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This is to certify that (Reshma Mali) of M.Com Banking &Finance Semester I (!"#$%#&) has s'ccessf'lly Com(lete) the (ro*ect on (I+TER+ATI,+A- FI+A+CIA- MAR.ETS) g'i)ance of /rof. A*it .arn)ikar.

Co'rse Co%or)inator /rinci(al

/ro*ect g'i)e0Internal E1aminer

E1ternal E1aminer


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I (Reshma Mali) a st')ent of Banking & Finance Semester I (!"#$%#&) here3y )eclare that I ha4e Com(lete) the (ro*ect on (International Financial Markets). The information s'3mitte) is tr'e an) original to the 3est of my kno5le)ge.

Signat're (Reshma Mali)


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I 5o'l) sincerely like to gi4e my heartfelt ackno5le)gement an) thanks to my (arents. Any amo'nt of thanks gi4en to them 5ill ne4er 3e s'fficient. I 5o'l) sincerely like to thank o'r /rinci(al 2r.Sangeeta .ohli. I 5o'l) also like to thank my (ro*ect g'i)e for his 4al'a3le s'((ort an) g'i)ance 5hene4er nee)e). I also feel heartiest sense of o3ligation my li3rary staff mem3ers & seniors 5ho hel(e) in collection of 2ata an) materials an) also in this (rocessing as 5ell as in )rafting man'scri(t. -ast8 3't not the least8 I 5o'l) like to thank my frien)s & colleag'es for al5ays 3eing there.

(Reshma Mali)


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Sr. +o.

/age +o. # Intro)'ction ,f Money -a'n)ering (M-) : ! M-% An ,rgani>e) Crime $ ?istorical E4al'ation & /rocess ,f M9 Techni@'es ,f M: ,(eration ,f M; ?armf'l Effects of M< Reg'lation ,f M- In In)ia = Role ,f RBI < = ## #$ #9 #; #= !9 !: $" $< &#


#" Role ,f SEBI ## Reg'lation ,f M-% International #! /ros(ecti4e #$ Concl'sion Bi3liogra(hy


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In economics, a financial market is a mechanism that allows people to buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible items of alue at low transaction costs and at prices that reflect the efficient!market hypothesis" #oth general markets (where many commodities are traded) and speciali$ed markets (where only one commodity is traded) e%ist" &arkets work by placing many interested buyers and sellers in one 'place', thus making it easier for them to find each other" (n economy which relies primarily on interactions between buyers and sellers to allocate resources is known as a market economy in contrast either to a command economy or to a non!market economy such as a gift economy"


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In finance8 financial markets facilitateA

*he raising of capital (in the capital markets) *he transfer of risk (in the deri ati es markets) *he transfer of li+uidity (in the money markets) International trade (in the currency markets)

, and are used to match those who want capital to those who have it" *ypically a borrower issues a receipt to the lender promising to pay back the capital" *hese receipts are securities which may be freely bought or sold" In return for lending money to the borrower, the lender will e%pect some compensation in the form of interest or di idends" In mathematical finance, the concept continuous!time #rownian motion stochastic process is sometimes used as a model"

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In economics, typically, the term market means the aggregate of possible buyers and sellers of a certain good or ser ice and the transactions between them" *he term 'market' is sometimes used for what are more strictly exchanges, organi$ations that facilitate the trade in financial securities, e"g", a stock e%change or commodity e%change" *his may be a physical location (like the ./01) or an electronic system (like .(02(3)" &uch trading of stocks takes place on an e%change4 still, corporate actions (merger, spinoff) are outside an e%change, while any two companies or people, for whate er reason, may agree to sell stock from the one to the other without using an e%change" *rading of currencies and bonds is largely on a bilateral basis, although some bonds trade on a stock e%change, and people are building electronic systems for these as well, similar to stock e%changes" 5inancial markets can be domestic or they can be international"

Types of financial markets *he financial markets can be di ided into different subtypes6
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8apital markets which consist of6


0tock markets, which pro ide financing through the issuance of shares or common stock, and enable the subse+uent trading thereof" #ond markets, which pro ide financing through the issuance of bonds, and enable the subse+uent trading thereof"

8ommodity markets, which facilitate the trading of commodities" &oney markets, which pro ide short term debt financing and in estment" 2eri ati es markets, which pro ide instruments for the

management of financial risk"

5utures markets, which pro ide standardi$ed forward contracts for trading products at some future date4 see also forward market" Insurance markets, which facilitate the redistribution of arious risks" 5oreign e%change markets, which facilitate the trading of foreign e%change"

*he capital markets consist of primary markets and secondary markets" .ewly formed (issued) securities are bought or sold in primary markets" 0econdary markets allow in estors to sell securities that they hold or buy e%isting securities" *he transaction in primary market e%ist between in estors and public while secondary market its

Raising the capital


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*o understand financial markets, let us look at what they are used for, i"e" what where firms make the capital to in est :ithout financial markets, borrowers would ha e difficulty finding lenders themsel es" Intermediaries such as banks help in this process" #anks take deposits from those who ha e money to sa e" *hey can then lend money from this pool of deposited money to those who seek to borrow" #anks popularly lend money in the form of loans and mortgages" &ore comple% transactions than a simple bank deposit re+uire markets where lenders and their agents can meet borrowers and their agents, and where e%isting borrowing or lending commitments can be sold on to other parties" ( good e%ample of a financial market is a stock e%change" ( company can raise money by selling shares to in estors and its e%isting shares can be bought or sold"

The follo5ing ta3le ill'strates 5here financial markets fit in the relationshi( 3et5een len)ers an) 3orro5ersA
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Relationshi( 3et5een len)ers an) 3orro5ers -en)ers Financial Interme)iaries Financial Markets Interbank Indi idual s 8ompanie s #anks Insurance 8ompanies <ension &utual 5unds 5unds 0tock 1%change &oney &arket #ond &arket 5oreign 1%change Borro5ers

Indi iduals 8ompanies 8entral =o ernment &unicipalities <ublic 8orporations

-en)ers :ho ha e enough money to >end or to gi e someone money from own pocket at the condition of getting back the principal amount or with some interest or charge, is the >ender"

In)i4i)'als & 2o'3les


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&any indi iduals are not aware that they are lenders, but almost e erybody does lend money in many ways" ( person lends money when he or she6

puts money in a sa ings account at a bank4 contributes to a pension plan4 pays premiums to an insurance company4 in ests in go ernment bonds4 or in ests in company shares"

Com(anies Companies tend to be borrowers of capital" :hen companies ha e surplus cash that is not needed for a short period of time, they may seek to make money from their cash surplus by lending it ia short term markets called money markets" *here are a few companies that ha e ery strong cash flows" *hese companies tend to be lenders rather than borrowers" 0uch companies may decide to return cash to lenders (e"g" lending it (e"g" in esting in bonds and stocks") Borro5ers Individuals borrow money ia bankers? loans for short term needs or longer term mortgages to help finance a house purchase" Companies borrow money to aid short term or long term cash flows" *hey also borrow to fund modernisation or future business e%pansion" ia a share buyback") (lternati ely, they may seek to make more money on their cash by


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Governments often find their spending re+uirements e%ceed their ta% re enues" *o make up this difference, they need to borrow" =o ernments also borrow on behalf of nationalised industries, municipalities, local authorities and other public sector bodies" In the @A, the total borrowing re+uirement is often referred to as the <ublic sector net cash re+uirement (<0.8B)" =o ernments borrow by issuing bonds" In the @A, the go ernment also borrows from indi iduals by offering bank accounts and <remium #onds" =o ernment debt seems to be permanent" Indeed the debt seemingly e%pands rather than being paid off" Cne strategy used by go ernments to reduce the value of the debt is to influence inflation" Municipalities and local authorities may borrow in their own name as well as recei ing funding from national go ernments" In the @A, this would co er an authority like Dampshire 8ounty 8ouncil" Public Corporations typically include nationalised industries" *hese may include the postal ser ices, railway companies and utility companies" &any borrowers ha e difficulty raising money locally" *hey need to borrow internationally with the aid of 5oreign e%change markets" #orrower?s ha ing same need can form them into a group of borrowers" It can also take an organi$ational form" Eust like &utual 5und" *hey can pro ide mortga$e on weight basis" *he main ad antage is that it lowers their cost of borrowings"

Derivative products
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2uring the 197;s and 199;s, a maEor growth sector in financial markets is the trade in so called )eri4ati4e (ro)'cts, or )eri4ati4es for short" In the financial markets, stock prices, bond prices, currency rates, interest rates and di idends go up and down, creating risk" 2eri ati e products are financial products which are used to control risk or parado%ically exploit risk" It is also called financial economics" 2eri ati e products or instruments help the issuers to gain an unusual profit from issuing the instruments" 5or using the help of these products a contract ha e to be made" 2eri ati e contracts are mainly 3 types6 1" 5uture 8ontracts 2" 5orward 8ontracts 3" Cption 8ontracts" Currency markets &ain article6 5oreign e%change market 0eemingly, the most ob ious buyers and sellers of currency are importers and e%porters of goods" :hile this may ha e been true in the distant past,

when international trade created the demand for currency markets,

importers and e%porters now represent only 1H32 of foreign e%change dealing, according to the #ank for International 0ettlements"F1G *he picture of foreign currency transactions today shows6

#anksHInstitutions 0peculators =o ernment spending (for e%ample, military bases abroad) ImportersH1%porters *ourists


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Analysis of financial markets ee tatistical analysis of financial markets, statistical finance!!! &uch effort has gone into the study of financial markets and how prices ary with time" 8harles 2ow, one of the founders of 2ow Iones J 8ompany and *he :all 0treet Iournal, enunciated a set of ideas on the subEect which are now called 2ow *heory" *his is the basis of the so! called technical analysis method of attempting to predict future changes" Cne of the tenets of 'technical analysis' is that market trends gi e an indication of the future, at least in the short term" *he claims of the technical analysts are disputed by many academics, who claim that the e idence points rather to the random walk hypothesis, which states that the ne%t change is not correlated to the last change" *he scale of changes in price o er some unit of time is called the olatility" It was disco ered by #enoKt &andelbrot that changes in prices do not follow a =aussian distribution, but are rather modeled better by >L y stable distributions" *he scale of change, or olatility, depends on the length of the time unit to a power a bit more than 1H2" >arge changes up or down are more likely than what one would calculate using a =aussian distribution with an estimated standard de iation" ( new area of concern is the proper analysis of international market effects" (s connected as today?s global financial markets are, it is important to reali$e that there are both benefits and conse+uences to a global financial network" (s new opportunities appear due to integration, so do the possibilities of contagion" *his presents uni+ue issues when attempting to analy$e markets, as a problem can ripple through the entire connected global network ery +uickly" 5or e%ample, a bank failure in


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one country can spread +uickly to others, which makes proper analysis more difficult" Financial market slang

/oison (ill, when a company issues more shares to pre ent being bought out by another company, thereby increasing the number of outstanding shares to be bought by the hostile company making the bid to establish maEority" B'ant, a +uantitati e analyst with a <h2Fcitation

(and abo e)

le el of training in mathematics and statistical methods"

Rocket scientist, a financial consultant at the $enith of mathematical and computer programming skill" *hey are able to in ent deri ati es of high comple%ity and construct sophisticated pricing models" *hey generally handle the most ad anced computing techni+ues adopted by the financial markets since the early 197;s" *ypically, they are physicists and engineers by training4 rocket scientists do not necessarily build rockets for a li ing" 6hite .night, a friendly party in a takeo er bid" @sed to describe a party that buys the shares of one organi$ation to help pre ent against a hostile takeo er of that organi$ation by another party"


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2istinction 3et5een Cre)it an) Bon) Market

#oth bonds and credit (currency) financing ha e their ad antages and disad antages" 5or a gi en company, under specific circumstances, one method of financing may be preferred to the other" *he maEor differences are6


Cost of 3orro5ing

#onds are issued in both fi%ed rate and floating rate forms" 5i%ed rate bonds are an attracti e e%posure management tool since the known long! term currency inflows can be offset by the known long!term outflows in the same currency" In contrast, currency loans carry rates" ariable



#onds ha e longer maturities while the period of borrowing in the currency market has tended to lengthen o er time"


Si>e of the iss'e

1arlier, the funds a ailable for lending at any time ha e been much more in the inter!bank market than in the bond market" #ut of late, this situation does not hold true" &oreo er, although in the past the flotation costs of a 1uro currency loan ha e been much lower than a 1uro bond
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(about ;"5 M of the total loan amount ersus about 2"25 M of the face alue of a 1uro bond issue), compensation has worked to lower 1uro bond flotation costs"



In a 1uro bond issue, the funds must be drawn in one sum on a fi%ed date and repaid according to a fi%ed schedule, unless the borrower pays a substantial prepayment penalty" #y contrast, the drawdown in a floating rate loan can be staggered to suit the borrowerNs needs and can be repaid in whole or in part at any time, often without penalty" &oreo er, a 1uro currency loan with a multi!currency clause enables the borrower to switch currencies on any roll!o er date, whereas switching the denomination of a 1uro bond from currency ( to currency # would re+uire a costly, combined, refunding and reissuing operation"



5unds can be raised by a known borrower ery +uickly in the 1uro currency market" Cften, a period of two to three weeks should suffice" ( 1uro bond financing generally takes more time, though the difference is becoming less significant" !. Cre)it Market


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8redit or >oans are the loans e%tended for one year or longer" *he market that deals in such loans is called 8redit &arket"

*he common maturity for credit loans is 5 years" 0ince banks accept short!term deposits and pro ide long!term loans, it is likely that asset liability mismatch may arise" *o a oid this banks often e%tend floating rate credit loans fi%ed to some market interest rate" *he >ondon Inter #ank Cffer Bate (>I#CB) is the most commonly used interest rate" It is the rate charged for loans between #anks"


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/artici(ants in cre)it Market *he maEor lending banks in the credit market are banks, (merican, Iapanese, #ritish, 0wiss, 5rench, =erman and (sian (specially that of 0ingapore) banks, 8hemical #ank, I< &organ, 8iticorp, #ankers *rust, 8hase &anhattan #ank, 5irst .ational #ank of 8hicago, #arclay?s #ank, .ational :estminster, #.<, etc" (mong the borrowers, there are banks, multinational groups, public utilities, go ernment agencies, local authorities, etc"

2ealing 5ith cre)its :hen a borrower approaches a bank for credit, a formal document is prepared on behalf of potential borrowers" *his document contains the principal terms and conditions of loan, obEecti es of loan and details of the borrower"

#efore launching syndication, the approached bank decides primarily, in consultation with the borrower, on a strategy to be adopted, i"e" whether to approach a large market or a restricted number of banks to form the syndicate" 1ach of the banks in syndicate lends a part of the loan" *he duration of this operation is normally about ) to 7 weeks"


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0e eral clauses may be introduced in the contract of debt6 O Pari!passu clause that pre ents the borrower from contracting new debts that subordinate the interest of lenders4 O "xchange option clause that allows the withdrawal of a part or totality of loan in another currency4 O #egative guarantee clause that commits the borrower not to contract other debts that subordinate the interest of lenders"

Characteristics of cre)it ( maEor part (more than 7; M) of the debts is made in @0 dollars" *he second (but far behind) is <ound 0terling followed by 2eutsch mark, Iapanese yen, 0wiss franc and others"

&ost of the syndicated debts are of the order of P5; million" (s far as the upper limits are concerned, amounts in ol ed are of as high magnitude as P5 billion and more" In 199;, 1uro tunnel borrowed P)"7 billion"

Cn an a erage, maturity periods are of about fi e years (in some cases it is about 2; years)" *he reimbursement of the loan may take place in one go (bullet) or in se eral installments"


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*he interest rate on 1uro debt is calculated with respect to a rate of reference, increased by a margin (or spread)" *he rates are a ailable and generally renewable (roll o er credit) e ery si% months, fi%ed with reference to >I#CB" *he >I#CB is the rate of money market applicable to short!term credits among the banks of >ondon" *he reference rate can e+ually be <I#CB at <aris and 5I#CB at 5rankfurt, etc" It is re ised regularly"

*he margin depends on the supply and demand of the capital as also on the degree of the risk of these credits and the rating of borrowers" 5inancial institutions are in igorous competition" *here is an acti e secondary market of 1uro debts" .umerous techni+ues allow banks to sell their titles in this market"

$. Bon) Market 1uro #ond issue is one denominated in a particular currency but sold to in estors in national capital markets other than the country that issued the denominating currency" (n e%ample is a 2utch borrower issuing 2&!denominated bonds to in estors in the @A, 0wit$erland and the .etherlands"

*he 1urobond market is the largest international bond market, which is said to ha e originated in 19)3 with an issue of 1urodollar bonds by


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(utos trade, an Italian borrower" *he market has since grown enormously in si$e and was worth about P 427 billion in 1994"

bond markets in all currencies e%cept the Iapanese /en are +uite free from any regulation by the respecti e go ernments" 0traight bonds are priced with reference to a benchmark, typically treasury issues" *hus a dollar bond will be priced to a yield a /*& (/ield!to!&aturity) somewhat abo e the @0 treasury bonds of similar maturity, the spread depending upon the borrowers ratings and market conditions" 5loatation costs of the bond are comparati ely higher than costs indicated with syndicated credits" &. Commercial (a(er(C/s) 8ommercial paper is a corporate short!term, unsecured promissory note issued on a discount to yield basis" 8ommercial paper maturities generally do not e%ceed 2-; days" 8ommercial paper represents a cheap and fle%ible source of funds :hile 8<s are negotiable, secondary markets tend to be not ery acti e since most in estors hold the paper to maturity" *he emergence of the 1uro 8ommercial <aper (18<) is much more recent" It e ol ed as a natural culmination of the .ote Issuance 5acility and de eloped rapidly in an en ironment of securitisation and disintermediation of traditional banking" 8< has also de eloped in the domestic segments of some 1uropean countries offering attracti e funding opportunities to resident entities"


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9. Certificate of 2e(osit (C2s) ( 8ertificate of 2eposit (82) is a negotiable instrument e idencing a deposit with a bank" ( 82 is a marketable instrument so that the in estor can dispose it off in the secondary market whene er cash is needed" *he final holder is paid the face alue on maturity along with the interest" It is used by the commercial banks as short! term funding instruments" 1uro 82s are mainly issued in >ondon by banks" Interest on 82s with maturity more than a year is paid annually than semi!annually"


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International Ca(ital Markets

International 8apital &arkets ha e come into e%istence to cater to the need of international financing by economies in the form of short, medium or long!term securities or credits" *hese markets also called markets, are the markets on which currencies, bonds, shares and bills are tradedHe%changed" C er the years, there has been a phenomenal growth both in olume and types of financial instruments transacted in these markets" currency deposits are the deposits made in a bank, situated outside the territory of the origin of currency" 5or e%ample, dollar is a deposit made in @0 dollars in a bank located outside the @0(4 banks are the banks in which currencies are deposited" *hey ha e term deposits in currencies and offer credits in a currency other than that of the country in which they are located"

( distincti e feature of the financial strategy of multinational companies is the wide range of e%ternal ser ices of funds that they use on an ongoing basis" #ritish *elecommunication offers stock in >ondon, .ew
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/ork and *okyo, while 0wiss #ank 8orporation!, aided by Italian, #elgian, 8anadian and =erman banks! helps corporations sell 0wiss franc bonds in 1urope and then swap the proceeds back into @0 dollars"

5irms ha e three general sources of funds a ailable6 (i) internally generated cash, (ii) short!term e%ternal funds, and (iii) long!term e%ternal funds" 1%ternal in estment comes in the form of debt or e+uity, which are generally negotiable (tradable) instruments" *he pattern of financing aries from country to country" 8ompanies in the @A get an a erage of );!-;M of their funds from internal sources" =erman companies get about 4;!5;M of their funds from e%ternal suppliers" In 19-5, Iapanese companies got more than -;M of their money from outside sources, but this pattern has since re ersed4 maEor chunks of finances come from internal sources"

(nother significant aspect of financing beha iour is that debt accounts for the o erwhelming share of e%ternal finance" Industry sources of e%ternal finance also differ widely from country to country" =erman and Iapanese companies ha e relied hea ily on bank borrowing, while the @0 and #ritish industry raised much more money directly from financial markets by the sale of securities" Dowe er, in all countries, bank borrowing is on a decline" *here is a growing tendency for corporate borrowing to take the form of negotiable securities issued in the public capital markets rather than in the form of commercial bank loans" *his process known as securitisation is most pronounced among the Iapanese companies"
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;. /etro 2ollar 2uring the oil crises of 19-3, the 8apital markets ha e played a ery important role" *hey accepted the dollar deposits from oil e%porters and channeled the funds to the borrowers in other countries" *his is called Qrecycling the petrodollarsN"

<. C'nk Bon)s ( Eunk bond is issued by a corporation or municipality with a bad credit rating" In e%change for the risk of lending money to a bond issuer with bad credit, the issuer pays the in estor a higher interest rate" 'Digh!yield bond' is a nicer name for Eunk bond *he credit rating of a high yield bond is considered 'speculati e' grade or below 'in estment grade'" *his means that the chance of default with high yield bonds is higher than for other bonds" *heir higher credit risk means that 'Eunk' bond yields are higher than bonds of better credit +uality" 0tudies ha e demonstrated that portfolios of high yield bonds ha e higher returns than other bond portfolios, suggesting that the higher yields more than compensate for their additional default risk"

Iunk bonds became a common means for raising business capital in the 197;s, when they were used to help finance the purchase of companies, especially by le eraged buyouts, the sale of Eunk bonds continued to be used in the 199;s to generate capital
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=. Sam'rai Bon)s *hey are publicly issued yen denominated bonds" *hey are issued by non!Iapanese entities" *he Iapanese &inistry of 5inance lays down the eligibility guidelines for potential foreign borrowers" *hese specify the minimum rating, si$e of issue, maturity and so forth" 5loatation costs tend to be high" <ricing is done with respect to >ong!term <rime Bate"

Shi3osai Bon)s *hey are pri ate placement bonds with distribution limited to banks and institutions" *he eligibility criteria are less stringent but the &C5 still maintains control"

0hogun H =eisha #onds *hey are publicly floated bonds in a foreign currency while =eisha are their pri ate counterparts" #". Dankee Bon)s *hese are dollar denominated bonds issued by foreign borrowers" It is the largest and most acti e market in the world but potential borrowers must meet ery stringent disclosure, dual rating and other listing re+uirements, options like call and put can be incorporated and there are no restrictions on si$e of the issue, maturity and so forth"
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/ankee bonds can be offered under rule 144a of 0ec" *hese issues are e%empt from elaborate registration and disclosure re+uirements but rating, while not mandatory is helpful" 5inally low rated or unrated borrowers can make pri ate placements" Digher yields ha e to be offered and the secondary market is ery limited"

$. 6hat are the )ifferent international financial marketsE

*he international financial markets consist of the credit market, money market, bond market and e+uity market"

*he international credit market, also called 1uro credit market, is the market that deals in medium term 1uro credit or 1uro loans"

International banks and their clients comprise the 1urocurrency market and form the core of the international money market" *here are se eral other money market instruments such as the 1uro 8ommercial <aper (18<) and the 1uro 8ertificate of 2eposit (182)"


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5oreign bonds and 1urobonds comprise the international bond market" *here are se eral types of bonds such as floating rate bonds, $ero coupon bonds, deep discount bonds, etc"

*he international e+uity market tells us how ownership in publicly owned corporations is traded throughout the world" *his comprises both, the primary sale of new common stock by corporations to initial in estors and how pre iously issued common stock is traded between in estors in the secondary markets"

International Financial Market% (general% can 3e 'se) in any)

*he last two decades ha e witnessed the emergence of a ast financial market across national boundaries enabling massi e cross!border capital flows from those who ha e surplus funds and a search of high returns to those seeking low!cost funding" *he degree of mobility of capital, the global dispersal of the finance industry and the enormous di ersity of markets and instruments, which a firm seeking funds can tap, is something new"








2e elopment) countries had began deregulating and liberali$ing their financial markets towards the end of se enties" :hile the process was far from smooth, the o erall trend was in the direction of relaxation of
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controls, which till then had compartmentali$ed the global financial markets" 1%change and capital controls were gradually remo ed, non! residents were allowed freer access to national capital markets and foreign banks and financial institutions were permitted to establish their presence in the arious national markets"

:hile opening up of the domestic markets began only around the end of se enties, a truly international financial market had already been born in the mid!fifties and gradually grown in si$e and scope during si%ties and se enties" *his refers to the 1uro currencies &arket where borrower (in estor) from country ( could raise (place) funds from (with) financial institutions located in country #, denominated in the currency of country 8" 2uring the eighties and nineties, this market grew further in si$e, geographical scope and di ersity of funding instruments" It is no more a 'euro' market but a part of the general category called Roffshore marketsS"

(longside liberali$ation, other +ualitati e changes ha e been taking place in the global financial markets" Bemo al of restrictions has resulted into geographical integration of the maEor financial markets in the C182 countries" =radually this trend is spreading to de eloping countries many of which ha e opened up their markets!at least partially! to non!resident in estors, borrowers and financial institutions"


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(nother noticeable trend is functional integration" *he traditional distinctions between different financial institutions!commercial banks, in estment banks, finance companies, etc"! are gi ing way to di ersified entities that offer the full range of financial ser ices" *he early part of eighties saw the process of disintermediation get underway" Dighly rated issuers began approaching in estors directly rather than going through the bank loan route"

Cn the other side, debt crisis in the de eloping countries, adoption of capital ade+uacy norms and intense competition, forced commercial banks to reali$e that their traditional business of accepting deposits and making loans was not enough to guarantee their long!term sur i al and growth" *hey began looking for new products and markets" 8oncurrently, the international financial en ironment was becoming more olatile! there were fluctuations in interest and e%change rates" *hese forces ga e rise to innovative forms of funding instruments and tremendous ad ances in risk management" *he decade saw increasing acti ity in and sophistication of the deri ati esN market, which had begun emerging in the se enties"

*aken together, these de elopments ha e gi en rise to a globally integrated financial marketplace in which entities in need of short! or long!term funding ha e a much wider choice than before in terms of market segment, maturity, currency of denomination, interest rate basis, incorporating special features and so forth" *he same fle%ibility is a ailable to in estors to structure their portfolios in line with their risk!
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return tradeoffs and e%pectations regarding interest rates, e%change rates, stock markets and commodity prices"


-ist o't the gro5th an) f'nctions of c'rrency markets

:hile opening up of the domestic markets began only around the end of se enties, a truly international financial market had already been born in the mid!fifties and gradually grown in si$e and scope during si%ties and se enties" *his refers to the well!known Q1urocurrencies &arketN" It is the largest offshore market"

<rior to 197;, 1urocurrencies market was the only truly international financial market of any significance" It is mainly an inter!bank market trading in time deposits and arious debt instruments" :hat matters is the location of the bank neither the ownership of the bank nor ownership of the deposit" *he prefi% %"uro% is now outdated since such deposits and loans are regularly traded outside 1urope"

C er the years, these markets ha e e ol ed a ariety of instruments other than time deposits and short!term loans, e"g" certificates of deposit (82s), euro commercial paper (18<), medium! to long! term floating


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rate loans, eurobonds, floating rate notes and euro medium!term notes (1&*.s)"

*he difference between markets and their domestic counterparts is one of regulation" 1urobonds are free from rating and a disclosure re+uirement applicable to many domestic issues as well as registration with securities e%change authorities"

1mergence of 1uro markets6 1" 2uring the 195;s, the erstwhile @00B was earning dollars from the sale of gold and other commodities and wanted to use them to buy grain and other products from the :est, mainly from the @0" Dowe er, they did not want to keep these dollars on deposit with banks in .ew /ork, as they were apprehensi e that the @0 go ernment might free$e the deposits if the cold war intensified" *hey approached banks in #ritain and 5rance who accepted these dollar deposits and in ested them partly in @0" 2" 2omestic banks in @0 (as in many other countries) were subEected to reser e re+uirements, which meant that a part of their deposits were locked up in relati ely low yielding assets" 3" *he importance of the dollar as a ehicle currency in international trade and finance increased, so many 1uropean corporations had cash flows in dollars and hence temporary dollar surpluses" 2ue to distance and time $one problems as well as their greater familiarity with
MCOM B & F SEM-IV Page 34


1uropean banks, these companies preferred to keep their surplus dollars in 1uropean banks, a choice made more attracti e by the higher rates offered by 1uro banks"

*he main factors behind the emergence and strong growth of the 1urodollar markets were the regulations on borrowers and lenders imposed by the @0 authorities which moti ated both banks and borrowers to e ol e 1urodollar deposits and loans" (dded to this are the considerations mentioned abo e, i$" the ability of 1uro banks to offer better rates both to the depositors and the borrowers and con enience of dealing with a bank that is closer to home, who is familiar with business culture and practices in 1urope"

0DCB* .C*10

#. /artici(ants in International /ro*ect Financing F a) S(onsors 3) -en)ers

0ponsors *hese are partners in the proEect who bring in the e+uity capital or risk capital" #eing so, they are keenly interested in the successful completion of the proEect and shoulder maEor responsibilities as regards its
MCOM B & F SEM-IV Page 35


e%ecution" *he fact that they bring in the e+uity capital is an indication of their interest" (lso the amount of e+uity that they bring has a marked bearing on the e%tent of debt that can be raised for the proEect"

0ometimes people who bring in the e+uity capital are Eust the initiators of the proEect" Included in this category are multinational firms, future buyers of products or ser ices of the proEect, the public or pri ate in estors, international organisations, de elopment banks etc"

>enders *hey bring in the debt capital" 5inancing of a big proEect necessitates inter ention of a banking pool consortium composed of banks, national or international financial institutions, e%port financing institutions etc"

=uarantors =uarantees maybe pro ided by banks, public financing organisations, international financial institutions, pri ate insurance companies etc"

<roEect Cperators (n operating company inter enes in the erection of the proEect" It brings its organisational know!how to manage the proEect"


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Risks associate) 5ith international (ro*ects% financial8 (olitical8 others


5inancial risk

In general, international proEects are prone to greater financial risk as a bulk of finance is in the form of debt" *he maEor factors affecting financial risk are degree of indebtedness, the terms and conditions of repayment of debt and currency used"

0ome proEects will ha e e%penses and re enues that in ol e se eral currencies" (s a result the e%change rate risk is ery high"

<roEects maybe financed with floating rates" In iew of the olatility obser ed on the rates like >I#CB, the interest rate risk is also significant" *herefore it is necessary to plan the co erage of all these risks" 2" 5oreign 1%change Bisk

(s corporations e%pand their international acti ities, they begin to ac+uire foreign assets and foreign liabilities" (s e%change rates change, the alues of these foreign assets and liabilities change accordingly" 5or a corporation, e%change rate risk is the sensiti ity of the

alue of the
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corporation when the e%change rates change" Cb iously, the change in the corporation alue is related to the net change in the alues of the foreign assets and foreign liabilities" (1"g" foreign direct in estment, foreign e%change loss, sales and income from foreign sources")


1conomic Bisk

1conomic risk is risk created by changes in the economy" *ypically, it is related to technological changes, the actions of competitors, shifts in consumer preferences, etc" Ideally, a pure domestic firm is affected only by domestic economic conditions ! the domestic economic risk" Dowe er, in today?s integrated world economy, the concept of a pure domestic firm has less practical rele ance" &any firms that appear strictly pure domestic confront foreign economic risk indirectly" (1"g"6 local restaurantHdept store, real estate agent)


<olitical Bisk

<olitical risk is risk created by political changes or instability in a country" *hese factors include, but are not limited to, nationali$ation, confiscation, price controls, foreign e%change and capital controls, administrati e hurdles, uncertain property rights, discriminati e or arbitrary regulations on business practices (hiring, contract negotiation), ci il wars, riots, terrorism, etc" 1ach country in the world presents a different political profile and represents a uni+ue source of political risk that firms must assess and manage when they make foreign in estments"


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In order to minimi$e this risk, local in estors or the local go ernment may be associated with the proEect" Insurance against political risk is another useful techni+ue recommended for the purpose"

&hat constitutes political risk and how to measure it? *he political risk management typically in ol es6 ! Identifying political risk and its likely conse+uences ! 2e eloping policies in ad ance to cope with the possibility of political risk ! 0trengthening a firm?s bargaining position ! 2e ising measures to ma%imi$e compensation in the e ent of e%propriation

8ountry Bisk6 It refers to elements of risk inherent in doing business in the economic, social, and political en ironment of another country"


8ounter party Bisk ! *he risk that a counter party will default on a financial obligation"


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>i+uidity Bisk !*he risk that a financial position cannot be sold +uickly at pre ailing prices"


2eli ery Bisk ! *he risk that a buyer will not deli er payment of funds after a seller has deli ered securities or foreign e%change that were purchased"


Bollo er Bisk ! *he risk of being closed out from a financial market and unable to renew (or roll o er) a short!term contract"


Cther risks ! Cther risks relate to the risk of cost o erruns and bad management"


Financing of M+Cs in local or international market

<roEect financing may be defined as financing of an economic unit, legally independent, created with a iew to setting up of a big proEect, which is commercially profitable and financially iable" <roEect is considered as a distinct legal entity and is financed, to a marked e%tent, by debt ()5 to -5 percent)" *herefore the risk to be borne is substantial"
MCOM B & F SEM-IV Page 4;


*here are two maEor methods of financing international proEects6


5inancing with total risk borne by lenders where only the future cashflows ensure the reimbursement of the loan" *his method of financing was used in petroleum and gas industry in the @0( and 8anada" 2ue to increased le el of risks, this method of proEect financing is generally not preferred"


In another type of financing, both the lender and the promoter share the risk" *he problem sometimes encountered in this method is to decide the proportion in which the risk is to be shared between two parties"

2omestic 40s offshore markets 5inancial assets and liabilities denominated in a particular currency ! say the 0wiss 5ranc ! are traded are primarily in the national financial markets of that country" *hese financial markets are known as Q2omestic &arketsN"


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In case of many con ertible currencies they are traded in the financial markets outside the country of that currency" *hese financial markets are known as QCffshore &arketsN"

:hile it is true that neither both markets will offer both the financing options nor any entity can access all segments of a particular market, it is true generally that a gi en entity has an access to both the segments of the markets for placing as well as raising funds"

*here are theories by e%perts that suggest that there are no two types of financial markets (vi$' 2omestic and offshore markets) but e erything is a part of single Q=lobal 5inancial &arketN"

0imilarity 1%perts suggest that QarbitrageN will ensure that both these markets will be closely linked together in terms of costs of funding and returns on assets'

2ifferences #oth of these markets significantly differ on the QBegulatory dimensionN" &aEor segments of the domestic markets are subEect to strict super ision by the rele ant authorities such as 018 in @0, &inistry of 5inance in
MCOM B & F SEM-IV Page 42


Iapan and the 0wiss .ational #ank in 0wit$erland" *hese authorities regulate foreign (non!resident) entitiesN access to the public capital markets in their countries by laying down eligibility criteria, disclosure J accounting norms and registration J rating re+uirements (similarly for domestic banks, reser e re+uirements and deposit insurance)"

*he offshore markets on the other hand ha e minimal regulation and often no registration" 5inally it must be noted that though the nature of regulation continues to distinguish 2omestic from the offshore markets, there are segments like <ri ate <lacements, @nlisted #onds, #ank loans etc" in domestic markets where regulation tends to be the least"

&. c'rrency Markets

:hile opening up of the domestic markets began only around the end of se enties, a truly international financial market had already been born in the mid!fifties and gradually grown in si$e and scope during si%ties and
MCOM B & F SEM-IV Page 43


se enties" *his refers to the well!known Q1urocurrencies &arketN" It is the largest offshore market"

<rior to 197;, 1urocurrencies market was the only truly international financial market of any significance" It is mainly an inter!bank market trading in time deposits and arious debt instruments" :hat matters is the location of the bank neither the ownership of the bank nor ownership of the deposit" *he prefi% %"uro% is now outdated since such deposits and loans are regularly traded outside 1urope"

C er the years, these markets ha e e ol ed a ariety of instruments other than time deposits and short!term loans, e"g" certificates of deposit (82s), euro commercial paper (18<), medium! to long! term floating rate loans, eurobonds, floating rate notes and euro medium!term notes (1&*.s)"

*he main factors behind the emergence and strong growth of the 1urodollar markets were the regulations on borrowers and lenders imposed by the @0 authorities which moti ated both banks and borrowers to e ol e 1urodollar deposits and loans" (dded to this are the considerations mentioned abo e, i$" the ability of euro banks to offer better rates both to the depositors and the borrowers and con enience of dealing with a bank that is closer to home, who is familiar with business culture and practices in 1urope"


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9. E1ternal Bon) Market

*he e%ternal bond market refers to bond trading acti ity wherein the bonds are underwritten by an international syndicate, are offered in se eral countries simultaneously, are issued outside any country?s Eurisdiction, and are not registered" *he 1urobond market is a maEor e%ternal bond market" *he e%ternal bond market combined with the internal bond market comprises the global bond market" 1%amples of an e%ternal bond are the 'global bond,' issued by the :orld #ank, and 1urodollar bonds" *he 1%ternal #ond &arket comprises of the 6 T T 5oreign #ond &arket and #ond &arket

5oreign #ond6 issue is one offered by a foreign borrower to the in estors in a national capital market and denominated in that nations currency" (n e%ample is =erman &.8 issuing dollar denominated bonds to the @"0" in estors"

#ond6 issue is one denominated in a particular currency but sold to in estors in national capital markets other than the country that issued the denominating currency" (n e%ample is a 2utch borrower issuing


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2&!denominated bonds to in estors in the @A, 0wit$erland and the .etherlands"


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