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Sikkim Manipal University 4th Semester Spring 2011

Name

: Alaji Mamadou Cire BAH

Roll No.

: 540910685

: Subject International Financial Management Subject Code : MF0006

Program

: MBA Semester 4

University University

Sikkim Manipal

Learning Centre : KnowledgeWorkz Limited (02544)


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Alaji Mamadou Cire BAH 540910685

MF0006 SET 2

Sikkim Manipal University 4th Semester Spring 2011

MBA SEMESTER 4 INTERNATIONAL FINANCIAL MANAGEMENT MF0006 SET - 2 1. What is meant by BOP? How are capital account convertibility and current account convertibility different? What is the current scenario in India? Answer: The balance of payments (or BOP): of a country is a record of international transactions between residents of this country and the rest of the world over a specified period, usually a year Thus, Indias balance of payments record year. records transactions between Indian residents and the rest of the world. International transactions include exchanges of goods, services or assets. The term residents means businesses, individuals and government agencies and includes citizens temporarily living abroad but excludes local subsidiaries of foreign corporations. The Balance of Payments of a country is the sum of the Current Account the Account, Capital Account and the Official Reserves Account. The current account is that balance of payments account in which all short payments shortterm flows of payments are listed. It is the sum of net sales from trade in goods and services, net investment income (interest and dividend), and net unilateral transfers (private transfer payments and government transfers) f from abroad. Investment income for a country is the payment made to its residents who are holders of foreign financial assets (includes interest on bonds and loans, dividends and other claims on profits) and payments made to its citizens who are temporary workers abroad. Unilateral transfers are official government orkers grants-in-aid to foreign governments, charitable giving (e.g., famine relief) and aid migrant workers transfers to families in their home countries. Net investment income and net transfers are small relative to imports and exports. Therefore a current account surplus indicates positive net exports or a trade surplus and a current account deficit indicates negative net exports or a trade deficit. The capital (or financial) account is that balance of payments account in which ayments all cross-border transactions involving financial assets are listed. All purchases border
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Alaji Mamadou Cire BAH 540910685

MF0006 SET 2

Sikkim Manipal University 4th Semester Spring 2011

or sales of assets, including direct investment (FDI) securities (portfolio investment) and bank claims and liabilities are listed in the capital ac account. When Indian citizens buy foreign securities or when foreigners buy Indian securities, they are listed here as outflows and inflows, respectively. When domestic residents purchase more financial assets in foreign economies than what foreigners purchase of domestic assets, there is a net capital outflow If se outflow. foreigners purchase more Indian financial assets than domestic residents spend on foreign financial assets, then there will be a net capital inflow A capital inflow. account surplus indicates net capital inflows or negative net foreign inflows investment. A capital account deficit indicates net capital outflows or positive net foreign investment. The Official reserves Account records the total reserves held by the official monetary authorities (central banks) within the country .These reserves are within normally composed of the major currencies used in international trade and financial transactions. The reserves consist of hard currencies such as US Dollar British Pound, Euro, Yen, official gold reserve and IMF Special Drawing Rights (SDR).The reserves are held by central banks to cushion against instability in international markets. The Balance of Payments identity states that: Current Account+ Capital Account = Change in Official reserve Account Account. 2. What are foreign exchange markets? Who are the players in the foreign exchange market? What is meant by exchange rate quotations? Answer: The foreign exchange market is the largest and most liquid market in the market: world. The estimated worldwide turnover of this market is at around $1 turnover trillion a day, which is several times the level of turnover in the U.S. Government securities market, which is the worlds second largest financial market. The turnover in the foreign exchange market is equivalent to mor than more $200 in foreign exchange market transactions, every business day of the year, for every man, woman, and child on earth! The breadth, depth, and liquidity of the market are very impressive. Individual trades of $200 million to $500 million can take place. The quoted prices change place. as often as 20 times a minute for active currencies. It has been estimated that the
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Alaji Mamadou Cire BAH 540910685

MF0006 SET 2

Sikkim Manipal University 4th Semester Spring 2011

worlds most active exchange rates can change up to 18,000 times during a single day. Almost two-third of the $1 trillion per day trade represents transactions among third represents the dealers themselves with only one third accounted for by their transactions with financial and non-financial customers. An initial dealer transaction with a financial customer in the foreign exchange market often leads to multiple furt further transactions, sometimes over an extended period, as the dealer institutions readjust their own positions to hedge, manage, or offset the risks involved. The foreign exchange market is a twenty four hour market. Each business day arrives first in the financial centers of Asia nancial Asia-Pacific first Wellington, then first Sydney followed by Tokyo, Hong Kong, and Singapore. A few hours later, while markets are still active in these Asian centers, trading begins in Bahrain and at other places in the Middle East. Later, when it is late in the business day when in Tokyo, markets open for business in Europe. When it is early afternoon in Europe, trading in New York and other U.S. centers begin. Finally, completing the circle, when it is mid or late afternoon in the United States, the next day has arrived in the Asia-Pacific area, the first markets there have opened, and the Pacific process begins again. The twenty-four hour market means that the exchange rates and market four conditions can change at any time in response to developments that c take can place at any time in the day. Traders and other market participants therefore, must be alert to the possibility that a sharp move in an exchange rate can occur during an off hour, elsewhere in the world. The large dealing institutions have thus introduced various arrangements for monitoring markets and trading on a roduced twenty-four hour basis. Some keep their New York or other trading desks open four twenty-four hours a day, others shift work from one office to the next, and the four others follow different approa approaches. The foreign exchange market consists of both an over-the-counter (OTC) market and an exchange-traded segment of the market. The OTC market is an international OTC network of major dealers mainly but not exclusively banks operating in financial centers around the world, trading with each other and centers with customers, via computers, telephones, and other means. The exchangetraded market covers trade in a limited number of foreign exchange products on the floors of organized exchanges.
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Alaji Mamadou Cire BAH 540910685

MF0006 SET 2

Sikkim Manipal University 4th Semester Spring 2011

The OTC market accounts for well over 90 percent of total foreign exchange ccounts market activity, covering both the traditional (pre 1970) products ( (pre-1970) (spot, outright forwards, and FX swaps) as well as the more recently introduced (post ) (post-1970) OTC products (currency options and currency swaps). On the organized currency ). exchanges, foreign exchange products traded are currency futures and certain currency options. The main players in the foreign exchange market are: customers, banks and Brokers. Customers, such as multinational corporations, are in the market because they corporations, require foreign currency in the course of their cross border trade or investment business. For example, an engineering firm based in the United Kingdom might use the foreign exchange market to buy the dollars it needs to pay to a firm in to the USA that is selling it capital goods; in this case, it would sell pounds and buy dollars. Commercial banks are by far the most active participants in the foreign exchange market. They deal with other financial institutions and corpo corporations who contact them, typically by telephone, to ask for their rates, and may then buy foreign currency from, or sell, to the bank at those rates. This process is known as market making the banks will at all times quote buying (bid rates) making: or selling rates (ask rates) for pairs of currencies dollars to the pound, ates Japanese yen to the euro and so on. The market makers earn a profit on the difference between their buying and selling rates (spread). The third type of participant, the brokers, who act as intermediaries between the banks. They are specialist companies with computer links or telephone lines to banks throughout the world so that at any time they know which bank has the highest bid (buying) rate for a currency, and which the lowest offer (selling) rate. The foreign exchange market links various foreign exchange trading centers from around the world into a single, unified, cohesive, worldwide market. Foreign exchange trading takes place among dealers and other market professionals in a large number of individual financial centers New York, number
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Alaji Mamadou Cire BAH 540910685

MF0006 SET 2

Sikkim Manipal University 4th Semester Spring 2011

Chicago, Los Angeles, London, Tokyo, Singapore, Frankfurt, Paris, Zurich, Milan, and many others. Foreign Exchange Rates and Quotation Base Currency and Terms Currency Exchange rate is a price to buy or sell currency. Exchange rate is terms sell currency per unit of base currency. Base currency is the currency that is currency. bought or sold. Terms currency is the pricing currency. Let us understand this with the help of an example. Let us take the Euro dollar quote of $1 Euro-dollar $1.2120. The base currency is the euro. The terms currency is dollar. The price of 1 euro is $1.2120. Every foreign exchange transaction involves two currencies and it is important to keep straight which is the base currency (or quoted underlying, quoted, or fixed currency) and which is the terms currency (or counter currency). A trader always buys or sells a fixed amount of the base currency most often the dollar and adjusts the amount of the terms currency as the exchange rate changes. The terms currency is thus the numerator and the base currency is the denominator. When the numerator increases, the base currency is strengthening . and becoming more expensive; when the numerator decreases, the base currency is weakening and becoming cheaper. In oral communications, the base currency is always stated first For example, a ications, first. quotation for dollar-yen means that the dollar is the base currency and yen therefore is in the denominator, and the yen is the terms currency and therefore is in the numerator; dollar dollar-swissie means that the Swiss franc is the terms ie currency and dollar is the base currency; and sterling dollar (usually called sterling-dollar cable) means that the dollar is the terms currency and pound is the base currency. Currency Codes Currency codes are also used to denote currency pairs. Each currency is to assigned a three-letter code. For example, US dollar is coded USD (United letter States Dollar), euro is coded EUR (Euro), Swiss frank is coded CHF (Confederation Helvetica Franc), Japanese yen is coded JPY (Japanese Yen) and the British pound is coded GBP (Great British Pound). The currency codes are defined by ISO-4217 standard. Usually they are formed as a two 4217 two-letter ISO3166 country code and the first letter of currency name. There are a few
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Alaji Mamadou Cire BAH 540910685

MF0006 SET 2

Sikkim Manipal University 4th Semester Spring 2011

exceptions, the most notable being the euro (EUR) which is not the currency of notable a single country but that of the European Union. Standard symbols for some of the most commonly traded currencies are: tandard EUR: Euros USD: United States dollar CAD: Canadian dollar GBP: British pound JPY: Japanese yen AUD: Australian dollar CHF: Swiss franc Bid Price and Ask Price In the foreign exchange market there are always two prices for every currency one price at which the sellers of that currency want to sell, and another price at which buyers of the currency want to buy. A market maker is expected to quote s simultaneously for his customers both a price at which he is willing to sell and a price at which he is willing to buy standard amounts of any currency for which he is making a market. Thus, Forex quotes always include a bid and an ask Thus, price. The bid price is the price at which the market maker (dealer) is willing to buy the base currency in exchange for the counter (or terms) currency. The ask price is the price at which the market maker is willing to sell the base currency in exchange for the counter currency. Traders always think in terms of how much it costs to buy or sell the base currency. A market makers quotes are always presented from the market makers point of view, so the bid price is the view, amount of terms currency that the market maker will pay for a unit of the base currency; the offer price (or ask price) is the amount of terms currency the market maker will charge for a unit of the base currency. The difference between the bid and the ask prices is referred to as the spread A wide spread nd spread. indicates illiquid trading conditions. A market maker asked for a quote on dollar swissie might respond 1.4975 dollar-swissie 1.497585, which indicates a bid price of CHF 1.4975 per dollar and an offer price of CHF 1.4985 per dollar. Usually, the market maker will simply give the quote as 75-85, and assume that the counterparty knows that the big figure is 1.49. 85, The bid price always is offered first (the number on the left), and is lower (a
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Alaji Mamadou Cire BAH 540910685

MF0006 SET 2

Sikkim Manipal University 4th Semester Spring 2011

smaller amount of terms currency) than the offer price (the larger number on the right). This differential is the dealers spread. Direct and Indirect Quotes Quotes: Exchange rate quotes, as the price of one currency in terms of another, come in two forms: a) Direct quotation is the amount of domestic currency per unit of foreign currency. Example: Rs. 77.30 / in India, $1.7676 / in US and b) Indirect quotation is the amount of foreign currency per unit of domestic currency. Example Swedish Kroner 0.1763/Rs in India, 0.8251 Euro/$ in US. 0.8251 European and American Terms Terms: The phrase American terms means a direct quote from the point of view of American terms someone located in the United States. For the dollar, that means that the rate is quoted in variable amounts of U.S. dollars per one unit of foreign currency (e.g., unit $1.2119 per Euro). The phrase . European terms means a direct quote from the point of view of someone located in Europe. For the dollar, that means variable amounts of foreign currency per one U.S. dollar (or Euro 0.8251 per $1 $1). In daily life, most prices are quoted directly, so when you go to the shop you pay x dollars and y cents for one loaf (unit) of bread (in US). For many years, all dollar exchange rates also were quoted directly. That meant that the dollar exchange rates were quoted in European terms in Europe, and in American es terms in the United States of America. However, in 1978, as the foreign exchange market was integrating into a single global market, for convenience, the practice in the U.S. market was changed at the initiative of the international broker community to conform to the European convention. Thus, OTC markets in all countries now quote dollars in European terms against nearly all other currencies (amounts of foreign currency per $1). That means that the dollar is nearly always the base currency, one unit of which (one dollar) t is being bought or sold for a variable amount of a foreign currency. The only exceptions to this convention are quotes in relation to the euro, the pound sterling and the Australian dollar these three are quoted as dollars per foreign alian currency. Pip:

Alaji Mamadou Cire BAH 540910685

MF0006 SET 2

Sikkim Manipal University 4th Semester Spring 2011

Prices are always quoted using five numbers (for example, JPY 134.85 / USD), the final digit of which is referred to as a point or a pip. A pip is the smallest price change that a given exchange rate can make. Since most major currency pairs are priced to four decimal places, the smallest change is that of the last decimal point for most pairs this is the equivalent of 1/100th of one percent, or one basis point. For example, the smallest move the USD/CAD currency pair can make is $0.0001, or one basis point. The smallest move in a currency does not always need to be equal to one basis point, but this is generally the case with most currency pairs. 3. Distinguish between Eurobond and foreign bonds? What are the unique characteristics of Eurobond markets? Answer: A Eurobond is a bond issued and traded within the mostly unregulated Euromarket. While that market originated within Europe and is still largely centered there, it is truly an international market. Transactions are not subject to any particular nations regulations. A Eurobond is a bond issued outside the country in whose currency it is denominated. For example to raise funds to finance its European activities a US company might sell a bond denominated in British pounds throughout Europe. A countrys foreign bond market is that market in which the bonds of issuers not domiciled in that country are sold and traded. The definition of foreign led refers to the nationality of the issuer in relation to the market place. issuer For example a US Dollar bond sold in the United States by the Swedish car producer Volvo is classified as a foreign bond while one issued by General Motors is a domestic bond. Foreign bonds have nicknames: foreign bonds sold in the U.S. are "Yankee sold bonds"; those sold in Japan are "Samurai bonds"; and foreign bonds sold in the United Kingdom are "Bulldogs." Characteristics of Eurobond markets markets: Currency denomination: The generic, plain vanilla Eurobond pays an annual fixed interest and has a long term maturity. There are a number of nterest long-term different currencies in which Eurobonds are sold. The major currency
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Alaji Mamadou Cire BAH 540910685

MF0006 SET 2

Sikkim Manipal University 4th Semester Spring 2011

denominations are the U.S. dollar, yen, and euro. (70 to 75 percent of Eurobonds are denominated in the U.S. dollar.) The centr bank of a central country can protect its currency from being used. Japan, for example, prohibited the yen from being used for Eurobond issues of its corporations until 1984. Non-registered: Eurobonds are usually issued in countries in which there is little regulation. As a result, many Eurobonds are unregistered, issued ulation. as bearer bonds. (Bearer form means that the bond is unregistered, there is no record to identify the owners, and these bonds are usually kept on deposit at depository institution). While this feature provides feature confidentiality, it has created some problems in countries such as the U.S., where regulations require that security owners be registered on the books of issuer. Credit risk: Compared to domestic corporate bonds, Eurobonds have fewer protective covenants, making them an attractive financing tive instrument to corporations, but riskier to bond investors. Eurobonds differ in term of their default risk and are rated in terms of quality ratings. Maturities: The maturities on Eurobonds vary. Many hav intermediate have terms (2 to 10 years), referred to as Euro notes, and long terms (10 (10-30 years), and called Eurobonds. There are also short term Euro paper and short-term Euro Medium-term notes. term Other features: 1. Like many securities issued today, Eurobonds often are so with many sold innovative features. For example: Dual-currency Eurobonds pay coupon interest in one currency and currency principal in another. Option currency Eurobond offers investors a choice of currency. For instance, a sterling/Canadian dollar bond gives the holder the right to holder receive interest and principal in either currency. 2. A number of Eurobonds have special conversion features. One type of robonds convertible Eurobond is a dual currency bond that allows the holder to dual-currency
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Alaji Mamadou Cire BAH 540910685

MF0006 SET 2

Sikkim Manipal University 4th Semester Spring 2011

convert the bond into stock or another bond that is denominated in that another currency. 3. A number of Eurobonds have special warrants attached to them. Some of the warrants sold with Eurobonds include those giving the holder the right to buy stock, additional bonds, currency, or gold.

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Alaji Mamadou Cire BAH 540910685

MF0006 SET 2

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