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INDIAN BANKS
DEFINITION OF BANK:A financial institution that is licensed to deal with money and its substitutes by accepting time and demand deposits, making loans, and investing in securities. The bank generates profits from the difference in the interest rates charged and paid.
BANKING STRUCTURE IN INDIA:Todays dynamic world banks are inevitable for the development of a country. Banks play a pivotal role in enhancing each and every sector. They have helped bring a draw of development on the worlds horizon and developing country like India is no exception. Banks fulfills the role of a financial intermediary. This means that it acts as a vehicle for moving finance from those who have surplus money to (however temporarily) those who have deficit. In everyday branch terms the banks channel funds from depositors whose accounts are in credit to borrowers who are in debit. Without the intermediary of the banks both their depositors and their borrowers would have to contact each other directly. This can and does happen of course. This is what has lead to the very foundation of financial institution like banks. Before few decades there existed some influential people who used to land money. But a substantially high rate of interest was charged which made borrowing of money out of the reach of the majority of the people so there arose a need for a financial intermediate.
Schedule Banks
Non-Schedule Banks
Commercial Banks
Commercial Banks
Indian
Foreign
EXPORT FINANCE
INTRODUCTION:Financial assistance is extended by the banks to the exporters at pre-shipment and post-shipment stages. Financial assistance extended to the exporter prior to shipment of goods from India falls within the scope of pre-shipment finance while that extended after shipment of the goods falls under post-shipment finance. While the pre-shipment finance is provided for working capital for the purchase of raw material, processing, packaging, transportation, warehousing etc. of the goods meant for export, post-shipment finance is generally provided in order to bridge the gap between shipment of goods and the realisation of proceeds.
OBJECTIVES
1. To cover commercial and non-commercial risks and political risks attendant on granting credit to a foreign buyer. 2. To cover natural risks such as earthquakes, floods etc. 3. To make available funds at the required time to the exporter. 4. To ensure that the cost of funds are affordable to the exporter.
Forms of Financial Assistance Provided by EXIM Bank to Indian Exporters:1. Delayed Payment Exports
Term loans are provided to those exporters who deal with exporting of goods and services and this enables them to offer delayed credit to the foreign buyers. This system of deferred credit covers Indian consultancies, technology and other services. Commercial banks take part in this program either directly or under risk syndication arrangements. 2. Pre-shipment credit
Indian companies which are highly involved in the execution of export activities beyond the cycle time of six months are funded by EXIM Bank. The construction or turnkey project exporters enjoy the provision of rupee mobilization. 3. Term loans for export production
EXIM Bank offers term loans to the 100 percent export oriented units, units involved in free trade zones, and exporters of various soft wares in India. EXIM bank also works in association with International Finance Corporation, Washington, to provide financial assistance to the small scale and medium industrial units EXIM Bank extends Lines of Credit (LOCs) to overseas governments, financial institutions, regional banks and other overseas entities, to finance India's exports to those countries. 4. Foreign Investment Finance
EXIM bank provides financial assistance for equity contribution to the Indian companies who form Joint Venture with the foreign companies. Financing export marketing
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It helps the exporters carry out their export market development plan in Indian market.
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OBJECTIVES
5. To cover commercial and non-commercial risks and political risks attendant on granting credit to a foreign buyer. 6. To cover natural risks such as earthquakes, floods etc. 7. To make available funds at the required time to the exporter. 8. To ensure that the cost of funds are affordable to the exporter.
Procure raw materials. Carry out manufacturing process. Provide a secure warehouse for goods and raw materials. Process and pack the goods. Ship the goods to the buyers. Meet other financial cost of the business.
Packing Credit Advance against cheques /Draft etc. representing Advance Payments.
Open account
In an open account transaction, the seller ships the goods together with the necessary documents to the buyer before the payment is made and without any form of guarantee. When the goods have been dispatched, the seller also sends the buyer an invoice asking for payment within the agreed credit terms, for example, 60 days from the invoice date. Seller: Do not agree to an open account when the buyer is new to you or you are unable to determine the risk or the reliability of the buyer. Keep in mind that your goods are delivered before payment; therefore, make sure that you supply your goods or services in accordance with the contract terms, thus avoiding disputes and non-payment. Insist on an electronic transfer (cleared funds) instead of a bank draft or cheque (unclear funds).
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Buyer: Make sure that the goods or services are satisfactory before you effect payment. Make sure that payment is made in accordance with the agreed credit terms to avoid damaging your trading relationship with the supplier. Make sure to pay according to the settlement instructions
Documentary credit
A documentary creditalso called a letter of creditis a conditional guarantee of payment in which an overseas bank takes responsibility for paying you after you ship your goods, provided you present all the required documents (such as documents of title, insurance policies, commercial invoices and regulatory documents). A documentary credit is a separate contract from an export contract. The parties to a documentary credit deal with documents, not the goods that the documents relate to. Documentary credits are a common method of payment in the international trade of goods as they offer some protection to both you and your buyer.
Your buyer pays the issuing bank to open and process a documentary credit.
The Australian bank will charge you a fee for advising and negotiating the documentary credit. You may pay a further fee if the credit is confirmed by another bank or if you receive an advance.
Irrevocablecannot be cancelled or amended without the consent of all parties, including the beneficiary. This is the most common type of documentary credit in the international trade of goods Revocablecan be cancelled by the issuing bank without warning to the beneficiary Confirmeda confirming bank (either in Australia or overseas) agrees to pay you under a documentary credit, whether or not payment is received from the issuing bank Transferablethe original beneficiary of the documentary credit can transfer their rights to a second beneficiary on the same or similar terms as the original documentary credit (the original beneficiary may be an intermediary between you and your ultimate buyer) Revolvingallows automatic reinstatement of the documentary credit after the amount for the original shipment has been paid, so subsequent shipments to your buyer are covered by a single documentary credit Standbya contingency documentary credit which you can draw on if your buyer, using another payment method, defaults in making a payment to you under the export contract Back-To-Back/Complementarywhere your buyer is the beneficiary of a separate documentary credit (in their capacity as a seller under a separate sales contract), they can sometimes use this credit as security to apply to their bank for a complementary documentary credit to cover their payment under an export contract with you Red Clausepre-shipment finance that allows you (the beneficiary) to receive an advance from the advising bank of all or part of the amount owed to you under a documentary credit so you can buy raw materials or other inputs required to manufacture the product for export.
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The characteristics of the post shipment finance Finance after the shipment of goods. 1. It is extended to those exporters in whose name the documents stand. (He may be the original exporter or the documents would have been transferred in his name.) 2. It can be a short term finance (for cash exports), or long term finance (for deferred exports) 3. It is working capital finance since it is against receivables. 4. It is extended only against the evidence of authenticated documents evidencing shipment of goods. 5. Only a fund based finance. 6. Concessionary rate of interest up to due dates (for normal transit period for sight bills and up to notional due date in case of usance bills). Rate of interest as per RBI guidelines. 7. Finance can be extended up to 100 % of the bill.
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WORKING CAPITAL
Export working capital (EWC) financing allows exporters to purchase the goods and services they need to support their export sales. More specifically, EWC facilities extended by commercial lenders provide a means for small and medium-sized enterprises (SMEs) that lack sufficient internal liquidity to process and acquire goods and services to fulfill export orders and extend open account terms to their foreign buyers. EWC financing also helps exporters of consigned goods have access to financing and credit while waiting for payment from the foreign distributor. EWC funds are commonly used to finance three different areas: (a) materials, (b) labor, and (c) inventory, but they can also be used to finance receivables generated from export sales and/or standby letters of credit used as performance bonds or payment guarantees to foreign buyers.
Factoring:
Export factoring is a complete financial package that combines export working capital financing, credit protection; foreign accounts receivable bookkeeping, and collection services. A factoring house, or factor, is a bank or a specialized financial firm that performs financing through the purchase of invoices or accounts receivable. Export factoring is offered under an agreement between the factor and exporter, in which the factor purchases the exporters short-term foreign accounts receivable for cash at a discount from the face value, normally without recourse. The factor also assumes the risk on the ability of the foreign buyer to pay, and handles collections on the receivables. Thus, by virtually eliminating the risk of non-payment by foreign buyers, factoring allows the exporter to offer open account terms, improves liquidity position, and boosts competitiveness in the global marketplace. Factoring foreign accounts receivables can be a viable alternative to export credit insurance, long-term bank financing, expensive short-term bridge loans or other types of borrowing that create debt on the balance sheet.
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Characteristics of Export Factoring Applicability Best suited for an established exporter who wants (a) to have the flexibility to sell on open account terms, (b) to avoid incurring any credit losses, or (c) to outsource credit and collection functions Risk Risk of non-payment inherent in an export sale is virtually eliminated Pros
Eliminates the risk of non-payment by foreign buyers Maximizes cash flows More costly than export credit insurance Generally not available in developing countries
Cons
2. Undisclosed: In undisclosed factoring, client's customers are not notified of the factoring arrangement. In this case, Client has to pay the amount to the factor irrespective of whether customer has paid or not.
Forfeiting:
1. The forfeiting typically involves the following cost elements: Commitment fee, payable by the exporter to the forfeiter for latters commitment to execute a specific forfeiting transaction at a firm discount rate with in a specific time 2. Discount fee, interest payable by the exporter for the entire period of credit involved and deducted by the forfeiter from the amount paid to the exporter against the availised promissory notes or bills of exchange.
Benefits to exporter:
100 per cent financing: Without recourse and not occupying exporter's credit line That is to say once the exporter obtains the financed fund, he will be exempted from the responsibility to repay the debt. Improved cash flow: Receivables become current cash inflow and its is beneficial to the exporters to improve financial status and liquidation ability so as to heighten further the funds raising capability. Reduced administration cost: By using forfeiting, the exporter will spare from the management of the receivables. The relative costs, as a result, are reduced greatly.
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Risk reduction: forfeiting business enables the exporter to transfer various risk resulted from deferred payments, such as interest rate risk, currency risk, credit risk, and political risk to the forfeiting bank. Increased trade opportunity: With forfeiting, the export is able to grant credit to his buyers freely, and thus, be more competitive in the market.
Benefits to banks:
Forfeiting provides the banks following benefits:
Banks can offer a novel product range to clients, which enable the client to gain 100% finance, as against 8085% in case of other discounting products.
Bank gain fee based income. Lower credit administration and credit follow up.
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Pre-Export Trade Financing Issuance of Letters of Credit, such as Documentary and Standby Letters of Credit
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COMMERCIAL RISKS
The Commercial Risk and Compliance practice provides customized risk advisory services to companies in the merchant acquiring and commercial card issuing industries, among others, including those with products that access deposit accounts. Payments companies today are operating in a risk landscape that is shifting ever more rapidly thanks to new technologies, changing regulatory regimes, volatile financial markets, and their growing interdependencies. Navigating this complex web of emerging risks and opportunities necessitates a more anticipatory approach to risk management. Our commercial risk practice is grounded in decades of industry experience and an exclusive focus on the payments vertical, ensuring in-depth and up-to-date understanding of the industry and the issues our clients face. Our roster of clients, which includes the largest, most successful and dynamic players in the industry, is testimony to our success in helping companies develop the insights that they need to detect and mitigate the ever-changing layers of risk. With our unparalleled industry experience and broad risk management capabilities, we are uniquely qualified to help clients identify and evaluate risk-adjusted business opportunities and extend their risk management function beyond compliance.
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COMMERCIAL RISKS TO BE COVERED:Commercial risks arise from foreign banks, companies or project companies. Typical commercial risks include the buyer's, borrower's or guarantor's insolvency or unwillingness to pay its debt. Factors considered assessing of the commercial risks of the transaction include:
Export transaction/project Line of business Financing Risk-sharing/coverage Securities Environmental aspects Buyer's country Other aspects involved, if any
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TRANSPORTATION RISK
Handling, Stowage, Storage
Nearly half of all transportation losses are due to handling, storage or stowing problems. Examples of this are:
Rapid acceleration or deceleration while hoisting Turning or lowering goods during loading or unloading Failure of handling equipment Failure of equipment such as lift trucks, cranes or porticoes during lifting Rough handling / incorrect stowage
Damage can be caused when inadequate equipment is used to move the goods or the operators of the equipment lack the necessary training to use it correctly. When heavy packages are stored on top of lighter ones damage is almost inevitable.
Storms or rough seas Failure of watertight seals Leaks or holes in containers Lorries with porous covers Failure of door joints
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Variations in temperature (changes in climate on long journeys) Humidity, Leaking of merchandise itself, Absence or insufficiency of drying products in the containers.
Flooding due to rivers overflowing their banks, heavy rains or failure of local drainage systems in areas where goods are stored during transit. Note : The newer container vessels without decks have increased capacities, but this considerably increases the risk of water damage, as large waves and swells can more easily penetrate the hold.
Fire or explosion
Common causes of fire or explosion are:
Sparking and fire caused by friction Spontaneous combustion Outside heat Chemical reactions
Any of the above can cause smoke damage or fire during the transportation of goods.
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Fraud
Marine fraud is as old as marine insurance. Until the middle of the 1970s this problem was regional, affecting local marine companies and insurance markets. Recently however along with the increasing globalisation of trade fraud is also breaking regional boundaries. Since the creation of the International Maritime Bureau in 1981, more than a million acts of piracy or marine fraud have been reported. The upsurge in international fraud has focused the attention of many governments and transportation bodies around the world, particularly as technology offers the potential for new opportunities for the fraudsters. Certainly the "best" frauds are the ones we don't know about yet!
Breaking of cartons and crates, theft of part or all of the goods.. Hijacking of packages, palettes, entire containers, entire lorries and even entire trains in certain countries.
Insufficient security in the loading and unloading, transit, and storage areas.
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POLITICAL RISK
Political risks are related either to the country of a foreign buyer or borrower, or to a third country which can cause the exporter, investor or financier to incur a credit loss. Political risks include restrictions on transfer of the credit currency, rescheduling of debts, expropriation, and war or insurrection. Sovereign risk is caused by an entity that represents the full faith and credit of State. In most cases this is the Ministry of Finance or the Central Bank. When Finnvera covers only the political risks involved, the commercial risks associated with the buyer, the borrower or the guarantor are not covered Political risks are assessed by continuously following the creditworthiness of the countries with political risk. The term political risk refers to all factors or events which influence the country's economy, internal stability and international relations. Political risk may materialise as the consequence of a long course of events, or may result from internal or external economic and political shocks. Political risks are assessed according to the following criteria:-
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structure of the economy natural resources export composition geographic location demographic factors
structure of the economy natural resources export composition geographic location demographic factors
Economic policy
Economic policy
Vulnerability
Vulnerability
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create value resources expended to mitigate risk should be less than the consequence of inaction, or (as in value engineering), the gain should exceed the pain
be an integral part of organizational processes be part of decision making process explicitly address uncertainty and assumptions be systematic and structured be based on the best available information be tailor able take human factors into account be transparent and inclusive be dynamic, iterative and responsive to change be capable of continual improvement and enhancement be continually or periodically re-assessed
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CREDIT RISK
The risk of loss of principal or loss of a financial reward stemming from a borrower's failure to repay a loan or otherwise meet a contractual obligation Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt. Investors are compensated for assuming credit risk by way of interest payments from the borrower or issuer of a debt obligation. Credit risk is closely tied to the potential return of an investment, the most notable being that the yields on bonds correlate strongly to their perceived credit risk. For example; mortgage loan, credit card, line of credit, or other loan, not pay a trade invoice, a government grants bankruptcy protection to an insolvent consumer or business
Risk-based pricing: Lenders generally charge a higher interest rate to borrowers who are more likely to default, a practice called risk-based pricing. Lenders consider factors relating to the loan such as loan purpose, credit rating , and loan-to-value ratio and estimates the effect on yield (credit spread).
Covenants: Lenders may write stipulations on the borrower, called covenants, into loan agreements:
Periodically report its financial condition Refrain from paying dividends, repurchasing shares, borrowing further, or other specific, voluntary actions that negatively affect the company's financial position
Repay the loan in full, at the lender's request, in certain events such as changes in the borrower's debt-to-equity ratio or interest coverage ratio
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Credit insurance and credit derivatives: Lenders and bond holders may hedge their credit risk by purchasing credit insurance or credit derivatives. These contracts transfer the risk from the lender to the seller (insurer) in exchange for payment. The most common credit derivative is the credit default swap.
Tightening: Lenders can reduce credit risk by reducing the amount of credit extended, either in total or to certain borrowers. For example, a distributor selling its products to a troubled retailer may attempt to lessen credit risk by reducing payment terms from net 30 to net 15.
Diversification: Lenders to a small number of borrowers (or kinds of borrower) face a high degree of unsystematic credit risk, called concentration risk. Lenders reduce this risk by diversifying the borrower pool.
Deposit insurance: Many governments establish deposit insurance to guarantee bank deposits of insolvent banks. Such protection discourages consumers from withdrawing money when a bank is becoming insolvent, to avoid a bank run, and encourages consumers to hold their savings in the banking system instead of in cash.
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BANK GUARANTEE
A guarantee from a lending institution ensuring that the liabilities of a debtor will be met. In other words, if the debtor fails to settle a debt, the bank will cover it.
Legal Requirements
Bank guarantee is issued by the authorised dealers under their obligated authorities notified vide FEMA 8/ 2000 date 3rd May 2000. Only in case of revocation of guarantee involving US $ 5000 or more need to be reported to Reserve Bank of India (RBI).
TYPES OF GUARANTEES
1. Direct or Indirect Bank Guarantee: A bank guarantee can be either direct or indirect.Direct Bank Guarantee it is issued by the applicant's bank (issuing bank) directly to the guarantee's beneficiary without concerning a correspondent bank. This type of guarantee is less expensive and is also subject to the law of the country.
Indirect Bank Guarantee With an indirect guarantee, a second bank is involved, which is basically a representative of the issuing bank in the country to which beneficiary belongs. This type of bank guarantee is more time consuming and expensive too.
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2. Confirmed Guarantee: It is cross between direct and indirect types of bank guarantee. This type of bank guarantee is issued directly by a bank after which it is send to a foreign bank for confirmations. The foreign banks confirm the original documents and thereby assume the responsibility.
3. Tender Bond: This is also called bid bonds and is normally issued in support of a tender in international trade. It provides the beneficiary with a financial remedy, if the applicant fails to fulfill any of the tender conditions.
4. Performance Bonds: This is one of the most common types of bank guarantee which is used to secure the completion of the contractual responsibilities of delivery of goods and act as security of penalty payment by the Supplier in case of non delivery of goods.
5. Advance Payment Guarantees: This mode of guarantee is used where the applicant calls for the provision of a sum of money at an early stage of the contract and can recover the amount paid in advance, or a part thereof, if the applicant fails to fulfill the agreement.
6. Payment Guarantees : This type of bank guarantee is used to secure the responsibilities to pay goods and services. If the beneficiary has fulfilled his contractual obligations after delivering the goods or services but the debtor fails to make the payment, then after written declaration the beneficiary can easily obtain his money from the guaranteeing bank.
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7. Loan Repayment Guarantees: This type of guarantee is given by a bank to the creditor to pay the amount of loan body and interests in case of non fulfillment by the borrower.
8. B/L Letter of Indemnity: This is also called a letter of indemnity and is a type of guarantee from the bank making sure that any kind of loss of goods will not be suffered by the carrier.
9. Rental Guarantee: This type of bank guarantee is given under a rental contract. Rental guarantee is either limited to rental payments only or includes all payments due under the rental contract including cost of repair on termination of the rental contract.
10.Credit Card Guarantee: Credit card guarantee is issued by the credit card companies to its customer as a guarantee that the merchant will be paid on transactions regardless of whether the consumer pays their credit.
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INSURANCE
Insurance is the equitable transfer of the risk of a loss, from one entity to another in exchange for payment. It is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss.
Credit Insurance:Credit insurance is a type of life insurance policy purchased by a borrower that pays off one or more existing debts in the event of a death, disability, or in rare cases, unemployment. Credit insurance is marketed most often as a credit card feature, with the monthly cost charging a low percentage of the card's unpaid balance. Credit insurance can be a financial lifesaver in the event of certain catastrophes. However, many credit insurance policies are overpriced relative to their benefits, as well as loaded with fine print that can make it hard to collect on. If you feel that credit insurance would bring you peace of mind, be sure to read the fine print as well as compare your quote against a standard term life insurance policy. Use of credit risk:Companies of all sizes use credit insurance. Euler Hermes has credit insurance solutions which suit the needs of an SME up to the largest multinational company Major Benefits:
Effective control of bad debt risks Expand sales securely in new markets A means to obtain more attractive financing Protection of your balance sheet and cash flow
Scope of cover:
Transportation insurance:Whether you are buying or selling goods from or to the international market, there is always a risk that they may be delayed, damaged or lost in transit. Most people in the supply chain who facilitate the movement of goods operate under conditions limiting their liability in cases of loss, damage or delay. Traders should therefore insure their goods against loss, damage or delay in transit. This guide explains how to ensure appropriate insurance is in place and that you dont assume another party has made the necessary arrangements, leaving you liable in the event of a claim. The guide looks at the different clauses in insurance contracts, contains details about finding the right policy and how to make a claim. A wide array of clients count on Lock ton for transportation risk management expertise in all sectors in the trucking industry including:
Primary Truckers' Liability Excess and Umbrella Liability Workers Compensation Warehouseman's Legal Liability General Liability Motor Truck Cargo Non-Trucking Use Liability Comprehensive Insurance Programs for public transportation firms
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Exchange Risk Insurance:An important advantage is that, unlike a currency forward contract, an obligation to purchase the foreign currency is not applicable. Insurance is provided in a manner whereby at radius Dutch State Business issues a guarantee rate (forward rate) and after the entry into force of the contract, the rate difference is settled (exchange losses or gains). If the relevant export contract is not awarded, the insurance expires and there are no further obligations. The 'standard' transferrable currencies (traditional industrialized countries) are eligible for insurance. These are: USD (US Dollar), CHF (Swiss franc), CAD (Canadian dollar), GBP (British pounds), AUD (Australian dollar), NZD (New Zealand dollar), JPY (Japanese yen), NOK (Norwegian krone), SEK (Swedish krona) and DKK (Danish kroner). Also some (so called) 'exotic currencies' can be insured. In this case, think of currencies linked to euro or US dollar but also currencies of certain emerging markets with a relatively high level of development are insurable. On a case-bycase basis it can be considered if other exotic currencies are eligible for coverage. An important indication is the existence of a developed currency futures market where the forward rates are determined on the basis of interest rate differentials (covered interest parity). Exotic currency insurance is more expensive than a standard currency cover. The standard cover percentage for insurance is 100%, but the possibility exists to choose a deductible of 1% up to 2.5%. If choose a deductible, the premium is obviously lower. The insured period is maximized at 36 months
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EXPORT FINANCE
Introduction Of Foreign Exchange Risk:Foreign exchange risk (also known as exchange rate risk or currency risk) is a financial risk posed by an exposure to unanticipated changes in the exchange rate between two currencies. Investors and multinational businesses exporting or importing goods and services or making foreign investments throughout the global economy are faced with an exchange rate risk which can have severe financial consequences if not managed appropriately.
Types Of Exposure
Transaction Exposure Economic Exposure Translation Exposure Contingent exposure
Risk Management
Managers of multinational firms employ a number of foreign exchange hedging strategies in order to protect against exchange rate risk. Transaction exposure is often managed either with the use of the money markets, foreign exchange derivatives such as forward contracts, futures contracts, options, and swaps, or with operational techniques such as currency invoicing, leading and lagging of receipts and payments, and exposure netting
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Meaning of derivative instrument:A derivative is a financial contract which derives its value from the performance of another entity such as an asset, index, or interest rate, called the "underlying". Derivative transactions include a variety of financial contracts, including futures, forwards, swaps, options, and variations of these such as caps, floors, collars, and credit default swaps. Most derivatives are marketed through overthe-counter (off-exchange) or through an exchange, while most insurance contracts have developed into a separate industry.
Advantages/importance of derivatives:1. Risk Mitigation: Derivatives are convenient risk mitigation contract for
buyers and sellers. These are used has hedging tools in commodity and especially in currency and stock markets. Forex currency contract are most popular too hedge risk of exchange rates in case of export and import trades.
3. Ease to Trading: Derivatives (F&O) are easy to buy and sell through well
organized markets. So, no elaborate procedures of legal documentations are necessary. These are ready to buy and sell contract. Its ease in trading.
5. Money Flows: Derivatives assist purchase sale transactions which are not
possible as cash or cash transactions. Hence they indirectly boost the turnover.
6. Equilibrium: more the value of the trade, faster the equilibrium achieved.
Derivatives make our markets more efficient. Inelasticity is curbed.
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FORWARD CONTRACT
In the context of foreign exchange, forward contracts enable you to buy or sell currency at a future date. Then again, all foreign exchange derivatives do the same. There are differences among foreign exchange derivatives in terms of their characteristics. Forward contracts have the following characteristics:
Commercial banks provide forward contracts. Forward contracts are not-standardized. This characteristic indicates that you can have a forward contract for any amount of money, such as buying 154,280.72 (as opposed to being able to buy only in multiples of 100,000).
Forward contracts imply an obligation to buy or sell currency at the specified exchange rate, at the specified time, and in the specified amount, as indicated in the contract.
The non-standardized and obligatory characteristics of forward contracts work well for exportimport firms because they deal with any specific amount of account receivables or payables in foreign currency. Additionally, these firms know their account receivables and payables in advance, so a binding contract isnt a problem. For example: Suppose that youre an American importer, and you have to pay 109,735.04 to a German exporter on November 12, 2012. You get a forward contract today to buy 109,735.04 at the dollareuro exchange rate of $1.10 on November 12, 2012. In this case, youre contractually obligated to buy 109,735.04 on November 12, 2012. On this date, you will pay $120,708.54 for it (109,735.04 x 1.10).
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Two types of forward currency exchange contract: Fixed forward contracts: You take delivery of your forward currency on a specific date in the future. Open forward contracts: You can take delivery of all the foreign currency at once, or drawn down smaller amounts as you need them - up to the amount of the value of the contract.
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FUTURE OR OPTION
Futures and options represent two of the most common form of "Derivatives". Derivatives are financial instruments that derive their value from an 'underlying'. The underlying can be a stock issued by a company, a currency, Gold etc. The derivative instrument can be traded independently of the asset. The value of the derivative instrument underlying changes according to the changes in the value of the underlying. Derivatives are of two types -- exchange traded and over the counter. Exchange traded derivatives, as the name signifies are traded through organized exchanges around the world. These instruments can be bought and sold through these exchanges, just like the stock market. Some of the common exchange traded derivative instruments are futures and options.
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Future Contract
forward contract.
Option contract
commercial privilege
Buy
To buy a future no upfront To buy an option, upfront option payment is required except premium is paid. This is non for margin money to broker refundable sunk cost. which is more of a safety feature of exchange trading.
Types
Future writer writes a future Option writer could write it with contract with a spirit of a spirit of buying as asset (put selling an underlying asset. option) or selling (call option). Future contract buyer buys it Option buyer is in opposite will. with spirit of buying that Put asset. option is to sell the
Settlement
On settlement date either Options are either exercised or writer is at loss or buyer. It is are lapsed. Writer gains with settled for cash payment. premium. He may make loss on exercise of the option.
Risk
Risks of written & buyer are Maximum gain of option writer almost equal. This is linearity is premium. Loss potential is feature of futures. unlimited. Loss of option buyer is limited to premium paid (and he lets the option lapse). Gain potential s unlimited. The is Non-linearity
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OTC Contract
An over-the-counter contract is a bilateral contract in which two parties (or their brokers or bankers as intermediaries) agree on how a particular trade or agreement is to be settled in the future. It is usually from an investment bank to its clients directly. Forwards and swaps are prime examples of such contracts. It is mostly done via the computer or the telephone. For derivatives, these agreements are usually governed by an International Swaps and Derivatives Association agreement. This segment of the OTC market is occasionally referred to as the "Fourth Market."
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SWAPS
Swap is one more derivative concept. It is a combination of two forwards. Somewhat like a barter with future date. In finance, a foreign exchange swap is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward). See Foreign exchange derivative. Foreign Exchange Swap allows sums of a certain currency to be used to fund charges designated in another currency without acquiring foreign exchange risk. It permits companies that have funds in different currencies to manage them efficiently. Interest rate swaps are also common. Fixed rate of interest is swapped with floating one. Two floating rates in two markets/ currencies are also swapped. This is called as basis swap.
1) Negotiated contracts: Swaps are not readily available on exchanges. These are negotiated by two parties with each other and are tailor made in rate and quantity.
2) Intermediary: Two parties of equal and opposite needs should meet for swap transaction. Intermediaries play an important role in match-making and also in negotiations process.
3) Combination of Forward Contracts: Swap contract is a combination of two forward contracts. Two forward sellers of two different assts (Dollars and Euros), buy each other forward contract. This is swap.
4) Settlement: Settlement may be by actual delivery or the perceived gain / loss between each other is settled by cash payment.
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Fall (1986) describes three methods LDCs use to hedge against the risk their export commodity prices face: 1. International commodity agreements (ICAS), 2. The futures markets, and 3. Countertrade
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CONCLUSION
Export finance:This Chapter has explained the need for trade finance and introduced some of the most common tradefinance tools and practices. A proactive role of governments in trade finance may alleviate the lack of trade finance in emerging GMS economies and contribute to trade expansion and facilitation. However, the best long-term solution in resolving the constraints in trade financing is to encourage the growth and development of a vibrant and competitive financial system, comprising mainly private sector players. This point is important as some of the government-supported trade financing schemes may increasingly be challenged by competing countries as unfair export subsidies under existing and future WTO rules. along with the countrys economy. The role of the
government and other parties involved in trade finance will need to evolve
Risk management:
The results obtained from the project clearly support the assertion that poor credit risk management contributed to a greater extent to the bank failures in banking system. Therefore effective credit risk management is important in banks and allows them to improve their performance and prevent bank distress. The success of the systems depends critically upon a positive risk culture. Banks should have in place a comprehensive credit risk management process to identify, measure, monitor and control credit risk and all material risks and where appropriate, hold capital against these risks. Establishment of a comprehensive credit risk management system in banks should be a prerequisite as it contributes to the overall risk management system of the bank. There is also need for banks to adopt sound corporate governance practices, manage their risks in an integrated approach, focus on core banking activities and adhere to prudential banking practices
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CHAPTER 6 BIBLIOGRAPHY
BIBLIOGRAPHY
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Chapter 7 WEBLIOGRAPHY
WEBLIOGRAPHY
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