GTU International Finance: Section A

GTU
International Finance
CHAPTER 1
SECTION A
1. MBA 4th Sem BU ( Finance Spec) 2010 edition – A16- Q8
2. MBA 4th Sem BU ( Finance Spec) 2010 edition – A3 – Q1


CHAPTER 2
SECTION A
Problems

CHAPTER 3
SECTION A
1. Write a note on International banking and Money market
A: - International Banking Services include providing banking services for clients

involved in cross-border commerce/investment (int'l. business/investment), e.g., MNCs,
exporters, importers, investors, fund/portfolio managers, etc.

Examples: Buy/sell FX, arrange trade financing, hedging services (forward contracts),
etc. Int'l. banks borrow/lend in the Eurocurrency market, which is a major part of the
Int'l. money market (short term credit < one year). Also, long term financing for MNCs.

Merchant Banks/Universal Banking. Banks that offer the banking services of both
commercial banks and investment banks, and offer a full range of financial services:
Deposits/loans, underwriting bonds and stocks, insurance, consulting, brokerage, etc.
"Full service banking," very common in Europe and Japan. Banks in Europe and Japan
can own equities, acting as "mutual funds" for depositors.

TYPES OF INTL BANKING OFFICES

1. Correspondent Banking - International network of large international. banks having
"correspondent" relationships with other banks around the world Part of the FX market,
to facilitate FX trading. Large banks maintain accounts with banks in other countries.
Allows MNCs to conduct business/commerce worldwide.

2. Representative Office. Small banking service facility in a foreign country, to provide
better service for MNCs, e.g. credit evaluation of GMs foreign customers. Example:
Chase may have a representative office in Toronto, London, Tokyo to assist GM, Ford,
etc. (Chase has operations in 50 countries).

3. Foreign Branch Bank. Example, Chase opens a full service branch bank in Toronto
or London, subject to FRS regulations and the regulations of the foreign country.
Advantages:
a. Fuller range of banking services vs. representative office
b. Faster check clearing
c. Large loans since the branch bank is part of the parent company, subject to the loan
limits of the parent company
d. Foreign branch banks are NOT subject to some FRS requirements such as FDIC and
reserve requirements, more competitive
e. Easiest way for US banks to expand overseas. More than 1000 U.S. foreign branch
banks worldwide, mostly in Europe especially U.K.

4. Offshore Banking Centers. Bahamas, Bahrain, the Cayman Islands, the Netherlands
Antilles, Panama, Hong Kong (full service), Singapore (full service). Started in 1960s to
allow U.S. banks to participate in the growing Eurodollar market, without having to set
up operations in Europe. U.S. bank will set up a foreign branch bank or operate a
subsidiary (locally incorporated bank owned by US bank).

Offshore banking countries generally offer: minimal banking regulations (no FDIC,
low/no reserve requirements), banking secrecy laws, low taxes. Offshore banks are
usually the largest and most reputable international banks, contrary to popular opinion
about "offshore banking," (shady or weak banks).

INTERNATIONAL MONEY MARKET

Eurocurrency or Eurodollars- Core of intl. money market. Eurocurrency is a time
deposit (CD) of one year or less, in an intl. bank, issued in a currency other than the
domestic currency. Examples: U.S. dollar time deposit in a U.K., German, Japanese or
Mexican bank, Euro time deposit in U.S., U.K. or Japanese bank, Yen time deposit in
French or Canadian bank, etc. "Eurodollar" is a misnomer, deposits don't have to be in
Europe and the deposits don't have to be in dollars, e.g. Yen deposit in a Mexican bank.

Eurodollar market started in 1950s as a way for Soviet Union to avoid political risk,
having dollar deposits in U.S. banks frozen or expropriated. Market grew because of cost
advantages of Eurodollar deposits vs. U.S. deposits.

Eurodollar deposits are NOT subject to reserve requirements or FDIC. $1m deposit in
U.S. bank: Bank would have to maintain reserves of $100,000 at 10% reserve ratio, and
pay FDIC (as much as $2300/year). If the $1m was at a foreign branch outside the U.S.,
no FDIC and no reserve requirement. Eurocurrency has grown tremendously, and
operates as an external banking system parallel to the domestic banks, both seeking
deposits and making loans.
Eurocurrency markets are at the wholesale level, minimum amounts of $1m, time
deposits for 1-12 months.
2. Write a note on International bond market
A: International Bond Market Overview
There is no single international bond market as such. The international bond market is divided
into three separate types of bond markets: Domestic Bonds, Foreign Bonds, and Eurobonds.
Domestic Bonds
The market for domestic bonds is a part of the international bond market. Domestic bonds are
brought out on a local basis and domestic borrowers are responsible for issuing the local bonds.
Domestic bonds are normally designated in the local currency.
Foreign Bonds
The foreign bond market is that in which bonds are brought out by foreign borrowers. The
foreign bonds are normally designated in the local currency. The local market authorities look
after the issuing and selling of foreign bonds.
Foreign Bond Markets

The foreign bonds are traded in the foreign bond markets which constituted a significant portion
of the international bond market until a few decades ago. Some defining characteristics of the
foreign bond markets are:
 Issuers are normally governments and private sector utilities such as the railway
companies
 It was standard practice to underwrite as well as organize underwriting risk
 Issues were pledged by the retail investors and the institutional investors
 The structure of a foreign bond at that time is similar to the present day foreign bonds
 Continental private banks and old merchant houses in London connected the investors
and the issuers
Eurobonds
Eurobonds differ from the others in that they are not sold in any particular national bond market.
Eurobonds are issued by a group of multinational banks. If a Eurobond is designated in any
currency, it would be sold outside the country which uses that currency. For example if a
Eurobond is denominated in the United States dollar, it would not be sold in the United States.
Euromarket
The Euromarket is the market where Eurobonds are traded apart from the Eurocurrency,
Euronotes, Eurocommercial Papers, and Euroequity. The Euromarket is normally an offshore
market. The traders of bonds prefer the Eurobond market as it has comparatively lower costs and
regulations
3. Write a note on LIBOR
A:
LIBOR is defined as:
"The rate at which an individual Contributor Panel bank could borrow funds, were it to do so by
asking for and then accepting inter-bank offers in reasonable market size, just prior to 11.00
London time."
The London Interbank Offered Rate (or LIBOR, pronounced /ˈlaɪbɔr/) is a daily reference rate
based on the interest rates at which banks borrow unsecured funds from other banks in the
London wholesale money market (or interbank market). Alternatively, this can be seen from the
point of view of the banks making the 'offers', as the interest rate the banks will lend to each
other, that is 'offer' money in the form of a loan for various time periods (maturities) and in
different currencies.
Scope of LIBOR
LIBOR rates are widely used as a reference rate for financial instruments such as
 forward rate agreements

 short-term-interest-rate futures contracts
 interest rate swaps
 inflation swaps
 floating rate notes
 syndicated loans
 variable rate mortgages
 currencies, especially the US dollar (see also Eurodollar).
They thus provide the basis for some of the world's most liquid and active interest-rate markets.
For the Euro, however, the usual reference rates are the Euribor rates compiled by the European
Banking Federation, from a larger bank panel. A Euro LIBOR does exist, but mainly for
continuity purposes in swap contracts dating back to pre-EMU times. LIBOR is an estimate and
not interred in the legally binding contracts of an LLC. It is however specifically mentioned as a
reference rate in the market standard International Swaps and Derivatives Association
documentation, which are used by parties wishing to transact in over-the-counter interest rate
derivatives.
LIBOR is used by the Swiss National Bank as their reference rate for monetary policy
8. BBM 6th Sem BU & Tumkur Univ compulsory & finance spec 2009 edition - B47- Q2
CHAPTER 4
SECTION A
Problems

CHAPTER 5
SECTION A
1. BBM 6th Sem BU & Tumkur Univ compulsory & finance spec 2009 edition - B9- Q2
2. Write a note on Letters of credit
A: A standard, commercial letter of credit is a document issued mostly by a financial

institution, used primarily in trade finance, which usually provides an irrevocable payment
undertaking.
The letter of credit can also be source of payment for a transaction, meaning that redeeming the
letter of credit will pay an exporter. Letters of credit are used primarily in international trade
transactions of significant value, for deals between a supplier in one country and a customer in
another. In such cases the International Chamber of Commerce Uniform Customs and Practice
for Documentary Credits applies. They are also used in the land development process to ensure
that approved public facilities (streets, sidewalks, storm water ponds, etc.) will be built. The
parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing
bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a
client. Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without
prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing
a transaction, letters of credit incorporate functions common to giros and Traveler's cheques.
Typically, the documents a beneficiary has to present in order to receive payment include a
commercial invoice, bill of lading, and documents proving the shipment was insured against loss
or damage in transit. However, the list and form of documents is open to imagination and
negotiation and might contain requirements to present documents issued by a neutral third party
evidencing the quality of the goods shipped, or their place of origin or place.
3. What are the types of letters of credit

A: Types of Letters of Credit
Unconfirmed
An unconfirmed irrevocable letter of credit provides a commitment by the issuing bank to pay,
accept, or negotiate a letter of credit. An advising bank forwards the letter of credit to the
beneficiary without responsibility or undertaking on its part except that it must use reasonable
care to check the authenticity of the credit which it advised. It does not provide a commitment
from the advising bank to pay, so the beneficiary is reliant upon the undertaking of the overseas
bank. The beneficiary is not protected from the credit risk of the issuing bank nor the country
risk.
Confirmed
A confirmed irrevocable letter of credit is one to which the advising bank adds its confirmation,
makes its own independent undertaking to effect payment, negotiation or acceptance, providing
documents are presented which comply with the terms of the letter of credit. The advising bank,
which may also be the confirming bank, assumes the country (political and economic) risk of the
applicant’s country as well as the credit risk, failure and default of the issuing bank and effects
payment to the beneficiary without recourse.
In order for a letter of credit to be confirmed, a bank accepting this risk would have a
correspondent relationship with the issuing bank. If the advising bank does not have such a
relationship, the letter of credit can be confirmed by an independent bank. The negative aspect
here is the cost of adding another bank to the scenario.
A seller should consider requesting a confirmed credit when
 the credit standing of the issuing bank is unknown to the seller or viewed by the seller as
questionable.
 exchange controls in the buyer’s country may prevent local banks from honoring certain
external payments.
 the importing country is suffering economic difficulties: large external debt and/or high
debt service ratios, a persistent negative balance of payments, or a record of being late or
having defaulted on its international payments.
Transferable Credit
Under a transferable letter of credit a beneficiary (the first beneficiary) can ask the
issuing/advising/confirming bank to transfer the letter of credit in whole or in part to another
party/ies such as supplier/s (second beneficiary/ies). A transferable letter of credit is usually used
when the beneficiary is not the manufacturer/original supplier of some/all of the goods/services.
This process enables the beneficiary to pay the manufacturer/original supplier by letter of credit.
If the bank agrees, this bank, referred to as the transferring bank, advises the letter of credit to the
second beneficiary/ies in the terms and conditions of the original letter of credit with certain
constraints defined in Article 48 of UCP 500.
In general, unless the letter of credit states that it is transferable, it is considered non-transferable.
Assignment of Proceeds
The right to the proceeds of a letter of credit can sometimes be assigned where the beneficiary of
a letter of credit is not the actual supplier of all or part of the letter of credit and wants the bank
to pay the supplier out of funds received from the letter of credit. The beneficiary may choose
this option if he or she
 does not want to request a transferable letter of credit from a buyer in order to keep the
buyer from knowing who is the actual supplier of the goods.
 does not have the necessary credit with the bank to issue a new letter of credit to a
supplier.
An assignment of proceeds takes the form of an irrevocable instruction from the beneficiary to
the bank requesting that it pay the supplier out of the proceeds of the letter of credit which
becomes due when documents are presented in compliance with the terms of the letter of credit.
Revolving
Although infrequently used today, revolving letters of credit were a tool created to allow
companies conducting regular business to issue a letter of credit that could “roll-over” without
the company having to reapply, thus enabling business flow to continue without interruption as
long as the terms and conditions, quantities, and other transaction details did not change. In
addition, if a letter of credit were a revolving one, there were few ways to stop it from rolling
over; so, should a conflict arise between the parties while the letter of credit was in place or
should the products change, there was little recourse for either party. In the business world today,
the fact is that, unless required by law or because of high risk, on-going business is usually
conducted without of letters of credit
Standby
As is the case with the revolving letter of credit, standby letters of credit are infrequently used
today. A standby letter of credit is one which is issued as a back-up or form of insurance for the
seller should the buyer default on the agreed-upon payment terms. A standby letter of credit is
issued in the same way a documentary credit is in that the collateral needed for issuance is
required by the issuing bank and the beneficiary must comply with every detail as outlined in the
letter of credit. The problem with this instrument is that the applicant has no guarantee, other
than the seller’s word, that the standby will not be drawn against even if payment is made as
agreed. This situation is challenging, especially if the letter of credit is confirmed and the
advising bank sees only documents pertaining to the shipment as outlined in the letter of credit
and has no knowledge of other payments being made.
4. Explain the Operations of letters of credit
A: Parties involved in LC transaction:
1. The Applicant is the party that arranges for the letter of credit to be issued.
2. The Beneficiary is the party named in the letter of credit in whose favor the letter of
credit is issued.
3. The Issuing or Opening Bank is the applicant’s bank that issues or opens the letter of
credit in favor of the beneficiary and substitutes its creditworthiness for that of the
applicant.
4. An Advising Bank may be named in the letter of credit to advise the beneficiary that the
letter of credit was issued. The role of the Advising Bank is limited to establish apparent
authenticity of the credit, which it advises.
5. The Paying Bank is the bank nominated in the letter of credit that makes payment to the
beneficiary, after determining that documents conform, and upon receipt of funds from
the issuing bank or another intermediary bank nominated by the issuing bank.
6. The Confirming Bank is the bank, which, under instruction from the issuing bank,
substitutes its creditworthiness for that of the issuing bank. It ultimately assumes the
issuing bank’s commitment to pay.
Letter of Credit Process:

5. What are the advantages and disadvantages of letters of credit
A: Advantages of Letter of Credit:
1. The beneficiary is assured of payment as long as it complies with the terms and
conditions of the letter of credit. The letter of credit identifies which documents must be
presented and the data content of those documents. The credit risk is transferred from the
applicant to the issuing bank.
2. The beneficiary can enjoy the advantage of mitigating the issuing bank’s country risk by
requiring that a bank in its own country confirm the letter of credit. That bank then takes
on the country and commercial risk of the issuing bank and protects the beneficiary.
3. The beneficiary minimizes collection time as the letter of credit accelerates payment of
the receivables.
4. The beneficiary’s foreign exchange risk is eliminated with a letter of credit issued in the
currency of the beneficiary’s country.
Risks involved in Letter of Credit.
1. Since all the parties involved in Letter of Credit deal with the documents and not with the
goods, the risk of Beneficiary not shipping goods as mentioned in the LC is still persists.
2. The Letter of Credit as a payment method is costlier than other methods of payment such
as Open Account or Collection
3. The Beneficiary’s documents must comply with the terms and conditions of the Letter of
Credit for Issuing Bank to make the payment.
4. The Beneficiary is exposed to the Commercial risk on Issuing Bank, Political risk on the
Issuing Bank’s country and Foreign Exchange Risk in case of Usance Letter of Credits.
6. MBA 3rd sem BU Finance spec 2009 edition – B41- Q1
7. What is credit Insurance?
A: Credit insurance is a term used to describe both business credit insurance and consumer
credit insurance, e.g., credit life insurance, credit disability, and credit unemployment insurance
The easy way to differentiate between these two types of insurance is:
 Business credit insurance is credit insurance that businesses purchase to insure payment
of credit extended by the business (their accounts receivable).
 Consumer credit insurance is credit insurance that consumers purchase to insure payment
of credit extended to the consumer (insurance pays lender or finance company).
Consumer credit insurance is a way for consumers to insure repayment of loans even if the
borrower dies, becomes disabled, or loses a job. Consumer credit insurance can be purchased to
insure all kinds of consumer loans including auto loans, credit card debt, loans from finance
companies, and home mortgage borrowing. Although purchased by the consumer/borrower, the
benefit payment goes to the company financing the purchase or extending the credit to the
consumer.
Credit insurance or trade credit insurance (also known as business credit insurance) is an
insurance policy and risk management product that covers the payment risk resulting from the
delivery of goods or services. Trade credit insurance usually covers a portfolio of buyers and
pays an agreed percentage of an invoice or receivable that remains unpaid as a result of
protracted default, insolvency or bankruptcy. Trade credit insurance is purchased by business
entities to insure their accounts receivable from loss due to the insolvency of the debtors. This
product is not available to individuals.
The costs (called a "premium") for this are usually charged monthly, and are calculated as a
percentage of sales of that month or as a percentage of all outstanding receivables.
Trade credit insurance insures the payment risk of companies, not of individuals. Policy holders
require a credit limit on each of their buyers for the sales to that buyer to be insured. The
premium rate is usually low and reflects the average credit risk of the insured portfolio of buyers.
In addition, credit insurance can also cover single transactions or trade with only one buyer.

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A: - International Banking Services include providing banking services for clients

2. Write a note on International bond market

A: International Bond Market Overview

Foreign Bond Markets

3. Write a note on LIBOR

LIBOR is defined as:

 forward rate agreements

 interest rate swaps

 floating rate notes

 variable rate mortgages

 currencies, especially the US dollar (see also Eurodollar).

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