate
5. Currency Cocktail or Currency Basket Bonds: Currency basket bonds have been developed to
stabilize the purchasing power of the coupon. This is accomplished by combining various
currencies as per some weighting process. The amount of each currency in basket generally
remain constant but the /a lux- of the basket changes, as some of the currencies depreciate or
appreciate 'relative to each other
International Equity Market
Global equity market is the worldwide markets of funds for equity financing the stock exchanges
throughout the world where investors and firm meets to buy and sell shares of stocks. The global
equity market is attributed to four reasons
1. The international trend towards privatization - i.e., the issuance of formerly state-owned
Companies representing sizable capital. The shares are offered in international markers
so called Eurocurrency tninc Banks participating in the S.No credit market generally also
participate in the Eurocurrency market
International Equity Sources
With the globalization and liberalization of the economy, Indian companies have started
generating funds from international markets. The international sources from where the funds can
be procured include foreign currency loans, commercial banks; financial assistance provided by
international agencies and issues of? Financial instruments like
1. American Depository Receipts (ADRs): An American Depositary Receipt (or ADR)
represents ownership in the shares of a non-U.S. company and trades in U.S. financial
markets. The stock of many non-U.S. companies trade on U.S. stock exchanges through the
use of ADRs
2. Global Depository Receipt (GDRs): Global Depository Receipt (GDR) - certificate issued by
international bank. Global Depository Receipt is a bank certificate given in more than one
county for shares in a foreign company. It is a financial instrument used by private markets to
increase capital denominated in either U.S. dollars or Euros
3. Foreign Currency Convertible Bond (FCCB): Foreign Currency Convertible Bond is just a
convertible bond that is issued in foreign currency. FCCB is a quasi-debt instrument that is
issued in a currency different than the issuers domestic currency with options to either
redeem it at maturity or convert it duo issuing companys stock; It gives two options. One is,
to get the regular interest and principal and the other is to convert the one in to equities. It is a
hybrid between bond and stock
Global/ international financial institution
A variety of agencies have been established to facilitate international trade and financial
transaction agencies often represent a group of nations. Some of the more important agencies are
as follows.
1.8.1
The international monetary fund was conceived in July 1944 during the United Nations monetary
and financial conference. The representatives of 45 governments met in the Mount Washington
hotel in the area of Bretton woods, New Hampshire, United States, with the delegates to the
conference agreeing on a frame work for international economic cooperation, the IMF was
formally organized on December 27, 1945 when the first 29 countries signed its articles of
agreement. The statutory purpose of the IMF today are the same as when they were formulated in
1943
The international monetary fund was created with a goal to stabilize exchange rates and assist the
reconstruction of the worlds international payment system. Countries contributed to a pool which
could be borrowed from, on a temporary basis by countries.
The IMF describes itself as an organization of 186 countries (as of June 29, 2009),
working to foster global monetaiy cooperation, secure financial stability, facilitate
international trade, promote high employment and sustainable economic growth,
and reduce poverty. The IMF was established to promote economic and financial cooperation among its members in order to facilitate the expansion and balanced
growth of world trade. It started functioning from March I, i94/. In June 1996, the
Fund had 182 members.
1.8.1.1
1.
Regulatory
Functions:
its
In
regulatory
1. Board of Governors: Board of Governors is the decision-making organ of the Fund. The
Board of Governors is the highest body. It exercises powers and takes decisions. The
Board of Governors consists of one Governor and one Alternate Governor appointed by
each member country. The member country appoints its Finance Minister or the Govemo:
of its Central Bank as the Governor. The Governor has the right to vote. The Alternate
Governor penktrates in the Board Meetings, but has voting right only in the absence of
the Governor.
2. Executive Board: The 24 executive directors land 24 alternates) of the IMF are
responsible for the Funds general operations, ana for this purpose the) exercise ail the
powers delegated to them by the Board of XJOVOV:> ) nooaucuQii u. continuous session
& the bund s headquarters and meet as often as business may require, usually several
times a week.
Of the 24 executive directors, five are appointed by the countries having the largest
quotas (United States, Japan. Germany, France, and the United Kingdom), and the other
19 are elected by regional groups of the remaining members. The IMFs managing,
director also serves as chairman of the Executive Board.
3. Managing Director The managing director, who is chosen by the executive directors, is
responsible for the conduct of the ordinary business of the Fund. He is appointed for a
five-year term and may not serve concurrency as a governor or executive director of the
IMF. The managing director chairs meetings of the executive directors but may vote only
in case of a tie.
The pemuu ,ient headquarters of the IMF are at 700 19^ Street, N.W., Washington, D.C.
20431. As of 21 August 2002, the staff consisted of about 2,650 persons from 140
countries.
The IMF has a regional office for Asia and the Pacific, located in Tokyo.
4. IMF Secretariat: IMF secretariat helps managing director in carrying out the activities.
5. interim Committee: The Interim Committee of the Board of Governors on the
International Monetary System is an advisory bod> made up of 22 Fund Governors,
ministers, or others of comparable rank, representing the same constituencies as in the
Funds Executive Board. The Interim Committee normally meets tvsice a year, in April or
May, and at the time of the Annual Meetings in September or October. It advises and
reports to the Board of Governors on the latters supervision of the management and
adaptation of the International Monetary System, considering proposals by the Funds
Executive Board to ircrease quotas or amend the Articles of Agreement, and dealing with
sudden disturbances that right threaten the International Monetary System; the Interim
Committee also advises the Funds Executive Board ci these matters.
6. Development Committee: The Development Committee (the Joint Ministerial Committee
cf the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources
to Developing Countries) has 22 members - Governors of the Fund and the Bank,
ministers, or others of comparable rank - and generally meets in conjunction with the
Interim Committee. It advises and reports to the Boards of Governors of the Bank and the
Fund on all aspects of the transfer of real resources to developing countries.
1.8.1.4. Advantages of International Monetary Fund
Following are the main benefits which have occurred to the world from the functioning of the
IMF as explained "below:
1. Establishment of a Monetary Reserve Fund: Under this system, the fund is able to
accumulate a sizeable stock of the national currencies of different countries. It is out of
this stock that the fund meets the foreign exchange requirements of the member
countries.
2. Setting up a Multilateral Trade and Payments System: The establishment of the fund has
given stimulus to the setting up of a multilateral trade and payments system. No doubt,
the member countries have been allowed to impose exchange control on commercial
transactions.
3. Improvement is Short Term Disequilibrium in Balance of Payments: By lending foreign
currencies to member countries against their national currency, the fund helps them to
eliminate short term disequilibrium in their balance of payments.
4. Stability of Foreign Exchange Rates: Till recently the fund had succeeded in attaining a
certain amount of stability in foreign exchange rates. The rate of exchange under the
I.M.F. has not circulated as much as they used to be before its establishment. This
stability in foreign exchange rates had the effect of promoting the flow of international
trade among different countries.
5. Check in Competitive Currency Devaluation: Before the-establishment of the fund,
different countries of the world often resorted to competitive currency devaluation to
boost their exports which naturally produced strains in their economic and political
relationship. But after the existence of the IMF no member country has allowed to
devalue its currency without the prior consent of the fund except under certain special
circumstances.
6. No Interference in Domestic Economic Affairs: The fund does not interfere in the internal
economic affairs of member countriesnordoesf it try 'to influence their economic and
monetary policies in any way.
concessional facilities. Interest rates, fees, and other terms associated with the
concessional facilities are significantly lower or easier to meet than the terms of regular
facilities. With in 'the regular lending facilities, the mechanisms for fast-turnaround
emergency lending differ in important ways from those for Longer-fuse lending
arrangements, in which the periods for negotiation and disbursement are more protracted
"0 Stand-By Arrangements: Stand-By Arrangements (SBAs) are designed to deal with
short-term balance of payments problems of a temporary or cyclical nature, and must be
repaid within 3 to 5 years. Drawings are normally made quarterly, with their release
conditional upon borrowers meeting quantitative performance criteria - generally in such
areas as bank credit, government or public sector borrowing, trade and payments
restrictions, and international reserve levels - and not infrequently structural performance
criteria. These criteria allow both the member and the IMF to assess progress under the
members program. Stand-By Arrangements typically over 12-18 month periods
(although they can extend for up to three years).
ii) Extended Fund Facility: Financial assistance provided through Extended Arrangements
under the Extended Fund Facility (EFF) is intended for countries with balance of
payments difficulties resulting primarily from structural problems and has a longer
repayment period, 4 to 10 years, to take account of the need to implement reforms that can
take longer to put in place and have full effect. A member requesting an Extended
Arrangement outlines its goals and policies for the period of the arrangement, which is
typically three years but can be extended for a fourth year, and presents a detailed
statements each year of the policies and measures to be pursued over the next 12 months.
The phasing of drawings and performance criteria are like those under Stand-Rv
Arrangements although phasing on a semiannual basis is possible
in) Precautionary Arrangements: Precautionary arrangements are used to assist members
interested in boosting confidence in their economic management. Under a Stand-By or an
Extended Arrangement that is treated as precautionary, the member agrees to meet the
conditions applied for such use of the IMFs resources but expresses its intention not to
draw on them. This expression of intent is not binding; consequently, as with an
arrangement under which a member is expected to draw, approval of a precautionary
arrangement signifies the IMFs endorsement of the members policies according to the
standards applicable to the particular form of arrangement
2. Special Leading Facilities and Policies: Supplemental Reserve Facility (SRF) was
introduced in 1997 to supplement resources made available under Stand-By and
Extended Arrangements in order to provide financial assistance for exceptional balance
of payments difficulties owing to a large short-term financing need resulting from a
sudden and disruptive loss of market confidence, such as occurred in the Mexican and
Asian financial crises in the 1990s. Its use requires a reasonable expectation that strong
adjustment policies and adequate financing will result in an early correction of the
members balance of payments difficulties. Access under the SRF is not subject to the
usual limits but is based on the financing needs of the member, its capacity to repay, the
strength of its program, and its record of past use of IMF resources and cooperation with
the IMF. Financing is committed for up to one year, and repayments are expected to be
made within 1 to 18 years, an4 must be made within 2 to 22 years, from the date of each
drawing. For the Erst year, the rate of change on SRF financing is subject to a surcharge
of 300 basis points above the usual
rate of charge on other IMF loans; the surcharge then increases by >0 basts iv>i,
tvwynyreadies 500 basis points.
i) Contingent Credit Lines: Contingent Credit Lmvs (U. u) "vt e*udtltd*d
Supplemental
Reserve
Facility,
the
CCL
is
designed
to
provide
Compensatory
Financing
Facility
iii) Natural Disaster Financing: IMF also provides emergency assistance to a member facing
balance ef payments difficulties caused by a natural disaster. The assistance is available
through outright purchases, usually limited to 25 per cent of quota, provided that the
member is cooperating with the IMF to find a solution to its balance of payments
difficulties. In most cases, this assistance has taeu followed by an arrangement with the
IMF under one of its regular facilities. In |W^ ^ ^\dkv on emergency assistance was
expanded to include well-defined post conflict situations where a members institutional
and administrative capacity has been disrupted as a result of eentUiL but where thvxe is
still sufficient capacity for planning and policy implementation and a demonstrated
commitment on the part of the authorities; and where there is an urgent balance of
payments need and a (ok- fer the IMF in catalyzing support from official sources as part
of a concerned international eflihrt to address the flirt situation The authorities must state
their intention to move as soon as possible to a Staud4t\v Extended, or Poverty Reduction
and Growth Facility Arrangement.
iv) Emergency Financing: The Emergency.Financing Mechanism (EFM) is a set of
procedures that allow for quick Executive Board approval'of IMF financial support to a
member (being a crisis hr its external accounts that requires an immediate IMF response.
The EFM was established in September' and was used to 1997 for the Philippines;
Thailand, Indonesia, Korea, and in t8 lb* Russia.
supported programs are expected to be based on country* designed poverty reduction strategics ami formulated in a
participator^' manner involving civil society and developmental partners The strategy, to be spelled out in a Poverty Reduction
Strategy Paper produced by ihe bortwwmg country in cooperation with tho World Bank and the IMF, should describe the
authorities goals and macroeconomic and structural policies for the three*yeur program to be supported by resources, as well as
the associated external financing needs and mtfiot sources ot financings HKw loans carry an interest rate of 0.5 per cent a year
and are repay able over Ifi y ou i s with a s year grace period on principal repayments,
Bank For International Settlement
Ssr international settlement (BIS) is an international organization fostering the cooperation of central banks
itcmational monetary policy-makers. It was established in 17 May 1930. It is the oldest international financial
Imzation. and was created to administer the transaction of money according to the Treaty of Versailles. Among
rs, its main goals are to promote information sharing and to be a key center for economic research.
Essentially, the BIS is a central bank for central banks; it does not provide financial services to individuals or corporations. The
BIS is located in Basel, Switzerland, and has representative offices in Mexico City and Hong Kong. The Bank for International
Settlements is an international organization which fosters international monetary and financial cooperation and serves as a bank
for central banks. The BIS fulfils this mandate by acting as:
1) A Forum to promote discussion and policy analysis among central banks and within the international financial community.
2) A cjcjhter for economic and monetary research.
3) A prime counterparty for central banks in their financial transactions; and
4) Agent or trustee in connection with international financial operations.
The head office is in Basel, Switzerland, and there are two representative offices - in the Hong Kong Special Administrative Region of the
Peoples Republic of China and in Mexico City.
Established on 17 May 1930, the BIS is the worlds oldest international financial organization. The objective of establishing this
international organization is to build central bank cooperation to strengthen the financial supervision so as to prevent frauds and
malpractices in the financial sector.
As its customers are central banks and international organizations, the BIS do not accept deposits from, or provide financial services to,
private individuals or corporate entities. The BIS strongly advises caution against fraudulent schemes. BIS has constituted a Committee
popularly known as Basel Committee to develop necessary guidelines for implementing effective financial supervision.
I.8.2.I.
In addition, the Bank is trustee for the new bonds of the German External Loan 1924 (Dawes
Loan) and of the German Government International Loan 1930 (Young Loan), which were issued
by the Government of the Federal RepHlirnf Germany in accordance with the London
Agreement of 1953, and for the assented bonds of the Austrian Government International Loan
1930. The Bank also carries-out the functions entrusted to it n IV04 by the Ministers of the
Group of Ten of tolleding and distributing to all the participants of the Group, and to Working
Party No. 3 of the OECD, statistical data for multilateral surveillance of international liquidity
creation.
I.8.2.4.
Organizational Structures
The governance of the Bank is determined by its Statutes} which were last revised in June 2005,
following a review of the governance of the Bank by three* leading independent legal experts.
The three most important decision-making bodies within the Bank-aci^ . \ ^.
Decisions taken at each of these levels concern the running of the Bank and as such are mainly of
an administrative and financial nature^related to its linking operations, the policies governing
internal management of the BIS and the allocatibif of budgetary resources., to the different
business areas. The Banks.
administrative and budgetary rules apply to the committees hosted by the BIS.
1) General Meetings of Member Central Banks: The BIS currently has 56 member central
banks. a# of ***** are entitled w be represented, and vote in tile General Meetings.
Voting power is proportionate to the ******* oi BIS shares issued in the country of each
member represented at the meeting. At the Annual General Meeting, key decisions by
member central banks focus on distribution of the dividend and profit, appiwsl of the
annual report and the accounts of the Bank, adjustments in the allowances paid to board
members. selection of the Banks external auditors. The Annual General Meeting is held
in late JunerearkJuK
Extraordinary General Meetings must be called in order to amend the Statutes of the
World Bank
The World Bank is an international financial institution that provides loans to developing
countries tor capital programmes. The World Bank has a stated goal of reducing poverty. By law,
all of its decisions must be guided by a commitment to promote foreign investment, international
trade and facilitate capital investment.
It is not a bank in the common sense; it is made up of two unique development institutions
owned by 1ST member countries: the International Bank for Reconstruction and Development
(IHRD'I and the Intcmatkmal Development Association (IDA).
Each institution plays a different but collaborative role in advancing the vision of inclusive and
sustainable globalization. The IBRD aims to reduce poverty in middle-income and creditworthy |
HXW countries, white IDA focuses on the world's poorest countries.
Their work is complemented by that of the International Finance Corporation (IFCJk Multilateral
Investment Guarantee Agency (MIGA) and the International Centre for the Settlement
oflnvealmeut Disputes (tCSIDV
TogetherH provides low-interest loans* interest-free credits nnd^HBSuuTv? of pwpeses that
include invesintents in education* health private sector development, agriculture and
environmental and natural rcsl
Functions TWorld Bank tts main functions of World Bank are as follows:
1) Advances Loans: Main function of the Bank is to advance loans to member countries or
to pr\v. entrepreneurs on the guarantee of their vemment, for productive purposes. These
loans are advance through the medium of the central bank of the country. The Bank
collects progress reports on those projects of the member countries for which loans are
advanced to them. Between 1945 to 2000, the World Bank sanctioned loans amounting to
$33,853 crore. World Bank gives loans for short and long periods. It mainly advances
three kinds of loans.
i) Direct Loans: It either gives loans out of its own funds or it borrows in the open market
and gives the proceeds to the member countries as loan.
ii) Guarantee Loans: It gives guarantee to the loans given by private investors and thus help
them to giye loans to member countries.
iii)Joint Loans: The bank advances loans in collaboration with commercial banks operating
in different countries.
2) Provides Technical Assistance: The bank also provides technical
assistance to member-countries. It is o two kinds. One relates to
development plans and the other to the study of economies, their
analysis a.n suggesting the ways for improvements. The Bank sends its
experts to member-countries in order to provide them with technical
assistance and guidance.
3) Imparts Training: The Bank also arranges to impart training to the
officials of the member-countries in matters relating to planning,
economic development, public finance and other economic activities.
Many training programmes have been initiated by the Bank for this
purpose. In the year 1956, the Bank established Economic Development
Institute for imparting training.
4) Co-ordinates Development Assistance:-The Bank also co-ordinates
assistance given to member-countries from various agencies/countries.
First attempt in this direction was made in 1958 when Aid India Club
was founded. Now, such clubs have been founded for many countries.
5) Settlement of International Disputes: World Bank also acts as a mediator to settle
international disputes. In I960, Indo-Pakistan River Water Dispute and Suez Canal Dispute
could be settled only by the efforts of the World Bank. For solving dispute regarding
foreign investment, recently a Centre for Settlement of Investment Disputes (ICSID) has
been set up.
6) Provides Financial Assistance to World Welfare Institutions: World Bank provides
financial assistance to UNICEF, UNESCO, World Health Organization (WHO),
International Labor Organization (1LO), Food and Agriculture Organization (FAO), etc.
These world level institutions work for welfare of various sections.
7) Conducts Economic Research: World Bank has been conducting economic research since
1978. For this purpose, a separate division has been iet up and experts are hired from all
over the world for conducting this research. These research projects are''related mainly to
economic development, infrastructure development, poverty eradication, etcTWorld-Bank
als,o publishes research reports in its journals.
8) Establishing Subsidiary Institutions:' World Bank has established its subsidiary institutions
namely International Development Association jIDA), International Finance
Corporation (IFC). Multinational Investment Guarantee Agency (MIGA). These subsidiary
institutions help the World Bank in achieving its objectives.
9) Reconstruction and Development: World bank provide capita), to developing countries for
reconstruction and development of their economies.
10) Encourage Private Foreign Investment: World bank encourage private foreign investment
by providing guarantees of repayment to the investors.
11) Growth of international trade: World bank promotes growth of intenfaiojialitrade and help
maintain BOP equilibrium of the merpber countries.
Functions of ADB
The following. functions of ADB are as follows
1) Lending Operation: As per foe Articles, any developing member country of foe region
can borrow from I ADB for any public or private sector enterprise. Foods are channeled
Sura OCRs if foe borrowing country I possesses the necessary debt service capacity- If
not, concessional loans are provided from foe special I foods. While leading. ADB takes
use account the following consideration:
i) Gescra! economic conditions of foe borrower,
ii) Its access to other sotnoes of funds,
Its actual need for the funds and its development plans and priorities It aids only those
projects that se economically nod socially viable. Economic viability includes among
etherthings, technical feasibility, financial somdness of foe project, removal of economic
bottlenecks, and raising of producDvicy, etc. The social aspect covers poverty redactionin
general and amelioration of w'nerable groups in particular, development of human resources,
especially foe role of women, and reduction in regional disparity, etc. There are some less
developed contries that do not possess foe vyfssj'yinfrastructure for preparing effective
project reports They are provided technical assistance for this wnwStnrv l>dv I9ri foe OCR
loans are nmviderl either as dollar loan nr as mvbimnaicviresits.
2) Co-Financing: ADB lends not only on its own nrcownt, bat also partkipsiesia co-fiaantring
activities, particularly when foe project cost is large. It also ananges for foe partkipatioo
of ocher public and private finance-lending institutions so that foe borrowers get large
resources and foe leading risk of individual tenders is reduced.
3) Technical .Assistance: Technical Assistance is channded for identifying, urptemewarig
and operating of projects or for strengthening the capability for formula lag of
development strategicsia developing member countries (DMCs). Technolog) transfer is
often a part of technical It is normally provided out of TASF either as a loan or as s grant.
4) Equity Investment: Equity investment is available to private-sector enterprises aod to
financial institutions. The practice was started in I9S : Sow k is common. This way ADB
also provides risk capital.
5) Regional Cooperation: Besides the itadafoaal n>k of finaocicg projects and programmes,
ADB helps foe process of regional cooperation among DMCs. Since different member
coontriss are a different stages of development, regional cooperation benefits them alLA
phased approach is bang followed since 1992. i) In the first phase, ADB tries to create
awareness through loczsuag foe potential areas for cooperation and through quantifying
the potential benefit.
In the second phase, it identifies foe particular projects and prograres. In foe third phase, funds
are extended lor identified projects and programmes that enhance regional cooperation.
African Development Bank (AfDB)
The AfDB was created in 1964 and was for nearly two decades an African-only institution,
reflecting the desire of African governments to promote stronger unity and cooperation among
the countries of their regioi. The AfDB was created in 1964 and was for nearly two decades an
African-only institution, reflecting the desire of African governments to promote stronger unity
and cooperation among the countries of their region, in 1973, ' the AfDB created a concessional
lending window, the African Development Fund (AfDF), to which non- regional countries could
become members and contribute. The U.S. joined the AfDF in 1976. In J 982/f membership in
the AfDB non-concessional lending window was officially opened to non-regional members. The
AfDB makes loans to private sector firms through its non-concessional window and does not
have a separate fund specifically for financing private sector projects v/ith a development focus
in the region.
Functions of AfDB
The AfDBs main functions are:
1) To make loans and equity investments for the economic and social advancement of the
regional member countries (RMCs):
2) To provide technical assistance for the preparation and execution of development projects
and programs:
3) To promote investment of public and private capital for development purposes:
4) To respond to requests for assistance in co-ordinating the development policies and plans
of the RMCs:
5) To give special attention to national and multinational projects and programs that
promote regional integration.
1.8.6. European Bank for Reconstruction and Development (EBRD)
The EBRD is the youngest MDB, founded in 1991. The motivation for creating the EBRD was
to ease the transition of the former communist countries of Central and Eastern Europe (CEE)
and the former Soviet Union from planned economies to free-market economies. The EBRD
To undertake such other activities and provide such other services as may further
these functions.
4) The Bank shall work in close cooperation with all its members and, in such manner
as it may deem appropriate within the terms of this Agreement, with the
International Monetary Fund, the International Bank for Reconstruction and
Development, the International Finance Corporation, the Multilateral Investment
Guarantee Agency, and the Organisation for Economic Co-operation and
Development, and shall cooperate with the United Nations and its Specialized
Agencies and other related bodies, and any entity, whether public or private,
concerned with the economic development of, and investment in, Central and
Eastern European countries.
1.8.7* Inter-American Development Bank (IDB)
The IDB was created in 1959 in response to a strong desire by Latin American countries for a
bank that would be attentive to their needs, as well as U.S. concerns about the spread of
communism in Latin America.
Consequently, the IDB has tended to focus more on social projects than large infrastructure
projects, although the IDB began lending for infrastructure projects as well in the 1970s. From
its founding, the IDB has had both non-concessional and concessional lending windows. The
IDBs concessional lending window is called the Fund for Special Operations (FSO). The IDB
Group also includes the Inter-American Investment Corporation (IIC) and the Multilateral
Investment Fund (MIF), which extend loans to private sector firms in developing countries,
much like the World Banks IFC.
Functions of IDB
Following are thee functions of IDB
1) The IDBs two main priorities are to promote poverty reduction and social equity as well
as environmentally sustainable growth the Bank focuses its work on three specific areas.
i) The first area, global competitiveness, aims to foster competitiveness through support for
policies and programs ih&tmucusi a wouuuy's potential foi development in an open
global ccouomv.
ii) The second area, modernization, has the IDB aiming to modernize borrowing states by
strengthening the efficiency and transparency of public institutions.
iii) The third area, social development, requires IDB investment in social programs that
expand opportunities for the poor.
2) The IDBs main function is to act as a multilateral lending institution.
3) IDB member states give money to the Bank, and these contributions are used to financially
assist countries in need through loans and grants. In addition to loaning money.
4) The IDB will also act as a policy advisor to help entities manage the loaned money as
efficiently as possible.
5) The IDB helps borrowing member countries in formulating development policies to help
stimulate economic growth, increase global competitiveness, enhance social equity,
modernize the state, and foster free trade and regional integration.
6) To that end, the IDB also finances technical assistance in the form of economic experts and
impartial monitors to achieve this growth.
maintain bank accounts outside their country of residence. International banking services provfc,
with confidentiality, with choice; it offers reduced complexity and a tax efficient internati
managing customers money. It is also known as Offshore Banking. International banking
service*^. ^ ' retail, commercial, corporate and trade finance services to clients around the world
through branches, representative offices, subsidiaries and affiliates.
From managing the risk, financing and paperwork associated with trade transactions to remitting
cash balance and establishing local banking services, international banks offers a comprehensive
range of services to help the company to operate around the world. Whatever the breadth and
depth of services the business needs, International banking services can make international
transactions more efficient and secure.
1.9.2.
based activities like commission on bills, guarantees, letters of credit, syndication fees,
loan processing, and counseling fees, etc., are more than the interest earned from
lending operations.
1.9.3. Functions of International Banking
The functions of international banking are as follows:
1) Taking deposits and making loans in domestic currency to foreign governments,
enterprises, and individuals:
2) Taking deposits and lending in foreign currencies to domestic and foreign entities:
3) Managing and acting as agents fotr syndicated loans; designing special financing
requirements for international trade and projects;
4) Foreign exchange transactions, dealing in' gold and precious metals, international money
transfers;
5) Providing documentary letters of credit, standby letters of credit, multiple currency
credit lines, bank acceptances, Euro note issuance facilities;
6) Trading in currency futures and options, financial future and options, interest rate and asset
swaps; writing interest rate caps;
7) Underwriting and placement of Eurobond issues, distribution of Euro commercial paper,
assisting cross- border mergers, acquisitions and sale financial advisory and
investment services.
1.9.4. Factors Leading to the Growth of International Banks
The following are the reasons for the growth of international banking:
1) Low Marginal Costs: Managerial and marketing knowledge developed at home can be
used abroad with low marginal costs.
2) Knowledge Advantage: The foreign bank subsidiaiy can draw on the contacts and credit
investigations for use in that foreign market I Nation Information Services
3) Local firms in jfmation on trade and financial markets in the (tunable from foreign
domestic banks.
4) restige: Very large multinational banks have high perceived prestige, liquidity, and
deposit safety that can be used to attract clients abroad.
5) Regulation Advantage: Multinational banks are often not subject to the same regulations
as domestic banks. There may be reduced need to publish adequate financial information,
lack of required deposit insurance and reserve requirements on foreign currency deposits,
and the absence of territorial restrictions (that is, U.S. banks may not be restricted to state
of origin).
6) Wholesale Defensive Strategy: Banks follow their multinational customer abroad to
prevent the erosion of their clientele to foreign banks seeking to service the
.multinational's foreign subsidiaries.
7) Retail Defensive Strategy: Multinational banks prevent erosion by foreign banks of
the travelers check, tourist, and foreign business market.
8) Transaction Costs: By maintaining foreign branches and foreign currency balances,
banks may reduce transaction costs and foreign exchange risk on currency
conversion if government controls can be circumvented.
9) Growth: Growth prospects in a home nation may be limited by a market largely
saturated with the services offered by domestic banks.
10) Risk Reduction: Greater stability of earnings is possible with international
diversification. Offsetting business and monetary policy cycles across nations
reduces the country specific risk of any one nation.
1.9..Forms of International Banking
There are different types of international banking offices ranging from correspondent bank*
relationships, through which minimal service can be provided to banks-customers, to branch
offices, and subsidiaries
the parent bank personnel that is designed to assist the foreign clients of the parent
bank in dealings with the banks correspondents and to provide the clients with a
level of service greater than that provided through merely a correspondent
relationship.
3) Foreign Branches: Foreign branches, which may provide full services, may be
established when the volume of business is sufficiently large and when the law of
the land permits it. Foreign branches facilitate better service to the clients and help
the growth of business.
4) Subsidiaries and Affiliates: A subsidiary bank is a locally incorporated bank that is
either wholly or largely owned by a foreign parent and an affiliate bank is one that
is only partially owned but not controlled by its foreign parent. Subsidiaries and
affiliates are normally meant to handle substantial volume of business. Their
autonomy, compared to branches, is more operational and has strategic management
leverage.
5) Offshore Financial Centers: A major contributor to the growth of international
banking is the offshore banking centres. An offshore banking center is a country
whose banking system is organized to permit external accounts beyond the normal
economic activity of the country. The principal features that make acountry
attractive for establishing an offshore banking operation are virtually total freedom
from host- country government banking regulations, e.g., low reserve requirements
and no deposit insurance, low taxes, a favorable time zone that facilitates
international banking transactions, and to a minor extent, strict banking secrecy
laws.
Offshore banks operate as branches or subsidiaries of the parent bank. Offshore financial
centers have one or more of the following characteristics;
i) Large foreign-currency (Eurocurrency) market for deposits and loans (that in
London, e.g.).
Market that is a large net supplier of funds to the world financial markets (that in
Switzerland, e.g.).
iv) Market that is an intermediary or pass-through for international loan funds (those in
the Bahamas and the Cayman Islands, e.g.).
Official regulatory climate favorable to the financial industry, in the sense that it
Euro Bank
A Euro Bank is defined as a financial intermediary that simultaneously bids for time deposits
and makes loans in a currency or currencies, other than that of the country in which it is
located. It accepts Euro currency deposits and gives Euro currency loans. A Euro Bank's
balance sheet consists of deposits and loans in other currencies. A Bank in Singapore,
accepting deposits of Euros by a British Company is called a Euro Bank. Thus, Euro Bank
refers to a function rather than an institution.
Euro Banks are international banks with the minimum of host government interference any
dealing in any convertible currency other than currency of the host country.
These Banks deal with both the residents and the non-residents but dealings are essentially in any
currency other than the currency of the host country:
Among the non-official funding agencies, international banks occupy the top position. If one
looks at their development since the 1950s,.distinct structural changes are evident. In the first
half of the twentieth century and till the late 1950s, international banks were primarily domestic
banks performing the functions of international banks. This , means that they operated in foreign
countries accepting deposits from, and making loans to, the residents of the host countries. They
dealt in the currency of the host countries, and at the same time, dealt in foreign currency while
making finance available for foreign trade transactions.
However, in the late 1950s and especially*in the early 1960s, banks with purely international
character emerged on the global financial scene. This new variety of banks came to be known as
Euro banks. The Euro banks emerged on a footing quite different from the traditionally known
international banks.
The Euro banks deal with both the residentsapd the .non-residents, but they deal essentially in
any currency other than the currency ofthe host couotjqr. For example, if-Euro bank is located in
London, it will deal in any currency other than the British Pound. The deposits and loans of the
Euro bank are remunerated at the interest rate set by the market forces operating in the Eurocurrency market and not by the interest rate prevailing among the domestic banks in the
host^ountry. Again, |p other difference between the traditional international bank and the Euro
bank is that the former Is'subjected to rules and jegulations of the host country, but the Euro
banks are free from those rules and regulations.
The rationale behind the deregulation is that the activities of the Euro banks do not touch the
domestic economy because they are concerned normally with the placement of the funds (foreign
currency) from one foreign market to another foreign market and so they are neutral from the
viewpoint of any direct impact on the balance of payments of the host country .
1.9.7. International Banking Services
worldwide, international banking services can help to manage overseas banking needs.
International banks always work for strengthening relationships with a wide range of
international financial institutions.
7) SWIFT: SWIFT enables its users to exchange automated, standardized financial
information securely and reliably, thereby lowering costs, reducing operational risk, and
eliminating operational inefficiencies. Whether clients are considering the use of
SWIFT file Act to fulfill the companys file transmission connections or simply need
prior and/or current day account reporting via SWIFT statements, as an active member
of SWIFT, international banks can provide those services.
8) Online Services: Conducting business overseas is never simple. Whether client is an
importer cc an exporter, he/she expend a great deal of time and resources on document
and transaction management That is why international banks have developed a set of
online resources to help customer to manage these processes more efficiently.
9) Strategic Sources: When dealing with buyers or suppliers in other countries, the rules
and regulations involved can often seem like a confusing maze of information and
requirements. -International banking services help client to navigate that maze by
introducing strategic sources - companies and agencies that can provide a foil range of
services to assist with his non-bank, trade services needs
10) Remittances: Remittance is a facility by which the bank makes funds available from a
customer at one place to him or anyone authorized by him, at another place within India
and abroad. International remittances can be inward or outward. International inward
remittances ensure quick and safe delivery of funds from exchange houses and banks to
beneficiaries in India. When any person, firm, organization or resident in India desires
to transfer funds to any place outside India, it gives rise to foreign outward remittances.
Funds are raised from the international financial market through the sale of securities,
such as international equities or Euro-equities, Euro bonds, medium-term and short-term
Euro notes and Euro commerctat papers. Presently, the use of securities is quite
extensive.
Funds are raised from the international financial market through the sale of securities,
ch
SU
equities or Euro-equities, international bonds like Euro bonds, medium-term and short-term.
Euro commercial papers. Presently, the use of securities is quite extensive.
Following are the various types of international financial instruments:
1.10.1.
Euro Commercial Paper (ECP)
It is a promissory note like the short-term Euro notes although it is different from Euro notes in
some ways. It is not underwritten, while the Euro notes are underwritten. The reason is that ECP
is issued only by those companies that possess a high degree of rating. Again, the ECP route for
raising funds is normally investor- driven, while the Euro note is said to be borrower-driven.
ECP came up on the pattern of domestic market commercial papers that had a beginning in the
USA and then in Canada as back as in 1950s. The prefix Euro means that the ECP is issued
outside the country in the currency in which it is denominated. Most of the ECPs are
denominated in U.S. dollars, but they are different from the U.S. commercial papers in the sense
that the ECPs have longer maturity going upto one year. Moreover, ECPs are structured on the
basis of all-in-cos^ whereas in U.S. commercial papers, various charges, such as front- end fee
and commission are collected separately.
ECPs face minimal documentation. Over and above, they are not underwritten. That is why their
use has been ilarge since their very inception. However, since 2000, there has been a marked
decline in the volume in favor of long-term bonds.
1.10.1.1. Features of Euro Commercial
Papers Following are the features of euro papery:
1) Euro commercial papers,are unsecured as they are backed only by the general credit
standing of the issuing companies and by the lines of credjt that they might be'in a
position to obtain from banks.
2) Euro commercial papers are negotiable by endorsement and delivery.
3) Euro commercial papers are regarded-as'highly safe&ndliqpiti instruments.
4) Euro commercial papers are also known To be a simple and flexible instrument in
Advantages of Euro Commercial Papers Euro commercial "papers provide the following
advantage
lie maturity,
{reification of short tenn funding through market that is found attractive by wide variety of
investors, Mobility in limits determined by the issuers cash flow requirements at any point of
time, successful Euro CP program will enhance the reputation of the issuer world wide among
the investing community.
In recent years, the growth in number of new issues and volume has showed down in Euro
Commercial Paper markets. As a result of some defaults, investors concern about credit
worthiness has increased dramatically.
1.10.2. Euro Bonds
Eurobonds constitute a major source of borrowing in the Eurocurrency market. A bond is a debt
security issued by the borrower, which is purchased by the investor and it involves in the process
some intermediaries like underwriters merchant bankers etc. Eurobonds are bonds of
international borrowers sold in different markets simultaneously by a group of international
banks. The bonds are issued on behalf of governments, big multinational corporations, etc.
Eurobonds are unsecured securities and hence normally issued by Governments, Governmental
Corporations, and Local Bodies which are generally guaranteed by the governments of the
countries concerned and big multinational borrowers of good credit rating.
The bonds are sold by a group of international banks, which form a syndicate. The lead banks in
the syndicate advises the issuer of the bond on the size of the issue, terms and conditions, timing
of the issue etc. and take up the responsibility of coordinating the issue. Lead managers take the
assistance of co-managing banks. Each issue is underwritten by a group of underwriters and then
is sold.
1.10.2.1. Features of Euro Bonds
Following are the features of euro bonds
1) Euro bond issues are not subject to the costly and time-consuming registration procedure.
Disclosure requirements are also less stringent than those which apply to domestic issues.
This feature appeals to many MNCs, which often do not wish to disclose detailed and highly
sensitive information.
2) Euro bonds are issued in bearer form, which facilitates their negotiation in the secondary
market This feature also means that the county of the ultimate owner of the bond is not a
matter of public record.
3) Euro bonds offer investors, exemption from tax-withholding provisions applicable to domestic
and foreign bonds. Hus feature allows US MNCs to reduce their borrowing cost by having
their offshore financing subsidiaries issue Eurodollar bonds, with payment of interest and
principal guaranteed by the parent company.
4) Euro bonds are commonly denominated in a number of currencies.
5) Euro bonds carry a convertibility clause allowing them to be converted into a specified
number of shares of common stock.
6) In euro bonds coupon payments are made yearly.
1.10.3. Foreign Bonds
Foreign bond is a bond that is issued in a -domestic market by a foreign entity, in the domestic
markets currency. Foreign bonds are regulated by the domestic market authorities and are
usually given nicknames that refer to the domestic market in which they are being offered. Since
investors in foreign bonds are usually the residents of the domestic country, investors find them
attractive because they can add foreign content to their portfolios without the added exchange
rate exposure. In other words, foreign bonds are debt instruments issued by foreign corporations
or foreign governments. Such bonds are exposed to default risk, especially the corporate bonds.
These bonds are denominated in the currency of the country where they are issued, however, in
case these bonds are issued in a currency other than the investors home currency, they are
exposed to exchange rate risks. An example of a foreign bond - A British firm placing dollar
denominated bdnds in U.S.A.
Features of Foreign Bonds
A foreign bond has following characteristics:
1) The bond is issued by a foreign entity (such as a government, municipality or corporation).
2) The bond is traded on a foreign financial market.
3) The bond is denominated in a foreign currency.
4) Issuers of foreign bonds include national governments and their sub-divisions, corporations,
and supranational (an entity that is formed by two or more central governments through
international treaties).
5) They can be publicly issued or privately placed.
Difference between Foreign Bonds and Euro Bonds
International bonds are classified as foreign bonds and Euro bonds. There is a difference between
the two, primarily on four counts:
1) In the case of foreign bond, the issuer selects a foreign financial market where the bonds are
issued in the currency of that very country. If an Indian company issues bond in New York
and the bond is denominated in U.S. dollar, it will be called a foreign bond. On the contrary,
in the case of Euro bonds, they are denominated in a currency other than the currency of the
country where the bonds are issued. If the Indian company's bond is denominated in U.S.
dollar, the bonds will be issued in any country other than the USA. Then only it will be
called Euro bond.
2) Foreign bonds are underwritten normally by the underwriters of the country where they are
issued. But the Euro bonds are underwritten by the underwriters of multi-nationality.
3) The maturity of a foreign bond is determined keeping in mind the investors of a particular
country where it is issued. On the other hand, the Euro bonds are tailored to the needs of the
multinational investors. In the beginning, the Euro bond market was dominated by
individuals who had generally a choice for shorter maturity, but now the institutional
investors dominate the scene who do not seek Euro bond maturity necessarily to match their
liabilities. The result is that the maturity of Euro bonds is diverse. In England, Euro bonds
with maturity between eight and twelve years are known as intermediate Euro bonds.
4) Foreign bonds are normally subjected to governmental regulations in the country where they
are issued. For example, in the case of Yankee bonds (the bonds issued in the USA), the
regulatory thrust lies on disclosures. In some of the European countries, the thrust lies on the
resource allocation and on monetary control. Samurai bonds (bonds issued in Japan)
involved minimum credit-rating requirements prior to 1996. But the Euro bonds are free
from the rules and regulations of the country where they are issued. The reason is that the
currency of denomination is not the currency of that country and so it does not have a direct
impact on the balance of payments.
Global Bonds
It is the World Bank which issued the global bonds for the first time in 1989 and 1990. Since
1992, such bonds are being issued also by companies. Presently, there are seven currencies in
which such boids are denominated, namely, the Australian dollar, Canadian dollar, Japanese yen,
Swedish krona and Euro. Global bonds are debt instruments that are issued simultaneously in
several
countries.
These
bonds
are
usually
issued
by
large
multinational
..
.*
Trading in global bonds is similar to that of regular bonds. However, unlike regular bonds, they
can be issued in die domestic as well as in international currencies. The returns on global bonds
could be impacted by fluctuations in the foreign currency market.
Thus, when investing in global bonds, an investor must select a bond that is:
1) Issued in a stable currency, like the U.S. dollar or the Euro, or opt for bonds in the
domestic currency.
2) Issued from a country that has a stable government. Although bonds from countries with
less stable government may offer higher yields, there is a higher risk of default.
1.10.4.3. Benefits of Global Bonds
Following are the benefits of global bond:
1) Global Bonds Help in Diversifying an Investment Portfolio: Investment in global bonds
helps reduce exposure to economic or political instability in a specific country and
improves a portfolio's risk profile. For example, returns to a U.S. investor who has
invested in Japanese and European bonds will not be impacted by fluctuations in the
U.S. interest rates.
2) Global Bonds Improve the Rate of Return: Returns from global bonds are typically
higher than returns offered by traditional government bonds and securities.
1.10.4.4. Risk Associated with Global Bonds
The risks associated with global bond investing are:
1) Capital gains can erode when an investors domestic currency appreciates visits the
currency in which the bond is issued.
2) The risk of the issuer defaulting on interest and principal payments is high due to the lack
of government data on these bonds.
3) High taxes are levied on profits generated through these bonds. These taxes, at times;
make global bonds unattractive.
1.10.5. Euro Equity
International equities or the Euro-equities do not represent debt, nor do they represent foreign
direct investment. They are comparatively a new instrument representing foreign portfolio
equity investment. In this case, the investor gets the dividend and not the interest as in case of
debt instruments. On the other hand, it does not have the same pattern of voting right that it
does have in the case of foreign direct investment. In foci. international equities are a
compromise between the debt and the foreign direct investment.
1.10.5.1.
The issuers issue international equities under certain conditions and with certain objectives
1) When the domestic capital market is already flooded with its shares, the issuing
company does not like to add further stress to the domestic stock of shares since such
additions will cause a foil in the share prices. In order to maintain the share prices, the
company issues international equities.
2) The presence of restrictions on the issue of shares in the domestic market facilitates
the issue of equities.
3) The company issues international equities also for the sake of gaining international
recognition among the public.
4) International equities bring in foreign exchange which is vital for a firm in a developing
country.
5) International capital is available at lower cost through the Euro equities Funds raised
through such an instrument do not add to the foreign exchange exposure.
From the viewpoint of the investors, international equities bring in diversification benefits and
ruse tennnjvritu a given risk or lower the risk with a given return. If investment is made m
international equates along wnh international bonds, diversification benefits are still greater.
Advantages of ADRs
1. Recti 'x investor enjoy rights which are comparable to those of holders of the
underlying securities
US securities markets merits to the Issuing Company: For issuers, there are several
reasons for launching and managing an VDR programme.
2. An ADR programme can stimulate investor interest, enhance a companys visibility,
broaden its stakeholder base* and increase liquidity ilBy enabling a company to tap US
equity markets, the ADR offers a new avenue for raising capital, often at highly
competitive costs. For companies with a desire to build a stronger presence in the
United States* an ADR programme can help finance US initiatives or facilitate US
iiit
acquisitions.
3. ADRs can provide enhanced communications with shareholders in the United States.
ADRs can provide enhanced communications with shareholders in the United States.
4. ADRs provide an easy way for US employees of non-US companies to invest in their
companies7 employee stock purchase plans
5. Features such as dividend reinvestment programmes can help ensure a continual stream
of investment into an issuers programme
6. ADR ratios can be adjusted to help in ensuring that an issuers ADRs trade is in a
comparable range with those of its peers in the US market.
7. May increase focal prices as a result of global demand / trading through a more
broadened and a more diversified investor exposure Benefits to the Investors:
Increasingly investors aim to diversify their portfolios internationally. Obstacles*
however, such as undependable settlements, costly currency conversions, unreliable
custodial services, poor information flow, unfamiliar market practices, confusing tax
conventions and internal investment policy may discourage institutions and private
investors from venturing outside their local market. As negotiable securities* ADRs are
quoted in US dollars and pay dividend of jnterest in US dollars. They overcome the
obstacles that mutual funds, pension funds, and other institutions may have in
purchasing and holding securities outside the focal market Enumerated below are the
principal advantages to the investors: i) Depositor) Receipts are US Securities:
Depository receipts are registered with the US Securities and Exchange Commission
and trade like any other US security in file over-the-counter market or on a national
exchange. Depository receipt investors enjoy rights which are comparable to those of
holders of the underlying securities, plus they have the benefits, convenience and
efficiency of trading in the US securities markets.
8. Depository Receipts are easy to Buy and Sell: Investors purchase and
sell depository receipts through their US brokers in exactly the same
way as they purchase or sell securities of US companies. Many
regt.;sal
NASD
brokers/dealers,
and
virtually
all
New
York
systems
within
three
business
days;
while
direct
Disadvantages of ADRs
1.10.1.7.
1. GDRs can hoisted oft any American and European Stock Exchange.
2. One GDR can represent more than one share, e.g., one GDR = two
3.
4.
5.
6.
7.
shares.
The bearer or holder of the GDRs can get them converted into shares.
The holder of the GDRs has not right to vote in the company.
However ,tJjg share holders to have this right.
The dividend on these GDRs is quite like the dividend on shares.
GDRs are in U.S. dollar denomination.
Vfoantxmomy places its equity shares in the custody of a domestic (Indian) bank which is the
Domestic Qmta Bank (DCS) - The Company authorizes an Overseas Depository Bank (ODB)
to issue GDRs (book b&afe$ adopted for price discover}') against issue of the companys
equity shares or Foreign Currency Ownffrihle Bonds. The ODB can be any bank in the country
where the Indian company plans to make the issue -O foe company's orders, the DCB
instructs the ODB to issue the GDRs to investors. GDRs are issued at a cofRua predetermined
ratio to the companys shares or bonds. A GDR is evidence of a Global Depository Share. TV
holder of one GDS will in reality be holding one or two or even ten equity Shares or bonds of
the Indian company.
Advantages of GDRs
TV -dbfef advantages cf issuing GDR are the following:
3) Getting Fwe^i Capital: The Indian companies can get foreign capital through the
medium of GDR. It nates sufficient finance available to them. It thus increases the
foreign exchange reserve in the country. Beat these factors help in the economic
development
T More Liquidity: There is more liquidity in the GDRs as compared to the shares because
they are issued by the financially sound companies. In other words, they can be sold
easily
II Increase InGoodwill of Company: A company that issues the GDR gains reputation in the
market This 3SgsaafiioB directly affects the sales of the company
Floating Costs: A company has to bear less expense in issuing GDR as compared to the
issuing of shares
5) Better Share Price: A company earns morq price by issuing GDR instead of issuing shares
in the domestic mazlaeti because foe GDR is an indicator of foe good financial position of
foe company
c Scattered Shareholders: The issue of the GDR makes it possible for the shareholders to cross
the domestic boundaries and spread for and wide. This ends foe financial problem of foe
company and it comes to be recognized an global basis
IJiTA Disadvantages of GDRs
TV disadvantages of GDRs are as follows:
GDR (Global Depository Receipt) is raised through public issues and, hence, is more expensive
in terms of adnasigretive expenses
GDRs do, however, have foreign exchange risk if foe currency of foe issuer is different from foe
currency of foe GDR, which is usually USD
hurodacticn to International financial Syste
Basis of
ADRs
GDRT^^
Difference
l) Centre The NYSE is the largest stock The LSE is not as large as theKY$^
exchange in the world by both value but is the global centre for
2) No legal or technical difference Unlike the NYSE, the LSE
Instniment between an ADR arid a GDR. The makeT^..demandsrequiring
US has three disclosure
levels ofrequired
ADR Detailed
companiesinformation
to give holds*
the righton
3) Comprehensive
required
Disclosure for F-l, the US prospective which fee \ company, but less onerous for
4) GAAP Foreign companies listing in the US LSE satisfied with a statement olpe
must reconcile their accounts to US difference between the UK and
5) Cost US listing could be expensive. Total GDR listing on the LSE
is
investors
cannot
7) Liability Legal liability of both, a company Legal liability of a company and its
and
its
individual
an ADR.