Lecture I - IBF

Introduction
Contact Info :

divyataved@gmail.com; Mob : 9930124529

Text Book - Vipul Prakashan

Chandra Iyer (Preferred) ; Deepak Abhyankar

(QP in the end)
Total Marks : 100 Marks (75+25)
75 Marks : 5 Questions, 15 Marks each. No
Objectives.
No of chapters for internal exams: 3 or 4
25 Marks Internal Exam (20M) + Class

Participation & Attendance (5M)

What is the subject all

about ?
International Trade
International Banking
Foreign Exchange
Capital inflow & Outflow
Balance of Payment
Historical evidence of various financial

systems and crisis

Chapter 1
International Trade - Mainly Imports &

Exports
System by which the countries exchange
goods and services
Goods : Equipment, Consumer Goods, Oil,
etc.
Service : Insurance, Transportation, Tourism
International trade has increased
significantly with the end of World War II.

Reasons for International

trade
Satisfaction of diverse needs : not possible

for a country to produce everything it

needs
Economies of Scale : Produce domestic +
foreign
Wider Choice : Customer choice + cost
advantage
Optimum Utilization of Resources : More
returns from same resources
Comparative cost advantage
Interdependence of nations : No country is
self reliant

Theory
Theory of Absolute Advantage was first

explained by renowned economist Adam

Smith .
Theory was modified further as Theory of
Comparative Advantage by David
Ricardo.
Theory explains the relative advantage a
country enjoys as compared to other
countries in terms of natural resources,
labor, cost, etc.

International Banking
Aliber A subset of commercial banking

having a cross country element

Difference vs. domestic banking on
following points
Currency denomination
Customer location
Bank location

Features of International
Banking
Currency Risk
Complexity of credit risk : Credit risk is default by

the borrower in repayment of loan. Complex due to

currency, regulatory, legal and political environment.
Completion of market share
Cyclical nature with periodic crisis
Competition for bank loans from international bond
markets
Importance of International interbank market :
important source of liquidity
Role of risk management activities : swaps, options,
futures, etc.

Reasons for International

Banking
Expansion of business activities across

borders
Strategic need of the business : Evolution
of LPG
Inter country difference in the cost of
capital
Market Imperfections & Regulatory
Avoidance : Different reserves, taxes,
reporting, etc.
Risk Reduction : benefit from company with
favorable eco. situations.

International Capital Markets

International
Capital Markets

International Bond
market

International Equity
market

International Equity Market

ADR -American Depository receipts
GDR - Global Depository receipts

IDR International
Depository receipts

ADR :
Negotiable certificate
Dollar Denominated
Represents non-U.S companys publicly traded equity
Issued by depository bank in U.S
Helps Americans invest in non-US companies
Foreign companies can list on US exchanges like the
New York Stock exchange and Nasdaq through this
process.

Three types :ADR Level I :

First step for an issuer in the U.S Public
equity market
Minimum disclosure to SEC
Not to comply to U.S GAAP
Traded in the OTC market
Not allowed to raise fresh capital or list on
any one of the national stock exchanges.

ADR Level II :
Listed on AMEX & BYSE
Noteworthy disclosures required to SEC
Meet listing requirements of a exchange
Enlarge the investor base to a great extent

ADR Level III :

Used for raising fresh capital through public

offering in the US capital markets.

The co. has to be registered with SEC
Comply with listing requirement of
AMEX/NYSE
Follow U.S GAAP

Advantages of ADR
Easy and cost effective way to buy shares of a foreign

company
Reduce administrative costs
Avoid foreign tax on every transaction
Helps listed companies to tap American equity markets.
Price and Dividends in USD
Denominated in USD, Traded in USD and can be brought
through any broker.
Right to exchange shares
Any foreigner can purchase these securities
Represents fraction of shares, single share or multiple
shares of foreign stock.

GDR Global Depository

Receipts
A negotiable certificate
Denominated in foreign currency USD or Euro
This is a way foreign companies can list on European

exchanges like the London Stock Exchange, etc

The shares trade as domestic shares, but are offered
for sale globally through the various bank branches.
A bank certificate issued in more than one country
for shares in a foreign company.

Definition of GDR
GDR is a negotiable instrument representing

publicly traded local-currency equity share.

It is a form of instrument in form of depository
receipt
Or
a certificate created by the Overseas
Depository Bank out side India
And
issued to non-resident investors against the
issue of ordinary shares or bonds of issuing
company.

Features of GDR
Collection in foreign currency
Listing
Lock-in-period
Marketing
No exchange risk
No voting rights

Advantages of GDR
For Issuers pg. 79 of TB
For Investors pg. 80 of TB

Role and function of intermediaries

in GDR
1. Lead Managers
2. Other managers or subscribers
3. Depository
4. Custodian
5. Clearing Systems

1. Lead Managers/Arrangers :
It

is an investment bank which has the main

responsibility of assessing the market and market
the GDR issue.
Helps in documentation, investor presentation,
selection of other managers, post-issuance process.
Due Diligence

2. Other managers or subscribers

Appointed by Lead Managers
Take some part of the GDR issuance as discussed

with lead manager

3. Depository :
A bank or financial institution
Appointed by Issuing Company
Receives compensation from the co. as well

as GDR holders (investors).

4. Custodian
Appointed by Depository
Fees from depository
Custody of share certificate, dividends,
rights and bonus.
Appointed in consultation with issuing
company.

5. Clearing Systems
European Registrar
EUROCLEAR
CEDEL

U.S Registrar
DTC (Depository Trust Company)

Steps in GDR Issuance

Amount in USD + Market Conditions +

impact on gearing, EPS company & lead

manager
Lead managers agree to subscribe to the
issue + subscription agreement on the
issue date
Green Shoe : Additional Quantity by lead
manager
Depository and custodian are appointed
Ready to launch the issue

The co. issues a share certificate equal to

the numbers of GDR to be sold.

Certificate in name of depository + kept in
custody of the custodian.
Before receipt of the proceeds ; certificate
is kept in escrow.
Investors pay money to subscribers
Subscriber deposit the funds with the
Depository deducting their commissions
and expenses.

The. Co registers the depository as holder

of shares in register of shareholders

The depository delivers the European GDR
for CEDEL, EUROCLEAR & DTC
Clearing systems allot GDR each to
ultimate investor
Thus, investors get GDR
They can sell after the cooling off period
Custodian will issue share certificate
instead of GDR, if it is sold.
Dividends collected by Custodian and paid
in local currency.

Self Study
Advantages/Disadvantage - GDR
Page 85 Self Study
Distinguish ADR vs. GDR
Page 87 Self Study

Mechanics of GDR issue

1. Shareholders approval needed
Issuance requires shareholders mandate
Terms of the issue
Committee of directors for fixing offering

memorandum, issue price, notify stock exchange,

etc.

2. Appointment of lead manager

3. Finalization of issue structure : provide

following information to the government.

Lead Manager
2. Co-Lead Manager
3. Currency
1.

4. Issue Price
5. Taxation
6. Issue amount
7. Green Shoe option
8. Commission

International Bond Markets

Widely used debt instrument
A loan from holder of the bond to the issuer

of the bond
Bond can be sold by issuing co.,
government, etc.
Those who dont want to issue equity
shares and dilute theor ownership, will
issue bonds

Types of International Bonds

EUROBONDS
Bonds issued and sold outside the home

country of the currency

Ex. A dollar denominated bond issued in UK
is Euro (dollar) bond.
A Yen denominated bond issued in US is a
Euro (Yen) bond.

International Bonds :
Sold simultaneously in several international

service centres
Denominated in one currency, USD or Euros
By offering in several markets, the co. is
reducing its costs.
Generally high rated and large firms

FOREIGN BONDS
Floated in domestic market denominated in
domestic currency by a non-resident entity.
Dollar denominated bonds issued in U.S

markets by a non-US company is called

Yankee bonds.
Yen denominated bonds issues in Japanese
domestic market by non-Japanese
companies are called Samurai Bonds
Pounds denominated issued in UK - by
non U.S company is called Bull dog bonds.

Short term/Long term funds

instruments
Short term
Euro Certificate of deposit
Bankers Acceptance
Euro Commercial Papers
Long term
Euro medium term notes
Euro bonds
Euro loans

Short term
Euro certificate of deposit :
Negotiable instrument evidencing a deposit
with a bank
Can be disposed off in secondary market
Holder paid face value + interest
Used by commercial banks for short term
Issued largely by banks in London

Bankers acceptance :
Issued by a firm + guaranteed by banks
Similar to Treasury Bills
Sold at discount in secondary market
Euro commercial papers :
short term debt security
Issued as a promissory note in bearer form
Unsecured generally

Issued by high rated corporates for their

business needs
Issues domestic or international
Euro does not mean Europe or Euro Currency.
It means commercial paper issued in one
country in the currency of another.

Long term instruments

Euro Medium term notes
They are issued in installments
Majority are not underwritten

Euro Bonds
A foreign co. issues a bond denominated in a

currency which is not the home currency of

the investors.
US company issues bond in Japan in US dollar

Euro Loans
Loans from bank to companies
Two broader categories
Club Loans
Syndicated Loans

Club loans :
Private arrangement between lending
banks and a borrower.
Generally when loans are small and parties
know each other

Syndicated loans :
Available for a longer maturity
Public arrangement for organizing loan

FCCB & FCEB

FCCB : Foreign Currency Convertible Bonds
FCEB : Foreign Currency Exchange Bonds

FCCB:
A Convertible bonds is a mix of debt and
equity instrument
It is a bond having regular coupon +
principal payment
But bondholder has an option to convert
the bonds into equity.
Issued other than in foreign currency
Investors receive guarantee + equity price
appreciation

FCEB
Issuer co. issues FCEB
FCEBs are convertible into shares of

another company (offered company)that

forms part of the same promoter group as
the issuer co.

FDI vs. FPI

FDI Foreign Direct Investment
It refers to an investment in foreign assets
with the aim of control and manage them.
Long term strategy
Co. generally benefit from access to local
markets and resources, in exchange of
expertise, technical know how, and capital.
FDI can be inward and outward.
Difference is call the net FDI inflow.

FPI
Foreign Portfolio Investment
Entry of funds into a country where
foreigners deposit money in a country's
bank or make purchases in the country's
stock and bond markets, sometimes for
speculation.
They are a volatile component of capital
flows
Not always long term in nature
Aim to make profits and diversification

Chapter 2 BOP
Refer word doc.

Concept of Convertibility
Currency of a country can be freely

converted into foreign exchange at

market determined rate of exchange
that is, exchange rate as determined
by demand for and supply of a
currency.
For

example, convertibility of rupee

means that those who have foreign
exchange (e.g. US dollars, Pound
Sterlings etc.) can get them converted
into rupees and vice-versa at the market
determined rate of exchange

Current Account
Convertibility
India is fully convertible on current

account
Currency may be convertible on
current account (that is, exports and
imports of merchandise and
invisibles) only.

Capital Account Convertibility

By capital account convertibility we mean

that in respect of capital flows, that is,

flows of portfolio capital, direct investment
flows, flows of borrowed funds and
dividends and interest payable on them, a
currency is freely convertible into foreign
exchange and vice-versa at market deter
mined exchange rate.
Thus, by convertibility of rupee on capital
account means those who bring in foreign
exchange can get them freely converted
into rupees without taking any permission
from the government.

Since capital convertibility is risky

and makes foreign exchange rate

more volatile, is introduced only some
time after the introduction of
convertibility on current account
when exchange rate of currency of a
country is relatively stable, deficit in
balance of payments is well under
control and enough foreign exchange
reserves are available with the
Central Bank.