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International Finance: Introduction

Text book: Morris Levi Ref Text: International Financial Management Cheol S Euel, Bruce G Resnick [COSMO], TMH edition -companies going global - Additional dimensions to be considered as compared to domestic scenarios. Important decisions taken by a financial manager Investment, Financial and dividend policy In case of IF cash flow used will be incremental IN case of MNC, Difference between the global Cashflow with the project and without the project incremental cash flow. Business risk? Variation in earnings (EBIT) coz of variation in sales. Operation risk fixed cost will be high. External factors are variation in demand

Financial risk due to the debt Shareholder has two types of risk business risk and financial risk Exchange risk Political risk \Country risk due to fragile political system or exchange control E xpropriation Financing decision (Domestic vs International) Backpacked loan - MNC s get loan based on the credit rating it has in diff countries, MNC s SWAP the loan in between based on the interest rate advantages they have in each country. o SWAP Dividend FDI profit earned by the first 5 years cannot be repatriated to the parent company - This kind a account is called BLOCKED account. [Subsidiary company can only reinvest in the new country, so for the parent company the cash flow will be zero, this can be considered as a BLOCKED account]

Undervalued in order to encourage the export.

FOREX Market Financial asset a claim for a future benefit. Transfer the financial claim over time and space.

Financial market 1. Money market short term financial instruments will be traded 2. Capital market long term instruments will be traded. 3. FOREX market foreign currency would be traded. - Most volatile market. - Volume of trade would be high. Four participants in FOREX market 1. Commercial banks o Buy and sell currencies in interbank and retail market o They will be ready to sell different currencies. o They are the market makers. o They provide adequate liquidity. o Their own behalf as well as for clients. 2. Forex brokers - Would be acting as a intermediary and bring the seller and buyer to facilitate a deal. - Specializing in certain currencies - Keep the identity of the buyer and seller until the deal is struck. - Give code of the buyer and seller 3. large corporate o Deal in market for their own requirement as well as speculation. o [Why do they speculate : ] 4. Central banks - Currency regimes fixed rate system and floating rate system. - RBI - formulate the monetary policy. - Exchange rate would be varying with in a bandwidth. [ - Intervention step to regulate the exchange rate - Role of central bank is to protect the currency from depreciations and appreciation [ buy dollar and sell the Indian currencies] 5. Agencies like Reuters, SWIFT - Provide information to the dealers.

Can trade through Reuters

SWIFT is a messaging agency for settlements. Like RTGS.

Buy foreign currency long position Sell foreign currency short position Open position Maximum time to keep an open position is 24 hrs. Commercial banks: Concerned about the turnover [ to increase the volume of transaction]

In FOREX there are two segments [part of the structure of forex market] 1) Whole sale or interbank segment y y between two banks 80 to 90% of the transaction happen in this segment

2) Retail segment [over the counter market] y y y y Recognized stock exchange. Doesn t have a physical location It is a network of dealers and participants like central bank. Dealing takes place in financial centers through electronic network.

Foreign exchange Rate Price of one currency expressed in terms of another currency. Numerator is the price , denominator is base Eg : Rs 50 /$ - > Direct Quote When somebody wants to buy Rs from indian market for dollars 1. $0.02/Rs ->Indirect Quote

Direct Quote Is a code expressed in terms of number of foreign currency per unit of home currency. Indirect Quote is a code expressed in terms of number of home currency per unit of foreign currency. Currency has symbol and code Rs/$ 50.10(Bid rate)/50.90(Ask rate) This is known as a two way quote.

Convention Quote is always given from the point of view of the dealer. Bid rate will precede the As rate Bid and Ask is separated by a slash Diff between Bid rate and Ask rate is called Spread or Bid Ask Spread. One Part of the spread is used to cover the transaction cost. Part of spread is to cover the risk involved in the transaction Risk premium. 1. Risk involved is Liquidity risk Third component is margin /profit

Based on the settlement, there are two types of transactions SPOT rate and Forward rate. SPOT transaction delivery of currency will take place on second business day.(Business day in both countries) 1. Settlement will take place in the country of its origin 2. Forward transaction delivery of currency will take place beyond second business day. A future is a forward contract done through exchanges. Hedging protecting against the price risk. Forward contract is a hedging Asset which is transacted is called Underlying Asset. Price at which the asset is transacted is called forward price or forward rate. Date on which the assets should be delivered is called settlement date or delivery date. Person who is buying the asset taking a long position. Person who is selling the asset taking a short position. Characteristics of forward contract 1- No exchange traded 2- Non standardized Futures contract is an exchange contract and standard Standardized contract means standardized with respect to asset, price and delivery date. In currency market, forward is available for 3 months, 6 months, 9 months and 12 months. Forward rate can be quoted in two ways 1. Outright forward 2. Swap Quote Importer selling the US dollar Exporter Buying

6 months OUTRIGHT FORWARD RS/$ SPOT SWAP Quote (Difference) SWAP point

50.40/50.90 50.10/50.40 30/50

When the SWAP point is in ascending order add the swap point to SPOT price to get forward and vice versa. Nostro Account Vostro Account Account of foreign bank with a domestic bank in domestic currency. Account of a domestic bank with a foreign bank (or with its own branch) in a foreign country in that country s currency.

Problem 1 You as a dealer in FOREX have the following position in swiss franc on 31st October 2010 SWISS FRANCS 100,000 50,000 80,000 60,000 30,000 75,000 30,000

Balance in Nostro account credit Opening position overbought Purchased bill on zurich Sold forward TT(Telegraphic transfer) Forward puchase contract cancelled Remitted by TT Draft on Zurich cancelled

What steps would you take if you are required to maintain a credit balance of swiss francs 30,000 in the nostro account and keep an over board position on swiss francs 10,000. Your position and balance of nostro account will be different Overbought means u have an excess long position. (Net long position) Oversold Net short position Two types TT rate and Normal rate. For evert long position there will be short position Exchange postion/Currency position (long) Purchase SFr Opening position overbought Bill on Zurich Forward sale TT Cancellation of forward contract TT sales Draft on Zurich cancelled 50,000 80,000 60,000 30,000 75,000 30,000 160,000 5,000 165,000 165,000 165,000 (short) SALE SFr

Closing balance oversold

Cash Position (Nostro Account) Credit Opening Balance Remitted by TT (Sale of SFr to customer) Closing balance 100,000 100,000 100,000 75,000 75,000 25,000 100,000 Debit

Bank has to buy spot TT SFr 5000 to increase the balance in Nostro account to SFr 30,000. This would bring down the oversold position on SFr to nil. Since the bank require an overbought position of SFr 10,000 , it has to buy forward SFr 10,000.

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