SDR- Special Drawing Rights (SDRs)

The SDR is an international reserve asset, created by the IMF in 1969 to supplement its member
countries’ official reserves. Its value is based on a basket of four key international currencies, and SDRs
can be exchanged for freely usable currencies. With a general SDR allocation that took effect on August
28 and a special allocation on September 9, 2009, the amount of SDRs increased from SDR 21.4 billion
to SDR 204 billion (equivalent to about $308 billion, converted using the rate of August 31, 2010).

The role of the SDR

The SDR was created by the IMF in 1969 to support the Bretton Woods fixed exchange rate system. A
country participating in this system needed official reserves—government or central bank holdings of
gold and widely accepted foreign currencies—that could be used to purchase the domestic currency in
foreign exchange markets, as required to maintain its exchange rate. But the international supply of two
key reserve assets—gold and the U.S. dollar—proved inadequate for supporting the expansion of world
trade and financial development that was taking place. Therefore, the international community decided
to create a new international reserve asset under the auspices of the IMF.

However, only a few years later, the Bretton Woods system collapsed and the major currencies shifted to
a floating exchange rate regime. In addition, the growth in international capital markets facilitated
borrowing by creditworthy governments. Both of these developments lessened the need for SDRs.

The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely
usable currencies of IMF members. Holders of SDRs can obtain these currencies in exchange for their
SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and
second, by the IMF designating members with strong external positions to purchase SDRs from
members with weak external positions. In addition to its role as a supplementary reserve asset, the SDR,
serves as the unit of account of the IMF and some other international organizations.

Basket of currencies determines the value of the SDR

The value of the SDR was initially defined as equivalent to 0.888671 grams of fine gold—which, at the
time, was also equivalent to one U.S. dollar. After the collapse of the Bretton Woods system in 1973,
however, the SDR was redefined as a basket of currencies, today consisting of the euro, Japanese yen,
pound sterling, and U.S. dollar. The U.S. dollar-equivalent of the SDR is posted dailyon the IMF’s
website. It is calculated as the sum of specific amounts of the four basket currencies valued in U.S.
dollars, on the basis of exchange rates quoted at noon each day in the London market.

The basket composition is reviewed every five years by the Executive Board to ensure that it reflects the
relative importance of currencies in the world's trading and financial systems. In the most recent review
(in November 2010), the weights of the currencies in the SDR basket were revised based on the value of
the exports of goods and services and the amount of reserves denominated in the respective currencies
that were held by other members of the IMF. These changes become effective on January 1, 2011. The
next review will take place by 2015.

The SDR interest rate

The SDR interest rate provides the basis for calculating the interest charged to members on regular (non-
concessional) IMF loans, the interest paid to members on their SDR holdings and charged on their SDR
allocations, and the interest paid to members on a portion of their quota subscriptions. The SDR interest
rate is determined weekly and is based on a weighted average of representative interest rates on short-
term debt in the money markets.

SDR allocations to IMF members

Under its Articles of Agreement, the IMF may allocate SDRs to members in proportion to their IMF
quotas. Such an allocation provides each member with an asset (SDR holdings) and an equivalent
liability (SDR allocation). If a member’s SDR holdings rise above its allocation, it earns interest on the
excess; conversely, if it holds fewer SDRs than allocated, it pays interest on the shortfall.

There are two kinds of allocations:

General allocations of SDRs. General allocations have to be based on a long-term global need to
supplement existing reserve assets. Decisions to allocate SDRs have been made three times. The first
allocation was for a total amount of SDR 9.3 billion, distributed in 1970-72 in yearly installments. The
second allocation, for SDR 12.1 billion, was distributed in 1979–81 in yearly installments.

The third general allocation was approved on August 7, 2009 for an amount of SDR 161.2 billion and
took place on August 28, 2009. The allocation increased simultaneously members’ SDR holdings and
their cumulative SDR allocations by about 74.13 percent of their quota.

Special allocations of SDRs. A proposal for a special one-time allocation of SDRs was approved by the
IMF's Board of Governors in September 1997 through the proposed Fourth Amendment of the Articles
of Agreement. Its intent is to enable all members of the IMF to participate in the SDR system on an
equitable basis and correct for the fact that countries that joined the Fund after 1981—more than one-
fifth of the current IMF membership—had never received an SDR allocation.

The Fourth Amendment became effective for all members on August 10, 2009 when the Fund certified
that at least three-fifths of the IMF membership (112 members) with 85 percent of the total voting power
accepted it. On August 5, 2009, the United States joined 133 other members in supporting the
Amendment. The special allocation was implemented on September 9, 2009. It increased members'
cumulative SDR allocations by SDR 21.5 billion using a common benchmark ratio as described in the
amendment.

Buying and selling SDRs

IMF members often need to buy SDRs to discharge obligations to the IMF, or they may wish to sell
SDRs in order to adjust the composition of their reserves. The IMF acts as an intermediary between
members and prescribed holders to ensure that SDRs can be exchanged for freely usable currencies. For
more than two decades, the SDR market has functioned through voluntary trading arrangements. Under
these arrangements a number of members and one prescribed holder have volunteered to buy or sell
SDRs within limits defined by their respective arrangements. Following the 2009 SDR allocations, the
number and size of the voluntary arrangements has been expanded to ensure continued liquidity of the
voluntary SDR market.

In the event that there is insufficient capacity under the voluntary trading arrangements, the Fund can
activate the designation mechanism. Under this mechanism, members with sufficiently strong external
positions are designated by the Fund to buy SDRs with freely usable currencies up to certain amounts
from members with weak external positions. This arrangement serves as a backstop to guarantee the
liquidity and the reserve asset character of the SDR.

QUOTAS- An import quota is a type of protectionist trade restriction that sets a physical limit on the
quantity of a good that can be imported into a country in a given period of time.Quotas, like other trade
restrictions, are used to benefit the producers of a good in a domestic economy at the expense of all
consumers of the good in that economy.

Critics say quotas often lead to corruption (bribes to get a quota allocation), smuggling (circumventing a
quota), and higher prices for consumers

IDA-The International Development Asso-ciation (IDA) is the part of the World Bank that helps the
world’s poorest countries. Established in 1960, IDA aims to reduce poverty by providing interest-free
credits and grants for programs that boost economic growth, reduce inequalities and improve people’s
living conditions.

IDA complements the World Bank’s other lending arm–the International Bank for
Reconstruction and Development (IBRD)–which serves middle-income countries with capital
investment and advisory services. IBRD and IDA share the same staff and headquarters and evaluate
projects with the same rigorous standards.

IDA is one of the largest sources of assistance for the world’s 79 poorest countries, 39 of which
are in Africa. It is the single largest source of donor funds for basic social services in the poorest
countries.

IDA lends money (known as credits) on concessional terms. This means that IDA credits have no
interest charge and repayments are stretched over 35 to 40 years, including a 10-year grace period. IDA
also provides grants to countries at risk of debt distress.

Since its inception, IDA credits and grants have totaled US$222 billion, averaging US$13 billion
a year in recent years and directing the largest share, about 50 percent, to Africa.

International Finance Corporation-The International Finance Corporation (IFC) is the private

sector lending arm of the World Bank Group, providing financial services to businesses investing in the
developing world. As private enterprises often privilege “business confidentiality” over the public’s
right to know, it is frequently difficult for the public to measure or influence the development impacts of
the IFC’s activities.

The IFC was established in 1956 to support the growth of the private sector in the developing
world. The IFC's stated mission is “to promote sustainable private sector investment in developing
countries, helping to reduce poverty and improve people's lives.”

While the World Bank (IBRD and IDA) provides credit and non-lending assistance to
governments, the IFC provides loans and equity financing, advice, and technical services to the private
sector. The IFC also plays a catalytic role, by mobilizing additional capital through loan syndication and
by lessening the political risk for investors, enabling their participation in a given project. The IFC has
worked with more than 3319 companies in 140 countries since its inception in 1956.

The IFC is one of the fastest growing institutions in the World Bank Group, with a committed portfolio
of USD $32.4 billion for IFCs own account, and $7.5 billion in loan syndications as of Fiscal Year 2008.

It is a public entity, although its clientele consists of transnational, national, and local private
sector companies, operating in a competitive and fast-moving business environment.

Multilateral Investment Guarantee Agency-The Multilateral Investment Guarantee Agency

(MIGA) is the political risk insurance arm of the World Bank Group.

Established in 1988 to help developing countries attract and retain private investment, it
furnishes private enterprises investing in developing countries with non-commercial risk insurance and
provides developing country members with technical assistance regarding investment promotion. MIGA
guarantees protected investors against loss resulting from expropriation, breach of contract, war and
civil disturbance including insurrection, coups d'état, revolution, sabotage and terrorism. In addition to
offering insurance to private companies, MIGA mobilizes additional guarantees for investors and assists
host governments with legal services and strategic advice regarding investment.

By September 2008, MIGA had issued 922 guarantees for over 96 developing countries
cumulatively worth over $19.5 billion since 1990

FUTURE VS FORWARD MARKET-

The forward market is the over-the-counter financial market in contracts for future delivery, so
called forward contracts. Forward contracts are personalized between parties (i.e., delivery time and
amount are determined between seller and customer). The forward market is a general term used to
describe the informal market by which these contracts are entered into. Standardized forward contracts
are called futures contracts and traded on a futures exchange(or future market)

CLEARING MARGINE- a fund set aside by an exchange for compensating customers whose
instructions have not been accurately carried out by members.These are Financial safeguards to ensure
that clearing members (usually companies or corporations) perform on their customers' open futures and
options contracts

CURRENCY OPTION-A contract that grants the holder the right, but not the obligation, to buy or
sell currency at a specified exchange rate during a specified period of time. For this right, a premium is
paid to the broker, which will vary depending on the number of contracts purchased. Currency options
are one of the best ways for corporations or individuals to hedge against adverse movements in
exchange rates.

CURRENCY CALL OPTION-A call option in which the underlying asset is a foreign currency.
The option gives the holder the right but not the obligation to buy a set amount of the currency at a
certain exchange rate on or before the expiration date. As with other currency options, these are largely
used when international corporations wish to hedge against the possibility of adverse movements in
foreign exchange rates.
CURRENCY PUT OPTION-A call option in which the underlying asset is a foreign currency.
The option gives the holder the right but not the obligation to buy a set amount of the currency at a
certain exchange rate on or before the expiration date. As with other currency options, these are largely
used when international corporations wish to hedge against the possibility of adverse movements in
foreign exchange rates.

FUTURE & OPTION-

A 'Future' is a contract to buy or sell the underlying asset for a specific price at a pre-determined time. If
you buy a futures contract, it means that you promise to pay the price of the asset at a specified time. If
you sell a future, you effectively make a promise to transfer the asset to the buyer of the future at a
specified price at a particular time. Every futures contract has the following features:

• Buyer
• Seller
• Price
• Expiry

Some of the most popular assets on which futures contracts are available are
equity stocks, indices, commodities and currency.

The difference between the price of the underlying asset in the spot market and the futures market is
called 'Basis'. (As 'spot market' is a market for immediate delivery) The basis is usually negative, which
means that the price of the asset in the futures market is more than the price in the spot market. This is
because of the interest cost, storage cost, insurance premium etc., That is, if you buy the asset in the spot
market, you will be incurring all these expenses, which are not needed if you buy a futures contract. This
condition of basis being negative is called as 'Contango'.

Sometimes it is more profitable to hold the asset in physical form than in the form of futures. For eg: if
you hold equity shares in your account you will receive dividends, whereas if you hold equity futures
you will not be eligible for any dividend.

When these benefits overshadow the expenses associated with the holding of the asset, the basis
becomes positive (i.e., the price of the asset in the spot market is more than in the futures market). This
condition is called 'Backwardation'. Backwardation generally happens if the price of the asset is
expected to fall.

It is common that, as the futures contract approaches maturity, the futures price and the spot price tend
to close in the gap between them ie., the basis slowly becomes zero.

Options
Options contracts are instruments that give the holder of the instrument the right to buy or sell the
underlying asset at a predetermined price
FISHER BLACK OPTION PRICING MODEL- The Black-Scholes model is used to
calculate a theoretical call price (ignoring dividends paid during the life of the option) using the five key
determinants of an option's price: stock price, strike price, volatility, time to expiration, and short-term
(risk free) interest rate.

The original formula for calculating the theoretical option price (OP) is as
follows:

Where:

The variables are:

S = stock price
X = strike price
t = time remaining until expiration, expressed as a percent of a year
r = current continuously compounded risk-free interest rate
v = annual volatility of stock price (the standard deviation of the short-term returns over one year). See
below for how to estimate volatility.
ln = natural logarithm
N(x) = standard normal cumulative distribution function
e = the exponential function

Assumptions

The Black-Scholes model assumes that the option can be exercised only at
expiration. It requires that both the risk-free rate and the volatility of the underlying stock price remain
constant over the period of analysis. The model also assumes that the underlying stock does not pay
dividends; adjustments can be made to correct for such distributions. For example, the present value of
estimated dividends can be deducted from the stock price in the model.

INTRACOMPANY TRANSFER- In an intra-company transfer, a company transfers an

employee to work temporarily in a different office, often in another country.

IFS AND ITS CHANNEL- The IMF International Financial Statistics (IFS) is a compilation of
financial data collected from various sources, covering over 200 countries worldwide, which is
published monthly by the International Monetary Fund (IMF). The IFS is the IMF’s principal statistical
publication covering numerous topics of international and domestic finance. It includes, for most
countries, data on exchange rates, balance of payments, international liquidity, money and banking,
interest rates, prices, etc.Most annual data begins in 1948, quarterly and monthly data dates back to 1957
and most balance of payments data begins in 1970.

The IMF compiles the data from various different sources including government departments,
national accounts, central banks, the United Nations (UN), Eurostat, the International Labour
Organisation (ILO) and private financial institutions.

GEOGRAPHICAL ARBITRAGE-Arbitrage activity from two currencies is known as

geographical arbitrage

INTREST ARBITRAGE- Interest arbitrage involves investing in foreign-bearing instruments

in foreign exchange in an effort to earn a profit due to interest rates differentials. For example, a trader
may invest $ 1000 in the United States for ninety days or convert $1000 into British pounds, invest the
money in the United Kingdom for ninety days and then convert the pounds back into dollars. The
investor would try to pick the alternative that would be the highest yielding at the end of ninety days.

International Bank for Reconstruction and Development-

The International Bank for Reconstruction and Development (IBRD) aims to reduce poverty in middle-
income and creditworthy poorer countries by promoting sustainable development through loans,
guarantees, risk management products, and analytical and advisory services. Established in 1944 as the
original institution of the World Bank Group, IBRD is structured like a cooperative that is owned and
operated for the benefit of its 187 member countries.
IBRD raises most of its funds on the world's financial markets and has become one of the most
established borrowers since issuing its first bond in 1947. The income that IBRD has generated over the
years has allowed it to fund development activities and to ensure its financial strength, which enables it
to borrow at low cost and offer clients good borrowing terms.
At its Annual Meeting in September 2006, the World Bank — with the encouragement of its shareholder
governments — committed to make further improvements to the services it provides its members. To
meet the increasingly sophisticated demands of middle-income countries, IBRD is overhauling financial
and risk management products, broadening the provision of free-standing knowledge services and
making it easier for clients to deal with the Bank. The IBRD provides loans to governments, and public
enterprises, always with a government (or "sovereign") guarantee of repayment subject to general
conditions. The latest member is Tuvalu, which joined in 2010. All members of the IBRD are also IMF
members, and vice versa.

History-
Commencing operations on June 25, 1946, it approved its first loan on May 9, 1947 ($250m to France
for postwar reconstruction, in real terms the largest loan issued by the Bank to date).
The IBRD was established mainly as a vehicle for reconstruction of Europe and Japan after World War
II, with an additional mandate to foster economic growth in developing countries in Africa, Asia and
Latin America. Originally the bank focused mainly on large-scale infrastructure projects, building
highways, airports, and powerplants. As Japan and its European client countries "graduated" (achieved
certain levels of income per capita), the IBRD became focused entirely on developing countries. Since
the early 1990s the IBRD has also provided financing to the post-Socialist states of Eastern Europe and
the republics of the former Soviet Union.
International Bond:Types-

In finance, a bond is a debt security, in which the authorized issuer owes the holders a debt and,
depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal
at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at
fixed intervals.

Thus a bond is like a loan: the issuer is the borrower (debtor), the holder is the lender (creditor), and the
coupon is the interest. Bonds provide the borrower with external funds to finance long-term investments,
or, in the case of government bonds, to finance current expenditure. Certificates of deposit (CDs) or
commercial paper are considered to be money market instruments and not bonds. Bonds must be repaid
at fixed intervals over a period of time.

Bonds and stocks are both securities, but the major difference between the two is that (capital)
stockholders have an equity stake in the company (i.e., they are owners), whereas bondholders have a
creditor stake in the company (i.e., they are lenders). Another difference is that bonds usually have a
defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding
indefinitely. An exception is a consol bond, which is a perpetuity (i.e., bond with no maturity).

• The definition of the eurobond market can be confusing because of its name.
Although the euro is the currency used by participating European Union countries, eurobonds refer
neither to the European currency nor to a European bond market. A eurobond instead refers to any bond
that is denominated in a currency other than that of the country in which it is issued. Bonds in the
eurobond market are categorized according to the currency in which they are denominated. As an
example, a eurobond denominated in Japanese yen but issued in the U.S. would be classified as a
euroyen bond.

• Foreign bonds are denominated in the currency of the country in which a foreign
entity issues the bond. An example of such a bond is the samurai bond, which is a yen-denominated
bond issued in Japan by an American company. Other popular foreign bonds include bulldog and yankee
bonds.

• Global bonds are structured so that they can be offered in both foreign and
eurobond markets. Essentially, global bonds are similar to eurobonds but can be offered within the
country whose currency is used to denominate the bond. As an example, a global bond denominated in
yen could be sold to Japan or any other country throughout the Eurobond market.