International Finance

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A) Balance Of Payments – BOP: A record of all transactions made between one particular country and all other countries during a specified period of time. BOP compares the dollar difference of the amount of exports and imports, including all financial exports and imports. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa. Balance of payments may be used as an indicator of economic and political stability. For example, if a country has a consistently positive BOP, this could mean that there is significant foreign investment within that country. It may also mean that the country does not export much of its currency. Features of Balance of Payments in international trade Balance of payments is a systematic record of all economic transactions. Visible as well as invisible, in a period, between one country and the rest of the world. It shows the relationship between one country's total payments to all other countries and its total receipts from them. Balance of payments thus is statement of payments and receipts on international transactions. Payments and receipts on international account are of three lands: (a) the visible balance of trade; (b) the invisible items; and (c) capital transfers. Kindleberger defines balance of payments as "a systematic record of all economic transactions between the residents of the reporting country and the residents of foreign countries during a given period of time." In the words of Benham, "Balance of payments of a country is a record of the monetary transactions over a period with the rest of the world." Features of Balance of Payments Balance of Payments has the following features: (i) It is a systematic record of all economic transactions between one country and the rest of the world. (ii) It includes all transactions, visible as well as invisible. (iii) It relates to a period of time. Generally, it is an annual statement. (iv) It adopts a double-entry book-keeping system. It has two sides: credit side and debit side. Receipts are recorded on the credit side and payments on the debit side. (v) When receipts are equal to payments, the balance of payments is in equilibrium; when receipts are greater than payments, there is surplus in the balance of payments; when payments are greater than receipts, there is deficit in the balance of payments. (vi) In the accounting sense, total credits and debits in the balance of payments statement always balance each other. The key features of India’s BoP that emerged in the first half of fiscal 2008-09 were: (i) widening trade deficit ($ 69.2 billion) led by high imports, (ii) significant increase in invisible surplus ($ 46.8 billion) led by remittances from overseas Indians and software services exports, (iii) higher current account deficit ($ 22.3 billion) due to high trade deficit, (iv) volatile and relatively lower net capital inflows ($ 19.9 billion) than April-September 2007-08 ($ 50.9 billion), and

(v) decline in reserves (excluding valuation) of $ 2.5 billion (as against an accretion to reserves of $ 40.4 billion in AprilSeptember 2007-08).

Explain Balance Of Payments Theory Of Exchange Rate The balance of payments theory of exchange rate is also named as general equilibrium theory of exchange rate. According to this theory, the exchange rate of the currency of a country depends upon the demand for and supply of foreign exchange. If the demand for foreign exchange is higher than its supply, the price of foreign currency will go up. In case, the demand of foreign exchange is lesser than its supply, the price of foreign exchange will decline. The demand for foreign exchange and supply of foreign exchange arises from the debit and credit items respectively in the balance of payments. The demand for foreign exchange comes from the debit side of balance of payments. The debit items in the balance of payments are import of goods and services and loans and investments made abroad. The supply of foreign exchange arises from the credit side of the balance of payments. It is made up of the exports of goods and services and capital receipts. If the balance of payments of a country is unfavourable, the rate of foreign exchange declines. On the other hand, if the balance of payments is favourable, the rate of exchange will go up. The domestic currency can purchase more amounts of foreign currencies. Distinguish Between Balance Of Trade And Balance Of Payments In order to calculate the balance of trade, you must calculate the difference between a country’s imports and exports. The goal is to have a surplus. In this situation, the value of a nation’s exports is higher than the import’s value. A truly wealthy nation has a large surplus, and maintains a high level of valuable export trade. A poor nation is one that cannot maintain a surplus. They do not make enough money through exporting to make up for the debt they acquire from importing. The balance of trade isn’t technically stable in any country. This is due to crop failures, unpredictable death of livestock, mining accidents, supply-and-demand issues, increases in taxes and tariffs, instability of the currency value, the availability and cost of raw materials needed in manufacturing, and production costs. Economies that have a wider variety of exports tend to have stronger economies because there is more probability that some of their exports will make a profit. Balance of payments is calculated based on every type of transaction (this includes exports, imports, service trade, transfers, loans, debt payments, bonds, and capital) that a particular country has with everyone else in the entire world. If the country is in debt, it is called a deficit. If the country has money, they have a surplus. A country can have a surplus in the balance of trade, but have a deficit in the balance of payments. For example, a country might have millions of diamonds and rubies they export every year which creates a huge surplus. They might not need to import very many goods, so they gain wealth in trade. This same country might have racked up billions of dollars in debt by taking out loans with another country, and the amount of money gained through exports does not make up the difference. It would be at a deficit overall. B) Theory of Comparative Advantage: A situation in which a country, individual, company or region can produce a good at a lower opportunity cost than a competitor. Let's break this down into a simple example. Suppose that two firms both produce two main products: ice cream and bicycles. The first firm, the ABC Co Ltd, where dairy milk is abundant; the second firm, the XYZ Co Ltd, is smack in the middle of the Gobi Desert.

The XYZ Co Ltd. must spend a lot of money to make ice cream, whereas the ABC Co Ltd. spends way less to produce the same amount. The two firms are dead even in their production costs for bicycles. Because the ABC Co Ltd. has a comparative advantage with ice cream production, it should probably consider turning exclusively to ice cream. Along the same vein, the XYZ Co Ltd. should probably give up the ice cream and focus on the product in which it is the least disadvantaged (bicycles). C) Foreign Exchange Market: The foreign exchange market or forex market as it is often called is the market in which currencies are traded. Not only is the forex market the largest market in the world, but it is also the most liquid, differentiating it from the other markets. D) Interest Rate Swap: An agreement between two parties (known as counterparties) where one stream of future interest payments is exchanged for another based on a specified principal amount. Interest rate swaps often exchange a fixed payment for a floating payment that is linked to an interest rate (most often the LIBOR). A company will typically use interest rate swaps to limit or manage exposure to fluctuations in interest rates, or to obtain a marginally lower interest rate than it would have been able to get without the swap. Interest rate swaps are simply the exchange of one set of cash flows (based on interest rate specifications) for another. Because they trade OTC, they are really just contracts set up between two or more parties, and thus can be customized in any number of ways. Generally speaking, swaps are sought by firms that desire a type of interest rate structure that another firm can provide less expensively. For example, let's say Cory's Tequila Company (CTC) is seeking to loan funds at a fixed interest rate, but Tom's Sports Inc. (TSI) has access to marginally cheaper fixed-rate funds. Tom's Sports can issue debt to investors at its low fixed rate and then trade the fixed-rate cash flow obligations to CTC for floating-rate obligations issued by TSI. Even though TSI may have a higher floating rate than CTC, by swapping the interest structures they are best able to obtain, their combined costs are decreased - a benefit that can be shared by both parties. E) OPTIONS: ROLE OF OPTIONS AND FUTURES IN INVESTMENT MANAGEMENT With the introduction of options and futures, investment risk management has assumed a new dimension. Though the manager can achieve a high degree of freedom, it does not alter the market profile of an equity portfolio economically or quickly. They however offer these managers risk and return patterns that did not exist earlier. We must realize that the options and future markets are solely and wholly dependent on the performance of the underlying financial instrument, that is the equity market. An option is basically a contract in which the writer of the option grants the buyer of the option the right to purchase from or sell to the writer an underlying security at a specified price, i.e. the strike price within a specified period of time. In exchange for the option the buyer pays the writer money called the option premium or price. There are two types of option contracts: Call Options and Put Options. Call Options give the option buyer the right to buy the underlying asset. Put Options give the option buyer the right the sell the underlying asset.

A "call" option, is when the option grants the buyer the right to buy the underlying security at the specified price during or at the end of the option period. A "put" option, is when the option grants the buyer the right to sell the underlying security at the specified price during or at the end of the option period. A future contract is an agreement between a buyer and seller, in which the buyer agrees to take delivery and the seller agrees to give delivery of some product at the end of the designated period of time, called the settlement date. Aside from the purely speculative application of these instruments, options and futures can be used to create a synthetic instrument that offers a higher return than a cash market instrument or an index. They can be used to adjust the risk exposure i.e. hedge a stock or bond portfolio quickly. They can also be used to alter the stock/bond mix of a portfolio quickly. Future contracts can be used to reduce the transaction cost of creating an index fund. These instruments are also used for portfolio insurance. We would expect the investor to realize that, options and futures are contracts based on the expected movement of an underlying security; and are not in themselves investments. The individual investor should avoid indulgence in options and futures, unless of course he has gained the knowledge on how to trade successfully in these instruments. Due to the speculative nature of these instruments we have not discussed them in detail. For a better understanding of options, we would suggest that the investor read through the above listed topics. We would strongly recommend that the investor first study these investment instruments; conduct dry runs with pen and paper; understand the nuances of the dynamics of the underlying security and the connectivity between the various risks that he or she would be taking on during the pendency of a futures or options position held by him. Buying put options enables investors to profit when the markets fall without having to sell short stock. Buyers of put options have unlimited profit potential if markets begin to sell off. Put option holders also have limited risk if the market goes against them i.e. up. To get a better understanding of the payoff of a put option, take a look at the following option strategy graphs: o o Long Put Option (Buying a Put Option) Short Put Option (Sell a Put Option)

And then compare put option graphs to the following call option graphs: o o Long Call Option (Buying a Call Option) Short Call Option (Selling a Call Option)

An option is a contract between two parties giving the taker (or buyer) the right, but not the obligation, to buy or sell a parcel of stocks (or shares) at a predetermined price; possibly on or before a predetermined date. To acquire this right the buyer pays a premium to the writer (or seller) of the contract. There are two types of options; namely: o o Call options Put options

We shall discuss both these types of options. You are advised to follow the thought, to understand the concept. The names and the prices in the illustrations below are not in real time and have only been used to help explain these options. Call Options: The call options give the taker (or buyer) the right, but not the obligation, to buy the underlying stocks (or shares) at a predetermined price, on or before a determined date. Call Options: Long and Short Positions: • When you expect prices to rise, then you take a long position by buying the Call Option. You are bullish on the underlying security. • When you expect prices to fall, then you take a short position by selling the Call Option. You are bearish on the underlying security. Put Options: A Put Option gives the holder the right to sell a specified number of shares of an underlying security at a fixed price for a period of time. Put Options: Long and Short Positions: • • When you expect price to fall, then you take a long position by buying Puts. You are bearish. When you expect prices to rise, then you take a short position by selling Puts. You are bullish.

Call Options and Put Options: Long and Short Positions: CALL OPTIONS Short Long PUT OPTIONS Long Short

If you expect a fall in price (Bearish) If you expect a rise in price (Bullish)

We have provided a matrix below to summarize the above discussion on Call and Put options: CALL OPTION BUYER Pays the premium Has right to exercise and buy the underlying shares Profits from rising prices Limited loss, potentially unlimited gain PUT OPTION BUYER Pays the premium Has right to exercise and sell the underlying shares Profits from falling prices Limited loss, potentially unlimited gain CALL OPTION WRITER (SELLER) Receives the premium Obligation to sell shares, if contract is exercised Profits from falling prices or remains neutral Potentially unlimited loss, limited gain PUT OPTION WRITER (SELLER) Receives the premium Obligation to buy the shares if contract is exercised Profits from rising prices or remains neutral Potentially unlimited loss, limited gain

For a better understanding of options, we would suggest that the investor read about role of options and futures ; what are options? ; option styles, class and series andoption concepts . We would strongly recommend that the investor first study these investment instruments; conduct dry runs with pen and paper; understand the nuances of the dynamics of the underlying security and the connectivity between the various risks that he or she would be taking on during the pendency of a futures or options position held by him. OPTION CONCEPTS The investor would find it useful to know certain important terms used with regard to transactions in options. These terms are listed below: • • • • • • Strike price, In-the-money, Out-of-the-money, At-the-money, Covered Call, and Covered Put

At this stage, we would like to reiterate, that the visitors who have not dealt in stocks and share, or investors who have dealt in stocks and shares but have not indulged in the leverage provided by options as a speculative instrument would be well advised to meet a qualified investment advisor to understand the nuances of this instrument. It is always better to be on the side of caution and have a healthy margin of safetyavailable to us at all times in our financial transactions. Strike price: The strike price denotes the price at which the buyer of the option has a right to purchase or sell the underlying. Five different strike prices will be available at any point of time. The strike price interval would be of 20. Let's say that the index is currently at 1410, then the strike prices available would be 1370, 1390, 1410, 1430 and 1450. The strike price is also called the exercise price. This strike price is fixed for the entire duration of the option, the profit or loss from the contract would depend on the price movement of the underlying stock or index in the Cash market. In-the-money: A Call option is said to be "in-the-money", if the strike price is les than the market price of the underlying (whether stock or index). A Put option is "in-the-money", when the strike price is greater than the market price of the underlying.

Let's say Raj purchases 1 SATCOM AUG 190 Call at a premium of ₹10.00. Here, the option is "in-the-money" till the market price of SATCOM is ruling above the strike price of ₹190.00. Which is the price at which Raj would like to buy 100 shares of SATCOM anytime before the end of August. Similarly, if Raj has purchased a Put option at the same strike price; then the option would be "in-the-money" if the market price of SATCOM was lower than ₹190.00 per share. Out-of-the-money: A Call option is said to be "out-of-the-money" if the strike price of the contract is greater than the market price of the underlying stock. Similarly, a Put option is "out-of-the-money" if the strike price is les than the market price of the underlying stock. To explain this further, let's say Raj purchases 1 INFTEC AUG 3500 Call at a premium of ₹150.00. The option is "out-ofthe-money", if the market price of INFTEC is ruling below the strike price of ₹3,500.00. Which is the same price at which Raj would like to buy 100 shares of INFTEC anytime before the end of August. Similarly, if Raj has purchased a Put option at the same strike price; then the option would be "out-of-the-money", if the market price of INFTEC was above INR 3,500.00 per share. At-the-money: The option with a strike price equal to that of the market price of the underlying stock is considered to be "atthe-money" or near-the-money. Let's say Raj purchases 1 ACC AUG 150 Call or Put at a premium of ₹10.00. In this case, if the market price of ACC is ruling at ₹150.00, which is equal to the strike price, then the option is said to be "at-the-money". To explain this further, let's say the Index is at 1410, then the strike prices available would be 1370, 1390, 1410, 1430 and 1450. The strike price for a Call option that are greater than the underlying Index are said to be "out-of-the-money" for strike prices 1430 and 1450 considering that the underlying in the cash market is at 1410. Similarly, "in-the-money" strike prices would be 1370 and 1390 which are lower than the underlying of 1410. And of course, the strike price 1410 would be "at-themoney". At these prices an investor can take a positive or negative view on the market; that is both Call and Put options would be available. Therefore, for a single series 10 options (that is 5 Calls and 5 Puts) would be available; and considering that there are 3 series, a total of 30 options would be available to take a position. Covered Call options: Covered option helps the writer to minimize his loss. In a covered call option, the writer of the call option takes a corresponding long position in the stock in the cash market; this would cover his loss in the options position, in case there is a sharp increase in the price of the stock. Further, he is able to reduce his average cost of acquisition in the cash market (which would be the cost of acquisition less the option premium received). To illustrate this, let's say Raj believes that HUL has hit rock bottom at a price level of ₹182.00 and that it would move up in a narrow range. He can take a long position in HUL shares and at the same time write a Call option with a strike price of ₹185.00 and collect a premium of ₹5.00 per share. This would bring down the effective cost of HUL shares to him to ₹177.00 (that is ₹182.00 less ₹5.00). If the price stays below ₹185.00 till expiry, then the Call option would not be exercised and Raj the writer of the Call option would keep the ₹5.00 per share he had collected as premium. If on the other hand the price goes above ₹185.00 and the option is exercised, then Raj would deliver the shares acquired in the cash market.

Covered Put options: Similarly, the writer of a Put option can create a covered position by selling the underlying security (that is, if it is already owned). The effective selling price will increase by the premium amount (if the option is not exercised at maturity). Here again, the investor is not in a position to take advantage of any sharp increase in the price of the stock, as the underlying asset has already been sold. However, if the there is a sharp decline in the price of the underlying asset, the option would be exercised and the investor would be left only with the premium amount. The loss in the option exercised would be equal to the gain in the short position of the underlying asset. For a better understanding of options, we would suggest that the investor read about role of options and futures; what are options?; types of options and option styles, class and series. We would strongly recommend that the investor first study these investment instruments; conduct dry runs with pen and paper; understand the nuances of the dynamics of the underlying security and the connectivity between the various risks that he or she would be taking on during the pendency of a futures or options position held by him. F) Arbitrage: The simultaneous purchase and sale of an asset in order to profit from a difference in the price. It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms. Arbitrage exists as a result of market inefficiencies; it provides a mechanism to ensure prices do not deviate substantially from fair value for long periods of time. Given the advancement in technology it has become extremely difficult to profit from mispricing in the market. Many traders have computerized trading systems set to monitor fluctuations in similar financial instruments. Any inefficient pricing setups are usually acted upon quickly and the opportunity is often eliminated in a matter of seconds. G) Hedging: Hedging is the process of managing the risk of price changes in physical material by offsetting that risk in the futures market. Hedging can vary in complexity from a relatively simple activity, through to a highly complex strategies, including the use of options. The ability to hedge means that industry can decide on the amount of risk it is prepared to accept. It may wish to eliminate the risk entirely and can generally do so quickly and easily using the LME.

H) FINANCIAL MANAGEMENT IN GLOBAL CONTEXT: The business world today depicts strong linkages among trade, capital, people, and technology. A large number of organizations which do not internationalize may perish is not a dire prediction but appears to be an inevitable outcome of the one-world management thesis. In many local and global markets, competition would be severe, value addition possibilities transient, and technology edge would be near inconspicuous. Thus, fortunes of most firms rest upon how they adapt their business strategies in an international setting. Particularly, the ability of a firm to customize its product development, pricing, promotion, logistics, finance, human resources, operations, and e-commerce strategies in an international setting will result in sustainable competitive advantage. Increasing international focus of most of the firms today provides impetus for inquiry into the application and execution of the principles of business management in international domain. Furthermore, the multifarious nature of business activities presents many challenges and opportunities for organizations and individuals in a dynamic global market environment. As more and more Indian and foreign-owned companies located in India are looking at the possibilities to invest abroad, it may be to take a multi-faceted strategic approach. Continuous value creation and delivery should be the focus of companies which are in the process of internationalizing. To create and operate value networks that span across national boundaries, gaining an understanding of cross-cultural work practices, regulatory frameworks, and economic environment is a prerequisite. Among others, making durable investments to attract, develop, and retain global executives can yield crucial competitive advantages to services and manufacturing organizations. This programme will discuss various analytical frameworks and examine their applicability to practical international business domain. Managers will be urged to examine novel ways of looking at international business and adopt strategies that match the realities and demands of the global marketplace. FINANCIAL MARKETS AND ITS INTERLINKAGES Financial Market Capital Market : Money Market : Forex Market Primary Market, Secondary Market : Call Money Market, T Bills Market, Gilt Market, Commercial Paper Market, Certificate of Deposits : Spot Market, Forward Market RECENT TRENDS IN GLOBAL FINANCIAL MARKETS: General perception of regulation of Indian Capital Market is that it is over regulated and regulations are retail-oriented – Indian Capital market has a concentrated market structure with majority of trading taking place two stock Exchanges – Technological innovations introduced in India viz. DMA, Algorithm trading & Smart Order Routing (SOR) – Contribution of automated trading tools restricted to foreign brokerage houses due to easy availability of advanced trading tools by group companies and a global client base – Regional players without significant relationships, market knowhow or access, research and improved technology. – Western market innovations like High frequency trading, Alternate Trading System & dark pools still a long way to make entry to India. FUNCTIONS : • • • Cross-cultural difference in buyer behaviour. International brand management. International pricing, promotions, and communications.

• • • • • • • • • • •

Launching a product internationally. International supply chain management. Using global alliances, partnerships, and acquisitions for gaining competitive advantage. Recruiting, developing, and managing international executives. Building global teams and managing across cultures. Management styles and culture. Cross-cultural negotiations. Business ethics. International law, payment mechanisms, and accounting practices. International economics. International finance and currency risk management.

GOALS FOR INTERNATIONAL FINANCIAL MANAGEMENT • • • o o • o including: • • • o o Employees Suppliers Customers In Japan, managers have typically sought to maximize the value of the keiretsu—a family of firms No matter what the other goals, they cannot be achieved in the long term if the maximization of The focus is to equip with the “intellectual toolbox” of an effective global manager—but what Maximization of shareholder wealth Long accepted as a goal in the Anglo-Saxon countries, but complications arise. Who are and where are the shareholders? In what currency should we maximize their wealth? Other Goals In other countries shareholders are viewed as merely one among many “stakeholders” of the firm

goal should this effective global manager be working toward?

to which the individual firms belongs. shareholder wealth is not given due consideration. INTERNATIONAL FINANCE • • • • In today's world finance cannot be anything but international Enormous growth in the volume of international trade Cross border capital flows and, in particular, direct investment have also grown enormously Veritable ( Genuine) revolution has been taking place in the money and capital markets around the world Liberalization, integration and innovation have created a giant international financial market which is extremely dynamic and complex • • • • • • • • • Multilateral negotiations regarding phased removal of trade barriers have made considerable progress and WTO had emerged as a meaningful platform Post war, World trade has grown faster than World GDP Almost all countries getting integrated with the global economy Indian economy needs substantial amount of foreign capital to augment domestic savings Technology up-gradation in India will require continuing import of foreign technology, hardware and software India’s increasing recourse to commercial borrowings and direct and portfolio investments by nonresidents The efforts of Indian companies to diversify into exports of engineering equipment and turnkey projects will have to be supported by the ability to offer long term financing to buyers A number of companies particularly in the Indian IT sector have begun venturing abroad for strategic reasons either as partners in joint ventures or by establishing foreign subsidiaries India's growing dependence on international financial markets



o o o • • •

Debt Equity FII investment

Indian companies have also been venturing abroad for setting up joint ventures and wholly owned subsidiaries For those who are willing to master its complexities the global financial market provides endless opportunities for creative financial management Finance managers must come to grips with with the conceptual foundations and practical issues of instruments and markets

FINANCE FUNCTION • • • • The finance function in a firm can be conveniently divided into two sub-functions viz. accounting and control and treasury management Decisions taken by the treasurer have implications for the controller and vice versa Treasury Function: Acquisition and allocation of financial resources so as to minimize the cost and maximize the return, consistent with the level of financial risk acceptable to the firm is the core of treasury management Accounting and Control: Internal and External Reporting, MIS, Control, etc.

EMERGING CHALLENGES • Five key categories of emerging challenges can be identified o o o o o To keep up-to-date with significant environmental changes and analyze their implications for the firm To understand and analyze the complex interrelationships between relevant corporate responses To be able to adapt the finance function to significant changes in the firm's own strategic posture To take in stride past failures and mistakes to minimize their adverse impact To design and implement effective solutions to take advantage of the opportunities offered by the markets and advances in financial theory RECENT CHALLENGES IN GLOBAL FINANCIAL MARKETS • • • • • The outstanding feature of the changes during the eighties was integration Both the potential borrower and the potential investor have a wide range of choice of markets Deregulation within the financial systems of the major industrial nations Assets denominated in various currencies became more nearly substitutable Deregulation involved action on two fronts o o • • Eliminating the segmentation of the markets for financial services permitting foreign financial institutions to enter the national markets and compete on an equal footing with the domestic institutions This is a part of the overall trend towards securitisation and disintermediation The attainment of the Economic and Monetary Union (EMU) and the birth of Euro in the closing years of the decade of 1990's SPECIAL ABOUT “INTERNATIONAL” FINANCE • Foreign Exchange Risk o • The risk that foreign currency profits may evaporate in dollar terms due to unanticipated unfavorable exchange rate movements. Political Risk o • Sovereign governments have the right to regulate the movement of goods, capital, and people across their borders. These laws sometimes change in unexpected ways. Market Imperfections o o o o • Legal restrictions on movement of goods, people, and money Transactions costs Shipping costs Tax arbitrage environmental variables and

Expanded Opportunity Set o o It doesn’t make sense to play in only one corner of the sandbox. True for corporations as well as individual investors.

1) DEVELOPMENT OF INTERNATIONAL MONETARY SYSTEM As the world slips once again into crisis, there is renewed discussion of the need to reform the global financial and monetary architecture. During the crises at the end of the 1990s, discussions covered many of the issues that are still being considered today—international policy coordination and surveillance, participation in global governance, financing for development, debt and crisis management. As was true of these issues, little progress was made in dealing with another critical issue, the monetary aspect of problems within the existing international system, even though those problems had been identified and discussed since the 1960s. Official discussions continued to revisit the familiar ground of earlier debates over fixed versus floating exchange rates. Countries that had experienced crises were moving to new ground with proposals centred on adopting another country's currency (dollarisation) or bloc solutions modelled on the euro area's single currency system, while academics and analysts from non-governmental organisations revived calls for new issues of special drawing rights (SDRs). The most basic element of the global system is the choice of the means of payment in cross-border transactions. It is an element that has been at the centre of the incremental process that determined international financial and monetary architecture in the past but slipped into non-priority status as a focus for reform after the collapse of the Bretton Woods regime in the early 1970s. President Richard Nixon's decision to end the dollar's convertibility into gold ushered in a new international monetary system in which international payments would be made by private banks in the national currencies of the so-called ‘strong’ currency countries rather than exchanges of gold by central banks. The value of the currency most used in these transactions—the US dollar—was no longer fixed in relation to gold. After 1973, it was allowed to ‘float’ with its value determined by changes in the supply and demand for the currency. So far, concerns about global payments imbalances have provoked little interest in monetary reform. There has been a widespread assumption that, after this period of economic and financial turmoil has passed, the euro will increase its share in the international monetary system and the current strong-currency regime will continue. But Europe is unlikely to assume the US role of importer of last resort and if no country or region is willing to run the trade deficits that provide the opportunity for other countries to earn the preferred reserve currency, a global system based on national currencies cannot continue. Over the next decade, it will either be replaced by conscious planning or transformed by the effort to adapt to the ever-larger crises that are fuelled by an unstable international monetary regime. • • • • • • The gold standard Bretton Woods: the dollar exchange rate regime Monetary collapse The proposal for an international commodity reserve currency Proposals for new issues of SDRs Proposals for alternative solutions

The gold standard In today's national economies and the current international monetary system, fiat currencies are the norm. With no backing other than the full faith and credit of the governments that issue them, the evolution of today's money began with the introduction and acceptance of paper money in the seventeenth century in the form of receipts for deposits of gold in the

Bank of Amsterdam. Bank notes thus became the standard currency for transactions within national economies in the eighteenth and nineteenth centuries. The gold exchange standard It is probable that the success of the gold standard also depended on a parallel development that emerged out of the mechanisms the industrializing countries used to ‘manage’ the gold standard—the development of the gold exchange standard. This monetary system differs from the gold standard in that international reserves consist of both gold and convertible currencies so that the system can function with less gold. Another difference is that, because those convertible currencies tend to be invested in interest-bearing financial assets, the gold exchange standard includes a mechanism that allows for growth in world reserves independent of increases in gold production. Bretton Woods: the dollar exchange rate regime The international monetary system set in place at Bretton Woods differed from the gold exchange standard, however, in that, as Joseph Gold noted, it was in practice ‘a solar system in which the US dollar was the sun’ (Dam, 1982, p. 95). The USA committed to exchange dollars for gold at the rate of $35 an ounce and other currencies were to keep their par values at a given relationship to the dollar. The burden of intervention was to be borne by the non-reserve currency countries. The value of the dollar was fixed but the value of other currencies, determined by the market, could appreciate or depreciate by 2% without the requirement to intervene. Monetary collapse In 1971, the dollar came under pressure from actions by Germany and France and the Bank of England's need to convert $700 million into gold to alleviate pressure on sterling. Foreseeing a run on the dollar, President Nixon closed the gold window in August, ending dollar convertibility. At a meeting of the G10 nations at the Smithsonian Institution in December, the USA announced a devaluation of the dollar to $38 to an ounce of gold, imposed a 10% tariff surcharge on Japanese imports and negotiated upward revaluations of the deutschmark, the yen and the Swiss franc. The proposal for an international commodity reserve currency Graham's initial work in the monetary field (Graham, 1937) offered a plan for a new US domestic currency in the form of receipts issued by a commodity storage facility. The objective of both his domestic plan and the international version was to ensure monetary stability through countercyclical mechanisms, preserve the link between monetary issuance and the real economy, and back currency issues with a class of financial assets that would be less likely to divert monetary resources into speculative activities. Proposals for new issues of SDRs The objective of these proposals is to move beyond the key currency system by creating an international reserve unit under multilateral governance. While new issues of SDRS are obviously looked on with favour as a mechanism for expanding reserves, they would remove the credit-generating attribute of foreign exchange reserves that introduced a procyclical aspect to reserve holdings and exacerbated booms and downturns as discussed above. Proposals for alternative solutions

Most criticisms of the current international monetary system have stressed the need to create a reserve asset not based on a national currency. Many note the system's inequities while others argue with Kaldor that it is inherently unsustainable. The author's three reform proposals outlined below are offered as part of the effort to enlarge the debate. Creating a public international investment fund for emerging economies Reforming the international payments system A new structure for reviving SDR issuance

2) FOREIGN EXCHANGE RISK 1. The risk of an investment's value changing due to changes in currency exchange rates. 2. The risk that an investor will have to close out a long or short position in a foreign currency at a loss due to an adverse movement in exchange rates. Also known as "currency risk" or "exchange-rate risk". This risk usually affects businesses that export and/or import, but it can also affect investors making international investments. For example, if money must be converted to another currency to make a certain investment, then any changes in the currency exchange rate will cause that investment's value to either decrease or increase when the investment is sold and converted back into the original currency. Every company that has exposure to foreign exchange risk must prudently manage & control its exposure together with management of other risks. Foreign exchange risk implies the exposure of a company to the potential impact of movements in foreign exchange rates. The risk that is caused by adverse fluctuations in exchange rates may result in a loss to the company. INTERNAL TECHNIQUES Netting: Netting implies offsetting exposures in one currency with exposure in the same or another currency, where exchange rates are expected to move high in such a way that losses or gains on the first exposed position should be offset by gains or losses on the second currency exposure. It is of two types bilateral netting & multilateral netting. In bilateral netting, each pair of subsidiaries nets out their own positions with each other. Flows are reduced by the lower of each company’s purchases from or sales to its netting partner. Matching: In contrast to netting, matching applies to both third parties as well inter-company cash flows. It can be used by the exporter/importer as well as the multinational company. It refers to the process in which a company matches its currency inflows with its currency outflows with respect to amount and timing. The aggressive company may decide to take forward cover on its currency payables and leave the currency receivables exposed to exchange risk; if forward rate looks cheaper than the expected spot rate. Leading and Lagging: It refers to the adjustment of intercompany credit terms, leading means a prepayment of a trade obligation and lagging means a delayed payment. It is basically intercompany technique whereas netting and matching are purely defensive measures. Intercompany leading and lagging is a part of risk-minimizing strategy or an aggressive strategy that maximizes expected exchange gains. Leading and lagging requires a lot of discipline on the part of participating subsidiaries.

Pricing Policy: In order to manage foreign exchange risk exposure, there are two types of pricing tactics: price variation and currency of invoicing policy. One way for companies to protect themselves against exchange risk is to increase selling prices to offset the adverse effects of exchange rate fluctuations. Selling price requires the analysis of Competitive situation, Customer credibility, Price controls and Internal delays. Trading or Financing Pattern: Intercompany or transfer price variation refers to the arbitrary pricing of intercompany transfer of goods and services at a higher or lower rate than the market price. In establishing international transfer prices, one tries to satisfy a number of objectives. The firms want to minimize taxes and at the same time win approval from the Government of the host country. Yet, the basic objectives of profit maximization and performance evaluation are also significant. Asset and Liability Management: This technique can be used to manage balance sheet, income statement and cash flow exposures. It can also be used aggressively or defensively. They aggressive approach reflects to increase exposed assets, revenues, and cash inflows denominated in strong currencies and to increase exposed liabilities, expenses, and cash outflows in weak currencies. The defensive firm will seek to minimize foreign exchange gains and losses by matching the currency denomination of assets/liabilities, revenues/expenses and cash inflows/outflows, irrespective of the distinction between strong and weak currencies.

EXTERNAL TECHNIQUES External techniques are used by both exporters and importers as well as by multinational companies. The costs of the external exposure management methods are fixed and predetermined. The main external exposure management techniques are forward exchange contracts, short term borrowing, discounting, forfeiting & government exchange risk guarantees. Forward Exchange Contracts: Forward exchange contracts refer to agreements in which two parties agree upon the exchange rate at which currencies will be exchanged on future date or within future specified duration. Forward contracts reduces exchange risk element in the foreign transactions. Price is paid for the protectionism and best-cost alternative should be chosen to reduce the cost of purchase. Short term Borrowing: Another alternative to hedge risks in the forward market is the short-term borrowing technique. A company can borrow either dollar or some other foreign currency or the local currency. Through short term borrowing techniques, two major difficulties of the settlement dates and the continuing stream of foreign currency are easily solved. Short-term borrowing has some advantages over forward cover. Discounting: This technique is used to resolve the problems of continuing foreign currency exposures and uncertain settlement dates. The discounting technique for covering receivables exposures is very similar to short term borrowing. The basic aim in discounting is to convert the proceeds from the foreign currency receivable into the home currency as soon as possible. Forfeiting: Forfeiting can be used as a means of covering export receivables. When the export receivable is to be settled on open account except by bill of exchange, the receivables can be assigned as collateral for selected bank financing. In forfeiting one simply sells his export receivables to the factor and receives home currency in return. Government Exchange Risk Guarantee: Government agencies in many countries provide insurance against export credit risk and introduces special export financing schemes for exporters in order to promote exports. In recent years a few of these agencies have begun to provide exchange risk insurance to their exporters and the usual export credit guarantees. The exporter pays a small premium on his export sales and for this premium the government agency absorbs all exchange losses and gains beyond a certain level. Forward Contracts: Forward cover can be used to hedge purchases as well as sales. It may be two types namely forward purchases cover & forward sales cover. Forward purchase cover is extended to have terms and conditions related to export of goods & services. Period of delivery of currency should not be beyond seven days of the probable date of receipt as per the purchases forward cover. Options: Options are rights & not obligations to make buy and sell decision. The buyer pays a price or premium to the seller for the right but not the obligation to buy or sell a certain amount of a specified quantity of one currency in exchange at a fixed price for a specified period of time. Futures: Futures are contracts to buy or sell financial instruments, for forward delivery or settlement on standardized terms and conditions. Future contacts are similar to forward contracts but are more liquid as these are traded on recognized exchanges. SWAPS: Swaps refer to a contract between two parties, termed as counter-parties, who exchange payments between them for an agreed period of time according to certain specified rules. Swap is like a series of forward contracts.

3) TRANSACTION EXPOSURE The risk, faced by companies involved in international trade, that currency exchange rates will change after the companies have already entered into financial obligations. Such exposure to fluctuating exchange rates can lead to major losses for firms. Often, when a company identifies such exposure to changing exchange rates, it will choose to implement a hedging strategy, using forward rates to lock in an exchange rate and thus eliminate the exposure to the risk. Transaction exposure, defined as a type of foreign exchange risk faced by companies that engage in international trade, exists in any worldwide market. It is the risk that exchange rate fluctuations will change the value of a contract before it is settled. Transaction exposure is also called transaction risk. Transaction Exposure Meaning: Transaction exposure, meaning risk that foreign exchange rate changes will adversely affect a cross-currency transaction before it is settled, can occur in either developed or developing nations. A cross-currency transaction is one that involves multiple currencies. A business contract may extend over a period of months. Foreign exchange rates can fluctuate instantaneously. Once a cross-currency contract has been agreed upon, for a specific quantity of goods and a specific amount of money, subsequent fluctuations in exchange rates can change the value of that contract. A company that has agreed to but not yet settled a cross-currency contract that has transaction exposure. The greater the time between the agreement and the settlement of the contract, the greater the risk associated with exchange rate fluctuations. Transaction Exposure Management: A company engaging in cross-currency transactions can protect against transaction exposure by hedging. The company can protect against the transaction risk by purchasing foreign currency, by using currency swaps, by using currency futures, or by using a combination of these hedging techniques. Any one of these techniques can be used to fix the value of the cross-currency contract in advance of its settlement. Transaction Exposure Example: For example, let’s say a domestic company signs a contract with a foreign company. The contract states that the domestic company will ship 1,000 units of product to the foreign company and the foreign company will pay for the goods in 3 months with 100 units of foreign currency. Assume the current exchange rate is: 1 unit of domestic currency equals 1 unit of foreign currency. The money the foreign company will pay the domestic company is equal to 100 units of domestic currency. The domestic company, the one that is going to receive payment in a foreign currency, now has transaction exposure. The value of the contract is exposed to the risk of exchange rate fluctuations. The next day the exchange rate changes and then remains constant at the new exchange rate for 3 months. Now one unit of domestic currency is worth 2 units of foreign currency. The foreign currency has devalued against the domestic currency. Now the value of the 100 units of foreign currency that the foreign company will pay the domestic company has changed – the payment is now only worth 50 units of domestic currency. The contract still stands at 100 units of foreign currency, because the contract specified payment in the foreign currency. However, the domestic firm suffered a 50% loss in value.

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