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Global financial system
The global financial system (GFS) is a financial system consisting of institutions and regulations that act on the international level, as opposed to those that act on a national or regional level. The main players are the global institutions, such as International Monetary Fund and Bank for International Settlements, national agencies and government departments, e.g., central banks and finance ministries, and private institutions acting on the global scale, e.g., banks and hedge funds. International institutions The most prominent international institutions are the IMF, the World Bank and the WTO: • The International Monetary Fund keeps account of international balance of payments accounts of member states. The IMF acts as a lender of last resort for members in financial distress, e.g., currency crisis, problems meeting balance of payment when in deficit and debt default. Membership is based on quotas, or the amount of money a country provides to the fund relative to the size of its role in the international trading system. The World Bank aims to provide funding, take up credit risk or offer favorable terms to development projects mostly in developing countries that couldn't be obtained by the private sector. The other multilateral development banks and other international financial institutions also play specific regional or functional roles. The World Trade Organization settles trade disputes and negotiates international trade agreements in its rounds of talks
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Government institutions Governments act in various ways as actors in the GFS: they pass the laws and regulations for financial markets and set the tax burden for private players, e.g., banks, funds and exchanges. They also participate actively through discretionary spending. They are closely tied to central banks that issue government debt, set interest rates and deposit requirements, and intervene in the foreign exchange market. Private participants Players acting in the stock-, bond-, foreign exchange-, derivatives- and commoditiesmarkets and investment banking are Commercial banks Pension funds Hedge funds and private equity
Managing foreign exchange
How do central banks manage exchange rates? Foreign exchange market and management of exchange rate of a country’s currency are two key areas that influence the economic well-being of the general public. The exchange rate of a country’s currency is the value of its money for international trade in goods, services and finance and, therefore, it is part and parcel of the monetary condition of a country. Therefore, the central banks being the monetary authorities have been given discretionary powers under the relevant statutes to decide appropriate foreign exchange policies along with its monetary, financial and economic development policies. In macroeconomic perspective, foreign exchange policies are instrumental in mobilization of foreign savings and capital to fill the domestic resource gap and expand investments. Various public views are often expressed as to how the central banks should decide exchange rate policies and what factors should be taken into consideration. Therefore, this article is intended to educate the public on the background how the central banks manage or regulate exchange rates and foreign exchange markets. Why exchange rates? An exchange rate is a price of a currency stated in units of another currency, i.e., Rs 108 a US Dollar (US $), US$ 1.5 a Euro or Chinese Yuan 7 a US$. The exchange rate between two currencies can be stated in two ways, domestic currency price of foreign currency or foreign currency price of domestic currency, i.e., Rs. 108 a US$ or US$ 0.01 a Rupee. Exchange rates exist because countries have to exchange their national currencies with foreign currencies to engage in trade and financial transactions with other countries. For example, when a Sri Lankan garment manufacturer exports garments to a buyer in US, Sri Lankan exporter receives the payment for his export in US$. Therefore, if the Sri Lankan exporter is to use his US$ income in Sri Lanka, he has to sell his US$ proceeds to a bank for Sri Lanka Rupees. Similarly, Sri Lankan importers have to buy currencies of the exporting countries for payments to suppliers in those countries. Accordingly, any foreign receipts to a country involve supply of foreign currencies (or foreign exchange) in exchange for domestic currency. On the other hand, any payments to foreign countries involve purchase (demand for) of foreign currencies by paying in the domestic currency. In addition, certain authorized parties undertake dealings (buying and selling) in foreign currencies seeking various kinds of financial gain. Since international transactions are conducted in major foreign currencies such as US$, Sterling Pounds, Yen and Euro, market participants and policymakers are concerned about the exchange rates of such major currencies. In Sri Lanka, the Central Bank (CBSL) monitors mainly the exchange rate for US$ as the Base Exchange rate in the foreign exchange market. However, CBSL has designated several foreign currencies for international transactions by the public through banks.
What determines the exchange rates? Exchange Rates are determined by supply and demand side factors. For example, increased demand for sterling will cause an appreciation in the Sterling exchange rate. These are some of the most significant factors in exchange rate determination: 1. Interest Rates. If interest rates increase in the SL then it becomes relatively more attractive to save money in banks and in bonds. Therefore, there is higher demand for SL rupee (to be able to buy the securities). This causes an appreciation. - It is known as hot money flows. 2. Relative inflation Rates. If SL inflation was to become higher than other countries, SL goods would become less competitive. Therefore, there would be less demand for SL goods and SL rupees, causing depreciation. General productivity and competitiveness will also have an influence on the exchange rate. 3. Balance of Payments. If a country has a large current account deficit it means it is importing more goods and services than it is exporting. This means more foreign exchange is leaving the country than going in. Therefore, (assuming it has difficulties in attracting a surplus on the financial account) a large current account deficit will usually cause depreciation. 4. Speculative buying. Foreign currencies are heavily traded and some investment banks try to make profit from buying and selling. If investors lose confidence in an economy and therefore the currency, the exchange rate will fall. This can depend on political as well as economic factors. At times currency movements can be unpredictable to say the least. 5. Public debt Countries will engage in large-scale deficit financing to pay for public sector projects and governmental funding. While such activity stimulates the domestic economy, nations with large public deficits and debts are less attractive to foreign investors. The reason? A large debt encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future. 6. Political stability and economic performance Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw
investment funds away from other countries perceived to have more political and economic risk. Why exchange rates are important? The changes in exchange rates will have both favorable and unfavorable impacts on economic activities and living standard of the public because of the largely globalised trade and finance involving exchange of currencies. In general, appreciation of a country’s currency will have the following effects whereas depreciation will have the opposite effects. • Lowering the domestic prices of imports because the cost of imports in domestic currency will be less due to higher value of the domestic currency, i.e., to pay for any given foreign price of imports will require less units of domestic currency. As a result, inflation will be lower depending on the extent of the imports in the domestic consumption and production activities. Country’s outstanding foreign debt equivalent of domestic currency will be lower and, therefore, burden on foreign debt repayment will less. One unfavorable effect will be that the lower import prices will encourage imports and worsen the country’s trade balance (net position between exports and imports). Another unfavorable effect will be that exporters will be discouraged by reduction in their income in domestic currency which will adversely affect the export industries. However, if domestic inflation will be lower due to reduced import prices, there will be higher foreign demand for exports which will off-set the initial reduction in exporters’ income.
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However, there is no any acceptable economic model to determine whether appreciation or depreciation is better for a country since each will have both favorable and unfavorable effects in the short run and in the long run, depending on the economic conditions and priorities prevailing at times. Therefore, the policymakers tend to adopt from time to time certain policies to permit the currency to depreciate or appreciate depending on the economic policy priorities. If the country has a foreign reserves problem and needs to encourage exports while discouraging imports, it is conventional to adopt a policy to permit the currency depreciation. Such policies include exchange rate determination system permitted and specific measures introduced from time to time within the permitted exchange rate system.
Direct foreign exchange The foreign exchange market is where currency trading takes place. FX transactions typically involve one party purchasing a quantity of one currency in exchange for paying a quantity of another. Today FX market is one of the largest and most liquid financial markets in the world, and includes trading between large banks, central banks, currency speculators, corporations, governments, and other institutions. The average daily volume in the global foreign exchange and related markets is continuously growing. Traditional daily turnover was reported to be over US$ 3.2 trillion in April 2007 by the Bank for International Settlements. Since then, the market has continued to grow. The purpose of FX market is to facilitate trade and investment. The need for a foreign exchange market arises because of the presence of multifarious international currencies such as US Dollar, Pound Sterling, etc, and the need for trading in such currencies. The foreign exchange market is unique because of its trading volumes, The extreme liquidity of the market, The large number of, and variety of, traders in the market, Its geographical dispersion, Its long trading hours: 24 hours a day except on weekends The variety of factors that affect exchange rates. The low margins of profit compared with other markets of fixed income The use of leverage
Market participants Banks
The interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's own account. Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching anonymous counterparts for small fees. Today, however, much of this business has moved on to more efficient electronic systems. Commercial companies
An important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have
little short term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants. Central banks
National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Milton Friedman argued that the best stabilization strategy would be for central banks to buy when the exchange rate is too low, and to sell when the rate is too high — that is, to trade for a profit based on their more precise information. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading. Hedge funds as speculators
About 70% to 90% of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor. Investment management firms
Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. Retail foreign exchange brokers
There are two types of retail brokers offering the opportunity for speculative trading: retail foreign exchange brokers and market makers. Retail traders (individuals) are a small fraction of this market and may only participate indirectly through brokers or banks. Retail foreign exchange brokers, while largely controlled and regulated by the CFTC and NFA might be subject to foreign exchange scams. At present, the NFA and CFTC are imposing stricter requirements, particularly in relation to the amount of Net Capitalization required of its members. Other
Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as Foreign Exchange Brokers but are distinct from Foreign exchange Brokers as they do not offer speculative trading but currency exchange with payments. There is usually a physical delivery of currency to a bank account. Financial instruments Spot
A spot transaction is a two-day delivery transaction, as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the spot market. Spot transactions have the second largest turnover by volume after Swap transactions among all FX transactions in the Global FX market. Forward
One way to deal with the Foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years. Future
Foreign currency futures are exchange traded forward transactions with standard contract sizes and maturity dates. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts. Swap
The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange. Option
A foreign exchange option is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and liquid market for options of any kind in the world.
Main currencies used in foreign exchange: The U.S. Dollar The United States dollar is the world's main currency. All currencies are generally quoted in U.S. dollar terms. Under conditions of international economic and political unrest, the U.S. dollar has been the main safe-haven currency, which was proven particularly well during the Southeast Asian crisis of 1997-1998. The U.S. dollar became the leading currency toward the end of the World War II and was at the center of the Bretton Woods Accord, as the other currencies were virtually pegged against it. The introduction of the euro in 1999 reduced the dollar's importance only marginally. The major currencies traded against the U.S. dollar are the euro, Japanese yen, British pound, and Swiss franc. The Euro The euro was designed to become the premier currency in trading by simply being quoted in American terms. Like the U.S. dollar, the euro has a strong international presence stemming from members of the European Monetary Union. The currency remains plagued by unequal growth, high unemployment, and government resistance to structural changes. The pair was also weighed in 1999 and 2000 by outflows from foreign investors, particularly Japanese, who were forced to liquidate their losing investments in euro-denominated assets. Moreover, European money managers rebalanced their portfolios and reduced their euro exposure as their needs for hedging currency risk in Europe declined. The Japanese Yen The Japanese yen is the third most traded currency in the world; it has a much smaller international presence than the U.S. dollar or the euro. The yen is very liquid around the world, practically around the clock. The natural demand to trade the yen concentrated mostly among the Japanese keiretsu, the economic and financial conglomerates. The yen is much more sensitive to the fortunes of the Nikkei index, the Japanese stock market, and the real estate market. The attempt of the Bank of Japan to deflate the double bubble in these two markets had a negative effect on the Japanese yen, although the impact was short-lived
The British Pound Until the end of World War II, the pound was the currency of reference. Its nickname, “cable”, is derived from the telex machine, which was used to trade it in its heyday. The currency is heavily traded against the euro and the U.S. dollar, but has a spotty presence against other currencies. The two-year bout with the Exchange Rate Mechanism, between 1990 and 1992, had a soothing effect on the British pound, as it generally had to follow the Deutsche mark's fluctuations, but the crisis conditions that precipitated the pound's withdrawal from the ERM had a psychological effect on the currency. Prior to the introduction of the euro, both the pound benefited from any doubts about the currency convergence. After the introduction of the euro, Bank of England is attempting to bring the high U.K. rates closer to the lower rates in the euro zone. The Swiss Franc The Swiss franc is the only currency of a major European country that belongs neither to the European Monetary Union nor to the G-7 countries. Although the Swiss economy is relatively small, the Swiss franc is one of the four major currencies, closely resembling the strength and quality of the Swiss economy and finance. Switzerland has a very close economic relationship with Germany, and thus to the euro zone. Therefore, in terms of political uncertainty in the East, the Swiss franc is favored generally over the euro. Typically, it is believed that the Swiss franc is a stable currency. Actually, from a foreign exchange point of view, the Swiss franc closely resembles the patterns of the euro, but lacks its liquidity. As the demand for it exceeds supply, the Swiss franc can be more volatile than the euro.
Bills of Exchange
The most common and yet most complex form of negotiable instrument used for business transactions is known as the draft, or the bill of exchange. A bill of exchange can be used for payment, credit, or security in a financial transaction. The term comes from the English and is defined as an unconditional order in writing that is addressed by one person to another and signed by the person giving it. Bills of exchange, also referred to as commercial bills, were initially developed in inland trade by merchants who wished to resell goods before making a payment on them. Later they came to be used as a type of IOU in international trade. In a bill of exchange transaction, a person, or the drawer, agrees to pay to another, also known as the drawer , a sum of money at a given date, usually three months ahead. In principle, the bill of exchange operates much a like a postdated check in that it can be endorsed for payment to the bearer or any other person named other than the drawer.
If the person accepts the bill of exchange by signing his name, or his name with the word "accepted," across the face of the paper, he is called an acceptor. The person to whom a bill is transferred by the acceptor's endorsement is called the endorsee. Any person in possession of a bill, whether as payee, endorsee, or bearer, is termed a holder. The basic rule applying to bills of exchange is that any signature appearing on a bill obligates the signer to pay the specified amount drawn on the bill. The bill of exchange then must be accepted or "endorsed" by an accepting house, an institution that deals exclusively with bills of exchange, such as a bank, or a trader. Once the bill is accepted, the drawee does not have to wait for the bill to mature before receiving his funds. If he so chooses, the drawee can also sell the bill on the money market for a small discount. A bill of exchange can also be passed beyond the drawer, drawee, and creditor. For the purposes of payment or borrowing, the creditor may transfer the bill of exchange to a fourth party, who in turn may pass it on and on through endorsement or signature of the transferor. Endorsement transfers the rights of the endorser to the new holder and also creates a liability of the endorser for payment of the amount of the draft if the drawee does not meet payment when the draft is due. A failure to pay a draft must be more or less formally recognized, and the draft holder may claim payment from any endorser whose signature appears on the instrument. In English laws, bills of exchange were defined in the Bills of Exchange Act of 1882. The act later influenced American legislation, particularly the passage of the United States Negotiable Instruments Act, which was eventually adopted throughout the United States. However, English law of what constitutes a bill of exchange is somewhat different than bills of exchange laws in Europe and Asia. In 1988, the United Nations Commission on International Trade Law (UNCITRAL) began working to synchronize these laws through the "United Nations Convention on International Bills of Exchange and International Promissory notes." With the development of other means of credit, the use of bills of exchange has declined. Characteristics of Bills of exchange incorporation, literality, abstraction, Autonomy. Incorporation Incorporation means that the obligation is incorporated in the instrument. In other words, who owns the document owns the right, meaning that it is enough to be the legitimate holder upon a continuous series of endorsements to have the right to claim and receive payment. This is so important because the good faith holder of the bill prevails over a previous holder that unfairly lost its possession
Literality Literality means that the existence and content of the obligation is defined by the document. This is another dimension of incorporation of the credit in the bill. But it goes further to justify the protection of the good faith holder in terms that several defects of will cannot be opposed to him, thus making circulation easier. Abstraction Abstraction means that the causal or underlying business is separated from the bill of exchange. In fact, the defects of the causal or underlying transaction cannot be opposed to subsequent good faith holders of the bill. However, in case they are in bad faith those defenses can be opposed to them. Autonomy Autonomy means that exceptions of the causal transaction cannot be opposed to subsequent holders in good faith (appraised at the moment of acquisition of the bill, and that the legitimate holder of the bill has an autonomous right, and therefore a previous holder that unfairly lost its possession cannot oppose to the legitimate holder the illegitimacy of the prior holder of the bill who has transmitted the bill to him. In this context, gross negligence means bad faith, for example, in case the holder gets the bill from someone well known to be a thief or an indigent person.
Forfeiting
Forfeiting and factoring are services in international market given to an exporter or seller. Its main objective is to provide smooth cash flow to the sellers. The basic difference between the forfeiting and factoring is that forfeiting is a long term receivables (over 90 days up to 5 years) while factoring is shorttermed receivables (within 90 days) and is more related to receivables against commodity sales. Definition of Forfeiting The terms forfeiting is originated from a old French word ‘forfait’, which means to surrender ones right on something to someone else. In international trade, forfeiting may be defined as the purchasing of an exporter’s receivables at a discount price by paying cash. By buying these receivables, the forfeiter frees the exporter from credit and the risk of not receiving the payment from the importer. How forfeiting Works in International Trade The exporter and importer negotiate according to the proposed export sales contract. Then the exporter approaches the forfeiter to ascertain the terms of forfeiting. After collecting the details about the importer, and other necessary documents, forfeiter estimates risk involved in it and then quotes the discount rate. The exporter then quotes a contract price to the overseas buyer by loading the discount rate and commitment fee on the sales price of the goods to be exported and sign a
contract with the forfeiter. Export takes place against documents guaranteed by the importer’s bank and discounts the bill with the forfeiter and presents the same to the importer for payment on due date. Documentary Requirements In case of Indian exporters availing forfeiting facility, the forfeiting transaction is to be reflected in the following documents associated with an export transaction in the manner suggested below:
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Invoice: Forfeiting discount, commitment fees, etc. needs not be shown separately instead, these could be built into the FOB price, stated on the invoice. Shipping Bill and GR form: Details of the forfeiting costs are to be included along with the other details, such FOB price, commission insurance, normally included in the "Analysis of Export Value "on the shipping bill. The claim for duty drawback, if any is to be certified only with reference to the FOB value of the exports stated on the shipping bill.
The forfeiting typically involves the following cost elements: 1. Commitment fee, payable by the exporter to the forfeiter ‘for latter’s’ commitment to execute a specific forfeiting transaction at a firm discount rate with in a specified time. 2. Discount fee, interest payable by the exporter for the entire period of credit involved and deducted by the forfeiter from the amount paid to the exporter against the avulsed promissory notes or bills of exchange. Benefits to Exporter 100 per cent financing: Without recourse and not occupying exporter's credit line That is to say once the exporter obtains the financed fund, he will be exempted from the responsibility to repay the debt. Improved cash flow: Receivables become current cash inflow and it is beneficial to the exporters to improve financial status and liquidation ability so as to heighten further the funds raising capability. Reduced administration cost: By using forfeiting, the exporter will spare from the management of the receivables. The relative costs, as a result, are reduced greatly. Advance tax refund: Through forfeiting the exporter can make the verification of export and get tax refund in advance just after financing. Risk reduction: forfeiting business enables the exporter to transfer vary risk resulted from deferred payments, such as interest rate risk, currency risk, credit risk, and political risk to the forfeiting bank.
Increased trade opportunity: With forfeiting, the export is able to grant credit to his buyers freely, and thus, be more competitive in the market. Problem areas in forfeiting
There is, presently, no legal framework to protect the banker or forfeiter except
the existing covers for the risks involved in any foreign transactions.
Data available on credit rating agencies or importer or foreign country is not
sufficient. Even exam bank does not cover high-risk countries like Nigeria. High country and political risks dissuade the services of factoring and banking to many clients. Government agencies and public sector undertakings (PSUs) neither promptly make payments nor pay interest on delayed payments.. The assignment of book debts attracts heavy stamp duty and this has to be waived.
Legislation is required to make assignment under factoring have priority over
other assignments.
There should be some provisions in law to exempt factoring organization from
the provisions of money lending legislations.
The order 37 of Civil procedure code should be amended to clarify that factor
debts can be recovered by resorting to
Letters of Credit
Letters of credit accomplish their purpose by substituting the credit of the bank for that of the customer, for the purpose of facilitating trade. There are basically two types: commercial and standby. The commercial letter of credit is the primary payment mechanism for a transaction, whereas the standby letter of credit is a secondary payment mechanism. Commercial Letter of Credit Commercial letters of credit have been used for centuries to facilitate payment in international trade. Their use will continue to increase as the global economy evolves. Letters of credit used in international transactions are governed by the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits. The general provisions and definitions of the International Chamber of Commerce are binding on all parties. Domestic collections in the United States are governed by the Uniform Commercial Code.
A commercial letter of credit is a contractual agreement between banks, known as the issuing bank, on behalf of one of its customers, authorizing another bank, known as the advising or confirming bank, to make payment to the beneficiary. The issuing bank, on the request of its customer, opens the letter of credit. The issuing bank makes a commitment to honor drawings made under the credit. The beneficiary is normally the provider of goods and/or services. Essentially, the issuing bank replaces the bank's customer as the payee. Elements of a Letter of Credit
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A payment undertaking given by a bank (issuing bank) On behalf of a buyer (applicant) To pay a seller (beneficiary) for a given amount of money On presentation of specified documents representing the supply of goods Within specified time limits Documents must conform to terms and conditions set out in the letter of credit Documents to be presented at a specified place
Beneficiary The beneficiary is entitled to payment as long as he can provide the documentary evidence required by the letter of credit. The letter of credit is a distinct and separate transaction from the contract on which it is based. All parties deal in documents and not in goods. The issuing bank is not liable for performance of the underlying contract between the customers and beneficiary. The issuing bank's obligation to the buyer is to examine all documents to insure that they meet all the terms and conditions of the credit. Upon requesting demand for payment the beneficiary warrants that all conditions of the agreement have been complied with. If the beneficiary (seller) conforms to the letter of credit, the seller must be paid by the bank. Issuing Bank The issuing bank's liability to pay and to be reimbursed from its customer becomes absolute upon the completion of the terms and conditions of the letter of credit. Under the provisions of the Uniform Customs and Practice for Documentary Credits, the bank is given a reasonable amount of time after receipt of the documents to honor the draft. The issuing banks' role is to provide a guarantee to the seller that if compliant documents are presented, the bank will pay the seller the amount due and to examine the documents, and only pay if these documents comply with the terms and conditions set out in the letter of credit. Typically the documents requested will include a commercial invoice, a transport document such as a bill of lading or airway bill and an insurance document; but there are many others. Letters of credit deal in documents, not goods. Advising Bank An advising bank, usually a foreign correspondent bank of the issuing bank will advise
the beneficiary. Generally, the beneficiary would want to use a local bank to insure that the letter of credit is valid. In addition, the advising bank would be responsible for sending the documents to the issuing bank. The advising bank has no other obligation under the letter of credit. If the issuing bank does not pay the beneficiary, the advising bank is not obligated to pay. Confirming Bank The correspondent bank may confirm the letter of credit for the beneficiary. At the request of the issuing bank, the correspondent obligates itself to insure payment under the letter of credit. The confirming bank would not confirm the credit until it evaluated the country and bank where the letter of credit originates. The confirming bank is usually the advising bank.
Factoring
In finance factoring, a business will sell off its accounts receivable, which are the invoices that the company has coming in, at a discounted rate. By doing this, the organization or business is able to obtain cash, or capital, that is readily available to them rather than waiting for the accounts receivable to actually come in to them. In many situations, this helps to keep the organization afloat and helps them to pay debts they may have. There are several differences between finance factoring and a business loan that may be obtained from a bank, for example. First, when considering this type of finance, the value of the receivables is the ultimate important number. This is in contrast to the credit worthiness of the business, which is what would happen in a business loan. Secondly, another area the two differ is that the factoring does not offer a loan to the business. Rather, it is more of a purchase of an asset that the business has. There is a third way in which finance factoring is different from a business loan. That is the structure of it. Whereas with a business loan involves just two parties, the bank and the borrower, the factoring system involves three parties. This includes the receivable clients, the business owner and the company that purchases the receivables In finance factoring, the business will sell their receivables to a third party who pays the business a fraction of what those receivables are worth. The customers of the business then pay the receivables to the third party at full price. In this transaction, any defaulting on the behalf of the receivables is not dealt with by the business any longer. There are many situations in which finance factoring becomes an important part of the business and therefore is used often.
How factoring can benefit your business
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Factoring is competitively priced compared to overdrafts and business loans You have more working capital to put back into your business The facility grows with your business so there is no need to keep increasing your overdraft or take out additional loans You’ll know when you’ll be paid, which helps you manage your cash flow You can react more quickly to market opportunities The Factor can manage your sales ledger and protect you from bad debts
What are the main features of Factoring?
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Up to 90% of the value of your invoices can be advanced by the next working day Flexible finance – Factor some or all of your sales ledger The Factoring company can take over management of your sales ledger The facility is easy to set up through Simply Business
International financial market
In economics, typically, the term market means the aggregate of possible buyers and sellers of a thing and the transactions between them. The term "market" is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities, e.g., a stock exchange or commodity exchange. This may be a physical location or an electronic system. Much trading of stocks takes place on an exchange; still, corporate actions (merger, spinoff) are outside an exchange, while any two companies or people, for whatever reason, may agree to sell stock from the one to the other without using an exchange. Trading of currencies and bonds is largely on a bilateral basis, although some bonds trade on a stock exchange, and people are building electronic systems for these as well, similar to stock exchanges. Financial markets can be domestic or they can be international.
Types of financial markets The financial markets can be divided into different subtypes:
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Capital markets which consist of:
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Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.
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Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.
Commodity markets, which facilitate the trading of commodities. Money markets, which provide short term debt financing and investment. Derivatives markets, which provide instruments for the management of financial risk.
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Futures markets, which provide standardized forward contracts for trading products at some future date; see also forward market.
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Insurance markets, which facilitate the redistribution of various risks. Foreign exchange markets, which facilitate the trading of foreign exchange.
The capital markets consist of primary markets and secondary markets. Newly formed (issued) securities are bought or sold in primary markets. Secondary markets allow investors to sell securities that they hold or buy existing securities. What is their purpose? Without financial markets, borrowers would have difficulty finding lenders themselves. Intermediaries such as banks help in this process. Banks take deposits from those who have money to save. They can then lend money from this pool of deposited money to those who seek to borrow. Banks popularly lend money in the form of loans and mortgages. More complex transactions than a simple bank deposit require markets where lenders and their agents can meet borrowers and their agents, and where existing borrowing or lending commitments can be sold on to other parties. A good example of a financial market is a stock exchange. A company can raise money by selling shares to investors and its existing shares can be bought or sold. Financial market participants There are four main participants 1. The Central Bank The Central Bank is the federal government's bank and has the following roles in the financial market: a) is the lender of last resort? b) Oversees and conducts monetary policy. c) Preserves the value of the dollar.
2. Deposit Intermediaries
Deposit intermediaries include the following institutions: a) Banks b) Credit Unions c) Mortgage and loan companies. d) Mortgage and loan agencies. 3. Contractual savings intermediaries Contractual savings intermediaries are in the form of the following: a) Life insurance companies. b) Pension funds. c) Property and casualty insurance companies d) Government pension plans. 4. Investment intermediaries Investment intermediaries include: a) Mutual funds companies, b) Investment dealers. c) Consumer loan companies. d) Business finance companies.
What is Foreign Direct Investment (FDI)
According to the IMF and OECD definitions, direct investment reflects the aim of obtaining a lasting interest by a resident entity of one economy (direct investor) in an enterprise that is resident in another economy (the direct investment enterprise). The “lasting interest” implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence on the management of the latter. Direct investment involves both the initial transaction establishing the relationship between the investor and the enterprise and all subsequent capital transactions between them and among affiliated enterprises, both incorporated and unincorporated. It should be noted that capital transactions which do not give rise to any settlement, e.g. an interchange of shares The fifth Edition of the IMF’s Balance of Payment Manual defines the owner of 10% or more of a company’s capital as a direct investor. This guideline is not a fast rule, as it acknowledges that smaller percentage may entail a controlling interest in the company. But the IMF recommends using this percentage as the basic dividing line between direct investment and portfolio investment in the form of shareholdings. Thus, when a nonresident who previously had no equity in a resident enterprise purchases 10% or more of the shares of that enterprise from a resident, the price of equity holdings acquired should be recorded as direct investment. From this moment, any further capital transactions between these two companies should be recorded as a direct investment. When a nonresident holds less than 10% of the shares of an enterprise as portfolio investment, and
subsequently acquires additional shares resulting in a direct investment (10% of more), only the purchase of additional shares is recorded as direct investment in the Balance of Payments. The holdings that were acquired previously should not be reclassified from portfolio to direct investment in the Balance of Payments but the total holdings should be reclassified in the IIP Foreign direct investment (FDI) has proved to be resilient during financial crises. For instance, in East Asian countries, such investment was remarkably stable during the global financial crises of 1997-98. In sharp contrast, other forms of private capital flows —portfolio equity and debt flows, and particularly short-term flows—were subject to large reversals during the same period (see Dadush, Dasgupta, and Ratha, 2000; and Lipsey, 2001). The resilience of FDI during financial crises was also evident during the Mexican crisis of 1994-95 and the Latin American debt crisis of the 1980s. This resilience could lead many developing countries to favor FDI over other forms of capital flows, furthering a trend that has been in evidence for many years (see Chart 1). Is the preference for FDI over other forms of private capital inflows justified? This article sheds some light on this issue by reviewing recent theoretical and empirical work on its impact on developing countries' investment and growth The case for free capital flows Economists tend to favor the free flow of capital across national borders because it allows capital to seek out the highest rate of return. Unrestricted capital flows may also offer several other advantages, as noted by Feldstein (2000). First, international flows of capital reduce the risk faced by owners of capital by allowing them to diversify their lending and investment. Second, the global integration of capital markets can contribute to the spread of best practices in corporate governance, accounting rules, and legal traditions. Third, the global mobility of capital limits the ability of governments to pursue bad policies. In addition to these advantages, which in principle apply to all kinds of private capital inflows?
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FDI allows the transfer of technology—particularly in the form of new varieties of capital inputs—that cannot be achieved through financial investments or trade in goods and services. FDI can also promote competition in the domestic input market. Recipients of FDI often gain employee training in the course of operating the new businesses, which contributes to human capital development in the host country. Profits generated by FDI contribute to corporate tax revenues in the host country.
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Of course, countries often choose to forgo some of this revenue when they cut corporate tax rates in an attempt to attract FDI from other locations. For instance, the sharp decline in corporate tax revenues in some of the member countries of the Organization for Economic Cooperation and Development (OECD) may be the result of such competition. (For a discussion, see the article by Reint Gropp and Kristina Kostial in this issue.)
Conclusion
The global financial system (GFS) is a financial system consisting of institutions and regulations that act on the international level, as opposed to those that act on a national or regional level. Foreign exchange market and management of exchange rate of a country’s currency are two key areas that influence the economic well-being of the general public. The exchange rate of a country’s currency is the value of its money for international trade in goods, services and finance and, therefore, it is part and parcel of the monetary condition of a country. Central banks, private banks, hedge funds, Investment management firms, Retail foreign exchange brokers are participate for foreign management. Dollars, Euro, Swiss frank, yen, pounds are the main currencies exchange in foreign exchange market. The most common and yet most complex form of negotiable instrument used for business transactions is known as the draft, or the bill of exchange. A bill of exchange can be used for payment, credit, or security in a financial transaction. Forfeiting and factoring are services in international market given to an exporter or seller. Its main objective is to provide smooth cash flow to the sellers. Letters of credit accomplish their purpose by substituting the credit of the bank for that of the customer, for the purpose of facilitating trade. International financial market is the world largest market in the world. It include bond market, stock market, capital market, derivatives markets, futures markets, insurance markets and foreign exchange market. According to the IMF and OECD definitions, direct investment reflects the aim of obtaining a lasting interest by a resident entity of one economy (direct investor) in an enterprise that is resident in another economy (the direct investment enterprise). The “lasting interest” implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence on the management of the latter.
Reference http://about.reuters.com/productinfo/s/foreign_exchange_management/
The global financial system (GFS) is a financial system consisting of institutions and regulations that act on the international level, as opposed to those that act on a national or regional level. The main players are the global institutions, such as International Monetary Fund and Bank for International Settlements, national agencies and government departments, e.g., central banks and finance ministries, and private institutions acting on the global scale, e.g., banks and hedge funds. International institutions The most prominent international institutions are the IMF, the World Bank and the WTO: • The International Monetary Fund keeps account of international balance of payments accounts of member states. The IMF acts as a lender of last resort for members in financial distress, e.g., currency crisis, problems meeting balance of payment when in deficit and debt default. Membership is based on quotas, or the amount of money a country provides to the fund relative to the size of its role in the international trading system. The World Bank aims to provide funding, take up credit risk or offer favorable terms to development projects mostly in developing countries that couldn't be obtained by the private sector. The other multilateral development banks and other international financial institutions also play specific regional or functional roles. The World Trade Organization settles trade disputes and negotiates international trade agreements in its rounds of talks
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Government institutions Governments act in various ways as actors in the GFS: they pass the laws and regulations for financial markets and set the tax burden for private players, e.g., banks, funds and exchanges. They also participate actively through discretionary spending. They are closely tied to central banks that issue government debt, set interest rates and deposit requirements, and intervene in the foreign exchange market. Private participants Players acting in the stock-, bond-, foreign exchange-, derivatives- and commoditiesmarkets and investment banking are Commercial banks Pension funds Hedge funds and private equity
Managing foreign exchange
How do central banks manage exchange rates? Foreign exchange market and management of exchange rate of a country’s currency are two key areas that influence the economic well-being of the general public. The exchange rate of a country’s currency is the value of its money for international trade in goods, services and finance and, therefore, it is part and parcel of the monetary condition of a country. Therefore, the central banks being the monetary authorities have been given discretionary powers under the relevant statutes to decide appropriate foreign exchange policies along with its monetary, financial and economic development policies. In macroeconomic perspective, foreign exchange policies are instrumental in mobilization of foreign savings and capital to fill the domestic resource gap and expand investments. Various public views are often expressed as to how the central banks should decide exchange rate policies and what factors should be taken into consideration. Therefore, this article is intended to educate the public on the background how the central banks manage or regulate exchange rates and foreign exchange markets. Why exchange rates? An exchange rate is a price of a currency stated in units of another currency, i.e., Rs 108 a US Dollar (US $), US$ 1.5 a Euro or Chinese Yuan 7 a US$. The exchange rate between two currencies can be stated in two ways, domestic currency price of foreign currency or foreign currency price of domestic currency, i.e., Rs. 108 a US$ or US$ 0.01 a Rupee. Exchange rates exist because countries have to exchange their national currencies with foreign currencies to engage in trade and financial transactions with other countries. For example, when a Sri Lankan garment manufacturer exports garments to a buyer in US, Sri Lankan exporter receives the payment for his export in US$. Therefore, if the Sri Lankan exporter is to use his US$ income in Sri Lanka, he has to sell his US$ proceeds to a bank for Sri Lanka Rupees. Similarly, Sri Lankan importers have to buy currencies of the exporting countries for payments to suppliers in those countries. Accordingly, any foreign receipts to a country involve supply of foreign currencies (or foreign exchange) in exchange for domestic currency. On the other hand, any payments to foreign countries involve purchase (demand for) of foreign currencies by paying in the domestic currency. In addition, certain authorized parties undertake dealings (buying and selling) in foreign currencies seeking various kinds of financial gain. Since international transactions are conducted in major foreign currencies such as US$, Sterling Pounds, Yen and Euro, market participants and policymakers are concerned about the exchange rates of such major currencies. In Sri Lanka, the Central Bank (CBSL) monitors mainly the exchange rate for US$ as the Base Exchange rate in the foreign exchange market. However, CBSL has designated several foreign currencies for international transactions by the public through banks.
What determines the exchange rates? Exchange Rates are determined by supply and demand side factors. For example, increased demand for sterling will cause an appreciation in the Sterling exchange rate. These are some of the most significant factors in exchange rate determination: 1. Interest Rates. If interest rates increase in the SL then it becomes relatively more attractive to save money in banks and in bonds. Therefore, there is higher demand for SL rupee (to be able to buy the securities). This causes an appreciation. - It is known as hot money flows. 2. Relative inflation Rates. If SL inflation was to become higher than other countries, SL goods would become less competitive. Therefore, there would be less demand for SL goods and SL rupees, causing depreciation. General productivity and competitiveness will also have an influence on the exchange rate. 3. Balance of Payments. If a country has a large current account deficit it means it is importing more goods and services than it is exporting. This means more foreign exchange is leaving the country than going in. Therefore, (assuming it has difficulties in attracting a surplus on the financial account) a large current account deficit will usually cause depreciation. 4. Speculative buying. Foreign currencies are heavily traded and some investment banks try to make profit from buying and selling. If investors lose confidence in an economy and therefore the currency, the exchange rate will fall. This can depend on political as well as economic factors. At times currency movements can be unpredictable to say the least. 5. Public debt Countries will engage in large-scale deficit financing to pay for public sector projects and governmental funding. While such activity stimulates the domestic economy, nations with large public deficits and debts are less attractive to foreign investors. The reason? A large debt encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future. 6. Political stability and economic performance Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw
investment funds away from other countries perceived to have more political and economic risk. Why exchange rates are important? The changes in exchange rates will have both favorable and unfavorable impacts on economic activities and living standard of the public because of the largely globalised trade and finance involving exchange of currencies. In general, appreciation of a country’s currency will have the following effects whereas depreciation will have the opposite effects. • Lowering the domestic prices of imports because the cost of imports in domestic currency will be less due to higher value of the domestic currency, i.e., to pay for any given foreign price of imports will require less units of domestic currency. As a result, inflation will be lower depending on the extent of the imports in the domestic consumption and production activities. Country’s outstanding foreign debt equivalent of domestic currency will be lower and, therefore, burden on foreign debt repayment will less. One unfavorable effect will be that the lower import prices will encourage imports and worsen the country’s trade balance (net position between exports and imports). Another unfavorable effect will be that exporters will be discouraged by reduction in their income in domestic currency which will adversely affect the export industries. However, if domestic inflation will be lower due to reduced import prices, there will be higher foreign demand for exports which will off-set the initial reduction in exporters’ income.
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However, there is no any acceptable economic model to determine whether appreciation or depreciation is better for a country since each will have both favorable and unfavorable effects in the short run and in the long run, depending on the economic conditions and priorities prevailing at times. Therefore, the policymakers tend to adopt from time to time certain policies to permit the currency to depreciate or appreciate depending on the economic policy priorities. If the country has a foreign reserves problem and needs to encourage exports while discouraging imports, it is conventional to adopt a policy to permit the currency depreciation. Such policies include exchange rate determination system permitted and specific measures introduced from time to time within the permitted exchange rate system.
Direct foreign exchange The foreign exchange market is where currency trading takes place. FX transactions typically involve one party purchasing a quantity of one currency in exchange for paying a quantity of another. Today FX market is one of the largest and most liquid financial markets in the world, and includes trading between large banks, central banks, currency speculators, corporations, governments, and other institutions. The average daily volume in the global foreign exchange and related markets is continuously growing. Traditional daily turnover was reported to be over US$ 3.2 trillion in April 2007 by the Bank for International Settlements. Since then, the market has continued to grow. The purpose of FX market is to facilitate trade and investment. The need for a foreign exchange market arises because of the presence of multifarious international currencies such as US Dollar, Pound Sterling, etc, and the need for trading in such currencies. The foreign exchange market is unique because of its trading volumes, The extreme liquidity of the market, The large number of, and variety of, traders in the market, Its geographical dispersion, Its long trading hours: 24 hours a day except on weekends The variety of factors that affect exchange rates. The low margins of profit compared with other markets of fixed income The use of leverage
Market participants Banks
The interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's own account. Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching anonymous counterparts for small fees. Today, however, much of this business has moved on to more efficient electronic systems. Commercial companies
An important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have
little short term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants. Central banks
National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Milton Friedman argued that the best stabilization strategy would be for central banks to buy when the exchange rate is too low, and to sell when the rate is too high — that is, to trade for a profit based on their more precise information. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading. Hedge funds as speculators
About 70% to 90% of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor. Investment management firms
Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. Retail foreign exchange brokers
There are two types of retail brokers offering the opportunity for speculative trading: retail foreign exchange brokers and market makers. Retail traders (individuals) are a small fraction of this market and may only participate indirectly through brokers or banks. Retail foreign exchange brokers, while largely controlled and regulated by the CFTC and NFA might be subject to foreign exchange scams. At present, the NFA and CFTC are imposing stricter requirements, particularly in relation to the amount of Net Capitalization required of its members. Other
Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as Foreign Exchange Brokers but are distinct from Foreign exchange Brokers as they do not offer speculative trading but currency exchange with payments. There is usually a physical delivery of currency to a bank account. Financial instruments Spot
A spot transaction is a two-day delivery transaction, as opposed to the futures contracts, which are usually three months. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. The data for this study come from the spot market. Spot transactions have the second largest turnover by volume after Swap transactions among all FX transactions in the Global FX market. Forward
One way to deal with the Foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be a few days, months or years. Future
Foreign currency futures are exchange traded forward transactions with standard contract sizes and maturity dates. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts. Swap
The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange. Option
A foreign exchange option is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and liquid market for options of any kind in the world.
Main currencies used in foreign exchange: The U.S. Dollar The United States dollar is the world's main currency. All currencies are generally quoted in U.S. dollar terms. Under conditions of international economic and political unrest, the U.S. dollar has been the main safe-haven currency, which was proven particularly well during the Southeast Asian crisis of 1997-1998. The U.S. dollar became the leading currency toward the end of the World War II and was at the center of the Bretton Woods Accord, as the other currencies were virtually pegged against it. The introduction of the euro in 1999 reduced the dollar's importance only marginally. The major currencies traded against the U.S. dollar are the euro, Japanese yen, British pound, and Swiss franc. The Euro The euro was designed to become the premier currency in trading by simply being quoted in American terms. Like the U.S. dollar, the euro has a strong international presence stemming from members of the European Monetary Union. The currency remains plagued by unequal growth, high unemployment, and government resistance to structural changes. The pair was also weighed in 1999 and 2000 by outflows from foreign investors, particularly Japanese, who were forced to liquidate their losing investments in euro-denominated assets. Moreover, European money managers rebalanced their portfolios and reduced their euro exposure as their needs for hedging currency risk in Europe declined. The Japanese Yen The Japanese yen is the third most traded currency in the world; it has a much smaller international presence than the U.S. dollar or the euro. The yen is very liquid around the world, practically around the clock. The natural demand to trade the yen concentrated mostly among the Japanese keiretsu, the economic and financial conglomerates. The yen is much more sensitive to the fortunes of the Nikkei index, the Japanese stock market, and the real estate market. The attempt of the Bank of Japan to deflate the double bubble in these two markets had a negative effect on the Japanese yen, although the impact was short-lived
The British Pound Until the end of World War II, the pound was the currency of reference. Its nickname, “cable”, is derived from the telex machine, which was used to trade it in its heyday. The currency is heavily traded against the euro and the U.S. dollar, but has a spotty presence against other currencies. The two-year bout with the Exchange Rate Mechanism, between 1990 and 1992, had a soothing effect on the British pound, as it generally had to follow the Deutsche mark's fluctuations, but the crisis conditions that precipitated the pound's withdrawal from the ERM had a psychological effect on the currency. Prior to the introduction of the euro, both the pound benefited from any doubts about the currency convergence. After the introduction of the euro, Bank of England is attempting to bring the high U.K. rates closer to the lower rates in the euro zone. The Swiss Franc The Swiss franc is the only currency of a major European country that belongs neither to the European Monetary Union nor to the G-7 countries. Although the Swiss economy is relatively small, the Swiss franc is one of the four major currencies, closely resembling the strength and quality of the Swiss economy and finance. Switzerland has a very close economic relationship with Germany, and thus to the euro zone. Therefore, in terms of political uncertainty in the East, the Swiss franc is favored generally over the euro. Typically, it is believed that the Swiss franc is a stable currency. Actually, from a foreign exchange point of view, the Swiss franc closely resembles the patterns of the euro, but lacks its liquidity. As the demand for it exceeds supply, the Swiss franc can be more volatile than the euro.
Bills of Exchange
The most common and yet most complex form of negotiable instrument used for business transactions is known as the draft, or the bill of exchange. A bill of exchange can be used for payment, credit, or security in a financial transaction. The term comes from the English and is defined as an unconditional order in writing that is addressed by one person to another and signed by the person giving it. Bills of exchange, also referred to as commercial bills, were initially developed in inland trade by merchants who wished to resell goods before making a payment on them. Later they came to be used as a type of IOU in international trade. In a bill of exchange transaction, a person, or the drawer, agrees to pay to another, also known as the drawer , a sum of money at a given date, usually three months ahead. In principle, the bill of exchange operates much a like a postdated check in that it can be endorsed for payment to the bearer or any other person named other than the drawer.
If the person accepts the bill of exchange by signing his name, or his name with the word "accepted," across the face of the paper, he is called an acceptor. The person to whom a bill is transferred by the acceptor's endorsement is called the endorsee. Any person in possession of a bill, whether as payee, endorsee, or bearer, is termed a holder. The basic rule applying to bills of exchange is that any signature appearing on a bill obligates the signer to pay the specified amount drawn on the bill. The bill of exchange then must be accepted or "endorsed" by an accepting house, an institution that deals exclusively with bills of exchange, such as a bank, or a trader. Once the bill is accepted, the drawee does not have to wait for the bill to mature before receiving his funds. If he so chooses, the drawee can also sell the bill on the money market for a small discount. A bill of exchange can also be passed beyond the drawer, drawee, and creditor. For the purposes of payment or borrowing, the creditor may transfer the bill of exchange to a fourth party, who in turn may pass it on and on through endorsement or signature of the transferor. Endorsement transfers the rights of the endorser to the new holder and also creates a liability of the endorser for payment of the amount of the draft if the drawee does not meet payment when the draft is due. A failure to pay a draft must be more or less formally recognized, and the draft holder may claim payment from any endorser whose signature appears on the instrument. In English laws, bills of exchange were defined in the Bills of Exchange Act of 1882. The act later influenced American legislation, particularly the passage of the United States Negotiable Instruments Act, which was eventually adopted throughout the United States. However, English law of what constitutes a bill of exchange is somewhat different than bills of exchange laws in Europe and Asia. In 1988, the United Nations Commission on International Trade Law (UNCITRAL) began working to synchronize these laws through the "United Nations Convention on International Bills of Exchange and International Promissory notes." With the development of other means of credit, the use of bills of exchange has declined. Characteristics of Bills of exchange incorporation, literality, abstraction, Autonomy. Incorporation Incorporation means that the obligation is incorporated in the instrument. In other words, who owns the document owns the right, meaning that it is enough to be the legitimate holder upon a continuous series of endorsements to have the right to claim and receive payment. This is so important because the good faith holder of the bill prevails over a previous holder that unfairly lost its possession
Literality Literality means that the existence and content of the obligation is defined by the document. This is another dimension of incorporation of the credit in the bill. But it goes further to justify the protection of the good faith holder in terms that several defects of will cannot be opposed to him, thus making circulation easier. Abstraction Abstraction means that the causal or underlying business is separated from the bill of exchange. In fact, the defects of the causal or underlying transaction cannot be opposed to subsequent good faith holders of the bill. However, in case they are in bad faith those defenses can be opposed to them. Autonomy Autonomy means that exceptions of the causal transaction cannot be opposed to subsequent holders in good faith (appraised at the moment of acquisition of the bill, and that the legitimate holder of the bill has an autonomous right, and therefore a previous holder that unfairly lost its possession cannot oppose to the legitimate holder the illegitimacy of the prior holder of the bill who has transmitted the bill to him. In this context, gross negligence means bad faith, for example, in case the holder gets the bill from someone well known to be a thief or an indigent person.
Forfeiting
Forfeiting and factoring are services in international market given to an exporter or seller. Its main objective is to provide smooth cash flow to the sellers. The basic difference between the forfeiting and factoring is that forfeiting is a long term receivables (over 90 days up to 5 years) while factoring is shorttermed receivables (within 90 days) and is more related to receivables against commodity sales. Definition of Forfeiting The terms forfeiting is originated from a old French word ‘forfait’, which means to surrender ones right on something to someone else. In international trade, forfeiting may be defined as the purchasing of an exporter’s receivables at a discount price by paying cash. By buying these receivables, the forfeiter frees the exporter from credit and the risk of not receiving the payment from the importer. How forfeiting Works in International Trade The exporter and importer negotiate according to the proposed export sales contract. Then the exporter approaches the forfeiter to ascertain the terms of forfeiting. After collecting the details about the importer, and other necessary documents, forfeiter estimates risk involved in it and then quotes the discount rate. The exporter then quotes a contract price to the overseas buyer by loading the discount rate and commitment fee on the sales price of the goods to be exported and sign a
contract with the forfeiter. Export takes place against documents guaranteed by the importer’s bank and discounts the bill with the forfeiter and presents the same to the importer for payment on due date. Documentary Requirements In case of Indian exporters availing forfeiting facility, the forfeiting transaction is to be reflected in the following documents associated with an export transaction in the manner suggested below:
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Invoice: Forfeiting discount, commitment fees, etc. needs not be shown separately instead, these could be built into the FOB price, stated on the invoice. Shipping Bill and GR form: Details of the forfeiting costs are to be included along with the other details, such FOB price, commission insurance, normally included in the "Analysis of Export Value "on the shipping bill. The claim for duty drawback, if any is to be certified only with reference to the FOB value of the exports stated on the shipping bill.
The forfeiting typically involves the following cost elements: 1. Commitment fee, payable by the exporter to the forfeiter ‘for latter’s’ commitment to execute a specific forfeiting transaction at a firm discount rate with in a specified time. 2. Discount fee, interest payable by the exporter for the entire period of credit involved and deducted by the forfeiter from the amount paid to the exporter against the avulsed promissory notes or bills of exchange. Benefits to Exporter 100 per cent financing: Without recourse and not occupying exporter's credit line That is to say once the exporter obtains the financed fund, he will be exempted from the responsibility to repay the debt. Improved cash flow: Receivables become current cash inflow and it is beneficial to the exporters to improve financial status and liquidation ability so as to heighten further the funds raising capability. Reduced administration cost: By using forfeiting, the exporter will spare from the management of the receivables. The relative costs, as a result, are reduced greatly. Advance tax refund: Through forfeiting the exporter can make the verification of export and get tax refund in advance just after financing. Risk reduction: forfeiting business enables the exporter to transfer vary risk resulted from deferred payments, such as interest rate risk, currency risk, credit risk, and political risk to the forfeiting bank.
Increased trade opportunity: With forfeiting, the export is able to grant credit to his buyers freely, and thus, be more competitive in the market. Problem areas in forfeiting
There is, presently, no legal framework to protect the banker or forfeiter except
the existing covers for the risks involved in any foreign transactions.
Data available on credit rating agencies or importer or foreign country is not
sufficient. Even exam bank does not cover high-risk countries like Nigeria. High country and political risks dissuade the services of factoring and banking to many clients. Government agencies and public sector undertakings (PSUs) neither promptly make payments nor pay interest on delayed payments.. The assignment of book debts attracts heavy stamp duty and this has to be waived.
Legislation is required to make assignment under factoring have priority over
other assignments.
There should be some provisions in law to exempt factoring organization from
the provisions of money lending legislations.
The order 37 of Civil procedure code should be amended to clarify that factor
debts can be recovered by resorting to
Letters of Credit
Letters of credit accomplish their purpose by substituting the credit of the bank for that of the customer, for the purpose of facilitating trade. There are basically two types: commercial and standby. The commercial letter of credit is the primary payment mechanism for a transaction, whereas the standby letter of credit is a secondary payment mechanism. Commercial Letter of Credit Commercial letters of credit have been used for centuries to facilitate payment in international trade. Their use will continue to increase as the global economy evolves. Letters of credit used in international transactions are governed by the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits. The general provisions and definitions of the International Chamber of Commerce are binding on all parties. Domestic collections in the United States are governed by the Uniform Commercial Code.
A commercial letter of credit is a contractual agreement between banks, known as the issuing bank, on behalf of one of its customers, authorizing another bank, known as the advising or confirming bank, to make payment to the beneficiary. The issuing bank, on the request of its customer, opens the letter of credit. The issuing bank makes a commitment to honor drawings made under the credit. The beneficiary is normally the provider of goods and/or services. Essentially, the issuing bank replaces the bank's customer as the payee. Elements of a Letter of Credit
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A payment undertaking given by a bank (issuing bank) On behalf of a buyer (applicant) To pay a seller (beneficiary) for a given amount of money On presentation of specified documents representing the supply of goods Within specified time limits Documents must conform to terms and conditions set out in the letter of credit Documents to be presented at a specified place
Beneficiary The beneficiary is entitled to payment as long as he can provide the documentary evidence required by the letter of credit. The letter of credit is a distinct and separate transaction from the contract on which it is based. All parties deal in documents and not in goods. The issuing bank is not liable for performance of the underlying contract between the customers and beneficiary. The issuing bank's obligation to the buyer is to examine all documents to insure that they meet all the terms and conditions of the credit. Upon requesting demand for payment the beneficiary warrants that all conditions of the agreement have been complied with. If the beneficiary (seller) conforms to the letter of credit, the seller must be paid by the bank. Issuing Bank The issuing bank's liability to pay and to be reimbursed from its customer becomes absolute upon the completion of the terms and conditions of the letter of credit. Under the provisions of the Uniform Customs and Practice for Documentary Credits, the bank is given a reasonable amount of time after receipt of the documents to honor the draft. The issuing banks' role is to provide a guarantee to the seller that if compliant documents are presented, the bank will pay the seller the amount due and to examine the documents, and only pay if these documents comply with the terms and conditions set out in the letter of credit. Typically the documents requested will include a commercial invoice, a transport document such as a bill of lading or airway bill and an insurance document; but there are many others. Letters of credit deal in documents, not goods. Advising Bank An advising bank, usually a foreign correspondent bank of the issuing bank will advise
the beneficiary. Generally, the beneficiary would want to use a local bank to insure that the letter of credit is valid. In addition, the advising bank would be responsible for sending the documents to the issuing bank. The advising bank has no other obligation under the letter of credit. If the issuing bank does not pay the beneficiary, the advising bank is not obligated to pay. Confirming Bank The correspondent bank may confirm the letter of credit for the beneficiary. At the request of the issuing bank, the correspondent obligates itself to insure payment under the letter of credit. The confirming bank would not confirm the credit until it evaluated the country and bank where the letter of credit originates. The confirming bank is usually the advising bank.
Factoring
In finance factoring, a business will sell off its accounts receivable, which are the invoices that the company has coming in, at a discounted rate. By doing this, the organization or business is able to obtain cash, or capital, that is readily available to them rather than waiting for the accounts receivable to actually come in to them. In many situations, this helps to keep the organization afloat and helps them to pay debts they may have. There are several differences between finance factoring and a business loan that may be obtained from a bank, for example. First, when considering this type of finance, the value of the receivables is the ultimate important number. This is in contrast to the credit worthiness of the business, which is what would happen in a business loan. Secondly, another area the two differ is that the factoring does not offer a loan to the business. Rather, it is more of a purchase of an asset that the business has. There is a third way in which finance factoring is different from a business loan. That is the structure of it. Whereas with a business loan involves just two parties, the bank and the borrower, the factoring system involves three parties. This includes the receivable clients, the business owner and the company that purchases the receivables In finance factoring, the business will sell their receivables to a third party who pays the business a fraction of what those receivables are worth. The customers of the business then pay the receivables to the third party at full price. In this transaction, any defaulting on the behalf of the receivables is not dealt with by the business any longer. There are many situations in which finance factoring becomes an important part of the business and therefore is used often.
How factoring can benefit your business
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Factoring is competitively priced compared to overdrafts and business loans You have more working capital to put back into your business The facility grows with your business so there is no need to keep increasing your overdraft or take out additional loans You’ll know when you’ll be paid, which helps you manage your cash flow You can react more quickly to market opportunities The Factor can manage your sales ledger and protect you from bad debts
What are the main features of Factoring?
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Up to 90% of the value of your invoices can be advanced by the next working day Flexible finance – Factor some or all of your sales ledger The Factoring company can take over management of your sales ledger The facility is easy to set up through Simply Business
International financial market
In economics, typically, the term market means the aggregate of possible buyers and sellers of a thing and the transactions between them. The term "market" is sometimes used for what are more strictly exchanges, organizations that facilitate the trade in financial securities, e.g., a stock exchange or commodity exchange. This may be a physical location or an electronic system. Much trading of stocks takes place on an exchange; still, corporate actions (merger, spinoff) are outside an exchange, while any two companies or people, for whatever reason, may agree to sell stock from the one to the other without using an exchange. Trading of currencies and bonds is largely on a bilateral basis, although some bonds trade on a stock exchange, and people are building electronic systems for these as well, similar to stock exchanges. Financial markets can be domestic or they can be international.
Types of financial markets The financial markets can be divided into different subtypes:
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Capital markets which consist of:
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Stock markets, which provide financing through the issuance of shares or common stock, and enable the subsequent trading thereof.
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Bond markets, which provide financing through the issuance of bonds, and enable the subsequent trading thereof.
Commodity markets, which facilitate the trading of commodities. Money markets, which provide short term debt financing and investment. Derivatives markets, which provide instruments for the management of financial risk.
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Futures markets, which provide standardized forward contracts for trading products at some future date; see also forward market.
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Insurance markets, which facilitate the redistribution of various risks. Foreign exchange markets, which facilitate the trading of foreign exchange.
The capital markets consist of primary markets and secondary markets. Newly formed (issued) securities are bought or sold in primary markets. Secondary markets allow investors to sell securities that they hold or buy existing securities. What is their purpose? Without financial markets, borrowers would have difficulty finding lenders themselves. Intermediaries such as banks help in this process. Banks take deposits from those who have money to save. They can then lend money from this pool of deposited money to those who seek to borrow. Banks popularly lend money in the form of loans and mortgages. More complex transactions than a simple bank deposit require markets where lenders and their agents can meet borrowers and their agents, and where existing borrowing or lending commitments can be sold on to other parties. A good example of a financial market is a stock exchange. A company can raise money by selling shares to investors and its existing shares can be bought or sold. Financial market participants There are four main participants 1. The Central Bank The Central Bank is the federal government's bank and has the following roles in the financial market: a) is the lender of last resort? b) Oversees and conducts monetary policy. c) Preserves the value of the dollar.
2. Deposit Intermediaries
Deposit intermediaries include the following institutions: a) Banks b) Credit Unions c) Mortgage and loan companies. d) Mortgage and loan agencies. 3. Contractual savings intermediaries Contractual savings intermediaries are in the form of the following: a) Life insurance companies. b) Pension funds. c) Property and casualty insurance companies d) Government pension plans. 4. Investment intermediaries Investment intermediaries include: a) Mutual funds companies, b) Investment dealers. c) Consumer loan companies. d) Business finance companies.
What is Foreign Direct Investment (FDI)
According to the IMF and OECD definitions, direct investment reflects the aim of obtaining a lasting interest by a resident entity of one economy (direct investor) in an enterprise that is resident in another economy (the direct investment enterprise). The “lasting interest” implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence on the management of the latter. Direct investment involves both the initial transaction establishing the relationship between the investor and the enterprise and all subsequent capital transactions between them and among affiliated enterprises, both incorporated and unincorporated. It should be noted that capital transactions which do not give rise to any settlement, e.g. an interchange of shares The fifth Edition of the IMF’s Balance of Payment Manual defines the owner of 10% or more of a company’s capital as a direct investor. This guideline is not a fast rule, as it acknowledges that smaller percentage may entail a controlling interest in the company. But the IMF recommends using this percentage as the basic dividing line between direct investment and portfolio investment in the form of shareholdings. Thus, when a nonresident who previously had no equity in a resident enterprise purchases 10% or more of the shares of that enterprise from a resident, the price of equity holdings acquired should be recorded as direct investment. From this moment, any further capital transactions between these two companies should be recorded as a direct investment. When a nonresident holds less than 10% of the shares of an enterprise as portfolio investment, and
subsequently acquires additional shares resulting in a direct investment (10% of more), only the purchase of additional shares is recorded as direct investment in the Balance of Payments. The holdings that were acquired previously should not be reclassified from portfolio to direct investment in the Balance of Payments but the total holdings should be reclassified in the IIP Foreign direct investment (FDI) has proved to be resilient during financial crises. For instance, in East Asian countries, such investment was remarkably stable during the global financial crises of 1997-98. In sharp contrast, other forms of private capital flows —portfolio equity and debt flows, and particularly short-term flows—were subject to large reversals during the same period (see Dadush, Dasgupta, and Ratha, 2000; and Lipsey, 2001). The resilience of FDI during financial crises was also evident during the Mexican crisis of 1994-95 and the Latin American debt crisis of the 1980s. This resilience could lead many developing countries to favor FDI over other forms of capital flows, furthering a trend that has been in evidence for many years (see Chart 1). Is the preference for FDI over other forms of private capital inflows justified? This article sheds some light on this issue by reviewing recent theoretical and empirical work on its impact on developing countries' investment and growth The case for free capital flows Economists tend to favor the free flow of capital across national borders because it allows capital to seek out the highest rate of return. Unrestricted capital flows may also offer several other advantages, as noted by Feldstein (2000). First, international flows of capital reduce the risk faced by owners of capital by allowing them to diversify their lending and investment. Second, the global integration of capital markets can contribute to the spread of best practices in corporate governance, accounting rules, and legal traditions. Third, the global mobility of capital limits the ability of governments to pursue bad policies. In addition to these advantages, which in principle apply to all kinds of private capital inflows?
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FDI allows the transfer of technology—particularly in the form of new varieties of capital inputs—that cannot be achieved through financial investments or trade in goods and services. FDI can also promote competition in the domestic input market. Recipients of FDI often gain employee training in the course of operating the new businesses, which contributes to human capital development in the host country. Profits generated by FDI contribute to corporate tax revenues in the host country.
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Of course, countries often choose to forgo some of this revenue when they cut corporate tax rates in an attempt to attract FDI from other locations. For instance, the sharp decline in corporate tax revenues in some of the member countries of the Organization for Economic Cooperation and Development (OECD) may be the result of such competition. (For a discussion, see the article by Reint Gropp and Kristina Kostial in this issue.)
Conclusion
The global financial system (GFS) is a financial system consisting of institutions and regulations that act on the international level, as opposed to those that act on a national or regional level. Foreign exchange market and management of exchange rate of a country’s currency are two key areas that influence the economic well-being of the general public. The exchange rate of a country’s currency is the value of its money for international trade in goods, services and finance and, therefore, it is part and parcel of the monetary condition of a country. Central banks, private banks, hedge funds, Investment management firms, Retail foreign exchange brokers are participate for foreign management. Dollars, Euro, Swiss frank, yen, pounds are the main currencies exchange in foreign exchange market. The most common and yet most complex form of negotiable instrument used for business transactions is known as the draft, or the bill of exchange. A bill of exchange can be used for payment, credit, or security in a financial transaction. Forfeiting and factoring are services in international market given to an exporter or seller. Its main objective is to provide smooth cash flow to the sellers. Letters of credit accomplish their purpose by substituting the credit of the bank for that of the customer, for the purpose of facilitating trade. International financial market is the world largest market in the world. It include bond market, stock market, capital market, derivatives markets, futures markets, insurance markets and foreign exchange market. According to the IMF and OECD definitions, direct investment reflects the aim of obtaining a lasting interest by a resident entity of one economy (direct investor) in an enterprise that is resident in another economy (the direct investment enterprise). The “lasting interest” implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence on the management of the latter.
Reference http://about.reuters.com/productinfo/s/foreign_exchange_management/
