International Financial Management (IFM

International Financial
Management (IFM)
(MBA-II, SEM-IV)
Institute of Management and Rural Development
Administration (IMRDA), Sangli.
Bharati Vidyapeeth (Deemed to be) University, Pune
1

Unit No-1 INTRODUCTION
• Overview, Scope and Objective of International Finance.
• Distinction between Domestic Finance and International Finance.
• Importance and Challenges of International Financial Management.
• Foreign Direct Investment: Concept, Cost and Benefits of Foreign
Direct Investment.
• Concept of International Portfolio Management.
2

Overview
INTERNATIONAL FINANCE-(Definition / Key Points)
• It is an important part of financial economics.
• It mainly discusses the issues related with monetary interactions of at least two or
more countries.
• International finance is concerned with subjects such as exchange rates of currencies,
monetary systems of the world, foreign direct investment (FDI), and other important
issues associated with international financial management.
• International finance is defined as the set of relations for the creation and using of
funds (assets), needed for foreign economic activity of international companies and
countries.
International Financial Management-
3

Purpose International Financial
Management-
• To identify the main goal of the multinational company
(MNC) and conflicts with the goal
• To describe the key theories that justify the international
business; and
• To explain the common methods used to conduct
international business
• Doing of trade and making money through the exchange of
foreign currency.
4

Scope of International Financial Management-
• Estimating Financial Requirements:-
The first task of financial manager is to estimate short term and long-term financial
requirements of his business. For this purpose, he will prepare a financial plan for
present as well as for future. The amount required for purchasing fixed assets as well as
for working capital will have to be ascertained.
• Deciding Capital Structure:-
The capital structure refers to the kind and proportion of different securities for raising
funds. After deciding about the quantum of funds required, it should be decided which
type of securities should be raised. It may be wise to finance fixed assets through long-
term debts and current assets through short-term debts.
• Selecting a Source of Finance:-
After preparing capital structure, an appropriate source of finance is selected. Various
sources from which finance may be raised include share capital, debentures, financial
institutions, commercial banks, public deposits etc. If finance is needed for short period,
then banks, public deposits and financial institutions may be appropriate. On the other
hand, if long-term finance is required then, share capital, and debentures may be useful.
5

• Selecting a pattern of Investment:-
When funds have been procured then a decision about investment pattern is to be taken.
The selection of an investment pattern is related to the use of funds. A decision will have
to be taken as to which asset is to be purchased. The funds will have to be spent first on
fixed assets and then an appropriate portion will be retained for working capital. The
decision-making techniques such as capital budgeting, opportunity cost analysis etc.
may be applied in making decisions about capital expenditures.
• Proper Cash Management:-
Cash management is an important task of finance manager. He has to assess various
cash needs at different times and then make arrangements for arranging cash. The cash
management should be such that neither there is a shortage of it and nor it is idle. Any
shortage of cash will damage the credit worthiness of the enterprise. The idle cash with
the business will mean that it is not properly used. Cash flow statements are used to find
out various sources and application of cash. 6

• Implementing Financial Controls:-
An efficient system of financial management necessitates the use of various control devises. Financial
control devises generally used are budgetary control, break even analysis; cost control, ratio analysis etc.
The use of various techniques by the finance manager will help him in evaluating the performance in
various areas and take corrective measures whenever needed.
• Proper use of Surplus:-
The utilization of profit or surplus is also an important factor in financial management. A judicious use of
surpluses is essential for expansion and diversification plan and also in protecting the interest of
shareholders. The finance manager should consider the following factors before declaring the dividend;
a. Trend of earnings of the enterprise
b. Expected earnings in future.
c. Market value of shares.
d. Shareholders interest.
e. Needs of fund for expansion etc.
7

Objective/ Goals of International Financial
Management-
Goals or objectives describe a particular result aimed to achieve with a
prescribed time frame and with available resources.
Goals of Financial Management:
• Profit Maximization: prime motto of any kind of business activity
Sales - Expenses = Profit The term ‘profit maximization’ implies
generation of huge amount of profits over the time period, this
includes both short-term and long-term.
• Wealth Maximization: It is process of increasing shareholders wealth
8

Objective/ Goals of International Financial
Management-
• Stock lending for environmentally and socially distractive projects
• Pursue cancellation of the debt of the poorest countries
• Investigate and develop a mechanism to control international currency
speculation
• Halt structural adjustment programmers as currently constituted so as
to prevent further social and ecological damage
• Fundamentally transform the international financial system who insure
democratic governance, transference and community involvement,
pull and open public participation and public accountability
9

Importance of International Financial
Management-
• International finance is an important tool to find the exchange rates,
compare inflation rates, get an idea about investing in international debt
securities, ascertain the economic status of other countries and judge the
foreign markets.
• Exchange rates are very important in international finance, as they let us
determine the relative values of currencies. International finance helps in
calculating these rates.
• Various economic factors help in making international investment
decisions. Economic factors of economies help in determining. Whether or
not investors" money is safe it foreign debt securities.
10

Importance of International Financial
Management-
• IFRS system (International Financial Reporting Standards),
which is a part of international finance, also helps in saving
money by following the rules of reporting on a single accounting
standard.
• International finance has grown in stature due to globalization. It
helps understand the basics of all international organizations and
keeps the balance intact among them.
• An international finance system maintains peace among the
nations. (Without a solid finance measure, all nations would work
for their self-interest. International finance helps in keeping that
issue at bay. 11

Challenges of International Financial
Management-
1. Challenge of Protection of Natural Resources
• When there is more international finance, its growth will affect
the natural resources.
• For example, after increasing the number of banks in India, ACs
are used at large scale due to this, there is increasing the
temperature of India. Who is responsible for this. Surely
international banks are responsible who are opening the branches
in India. Every increase in the number of bank branch means, 5
new installation of ACs which increases open environmental
temperature. So, this is big challenge of international finance. It
has to reduce by planting the tree and not to use ACs in office.
12

Management-
2. Terrorism
• Terrorism is also main challenge of International Finance. If
any country will increase the terrorism in other country, its
international finance will be affected.
• Motherland is first and then, there is any international
finance. India should ban all international finance and
business relating to the countries which are promoting
terrorism in India.
• Other countries which have the problem of terrorism, should
strictly ban on it if it has to increase its international finance
with other countries. 13

Management-
3. Culture
• International finance has also challenge of culture of each
country.
• India is veg. country. So, McDonnell and other non-veg.
country should ban to produce the non-veg. in India.
4. Follow the Political Policies and Law of Nation
If businesspeople have to grow international finance in any
country, they have to make their policy according to the law
and political policy of same country.
14

Management-
5. International Currencies
• International finance also affects from international
currencies.
• You have some foreign currency if you have to deal with
foreign country.
• At the time of dealing, you know what is the current market
rate of forex.
• If your own currency is low value, you should wait for
business, otherwise, your own capital will decrease at fast
rate.
15

Distinction between Domestic Finance and
International Finance
• Culture, history, and institutions-
Each foreign country is unique and not
always understood by MNE
management understood by MNE
management
• Corporate governance- Foreign
countries' regulations and institutional
Practices are all uniquely different
• Foreign exchange risk- MNEs face
foreign exchange risks due to their
subsidiaries, as well as import/export
and foreign competitors
Domestic Finance
• Culture, history, and institutions-
Each country has a known base case
• Corporate governance- Regulations
and institutions are well known
• Foreign exchange risk- Foreign
exchange risks from import/export and
foreign competition
16

• Political risk- MNEs face political
risks because of their foreign
subsidiaries and high profile
• Modification of domestic finance
theories- MNEs must modify finance
theories like capital budgeting and
cost of capital because of foreign
complexities
• Modification of domestic financial
instruments- MNEs utilize modified
financial instruments such as options,
futures, swaps, and letters of credit
Domestic Finance
• Political risk- Negligible political
risks
• Modification of domestic finance
theories- Traditional financial theory
applies
• Modification of domestic financial
instruments- Limited use of financial
instruments and derivatives because of
fewer foreign exchange and political
risks
17

18

International Portfolio Management
19
Global Portfolio Management, also known as International Portfolio
Management or Foreign Portfolio Management, refers to grouping of
investment assets from international or foreign markets rather than from
the domestic ones. The asset grouping in IPM mainly focuses on
securities. The most common examples of Global Portfolio
Management are −
• Share purchase of a foreign company
• Buying bonds that are issued by a foreign government
• Acquiring assets in a foreign firm

Factors Affecting International Portfolio Investment
20
International Portfolio Management (IPM) requires an acute understanding of the market in
which investment is to be made. The major financial factors of the foreign country are the
factors affecting IPM. The following are the most important factors that influence IPM
decisions.
Tax Rates
Tax rates on dividends and interest earned is a major influencer of IPM. Investors usually
choose to invest in a country where the applied taxes on the interest earned or dividend
acquired is low. Investors normally calculate the potential after-tax earnings they will secure
from an investment made in foreign securities.
Interest Rates
High interest rates are always a big attraction for investors. Money usually flows to
countries that have high interest rates. However, the local currencies must not weaken for
long-term as well.
Exchange Rates
When investors invest in securities in an international country, their return is mostly
affected by −
The apparent change in the value of the security.
The fluctuations in the value of currency in which security is managed.

Modes of International Portfolio Investment
21
Foreign securities or depository receipts can be bought directly from a particular
country’s stock exchange. Two concepts are important here which can be
categorized as Portfolio Equity and Portfolio Bonds. These are supposed to be the
best modes of IPM. A brief explanation is provided here under.
Portfolio Equity
Portfolio equity includes net inflows from equity securities other than those
recorded as direct investment and including shares, stocks, depository receipts
(American or global), and direct purchases of shares in local stock markets by
foreign investors.
Portfolio Bonds
Bonds are normally medium to long-term investments. Investment in Portfolio Bond
might be appropriate for you if −
You have additional funds to invest.
You seek income, growth potential, or a combination of the two.
You don’t mind locking your investment for five years, ideally longer.
You are ready to take some risk with your money.
You are a taxpayer of basic, higher, or additional-rate category.

Modes of International Portfolio Investment
22
• International Mutual Funds
International mutual funds can be a preferred mode if the
Investor wants to buy the shares of an internationally diversified
mutual fund. In fact, it is helpful if there are open-ended mutual
funds available for investment.
• Closed-end Country Funds
Closed-end funds invest in internationals securities against the
portfolio. This is helpful because the interest rates may be higher,
making it more profitable to earn money in that particular country.
It is an indirect way of investing in a global economy. However, in
such investments, the investor does not have ample scope for
reaping the benefits of diversification, because the systematic
risks are not reducible to that extent.

Drawbacks of International Portfolio Investment
23
• Unfavorable Exchange Rate Movement − Investors are unable to ignore the probability of exchange
rate changes in a foreign country. This is beyond the control of the investors. These changes greatly
influence the total value of foreign portfolio and the earnings from the investment. The weakening of
currency reduces the value of securities as well.
• Frictions in International Financial Market − There may be various kinds of market frictions in a
foreign economy. These frictions may result from Governmental control, changing tax laws, and explicit
or implicit transaction costs. The fact is governments actively seek to administer international financial
flows. To do this, they use different forms of control mechanisms such as taxes on international flows of
FDI and applied restrictions on the outflow of funds.
• Manipulation of Security Prices − Government and powerful brokers can influence the security prices.
Governments can heavily influence the prices by modifying their monetary and fiscal policies.
Moreover, public sector institutions and banks swallow a big share of securities traded on stock
exchanges.
• Unequal Access to Information − Wide cross-cultural differences may be a barrier to IPM. It is difficult
to disseminate and acquire the information by the international investors beforehand. If information is
tough to obtain, it is difficult to act rationally and in a prudent manner.

Shares and Debentures
• Shares- A tiny part of a firm’s capital is identified as shares and is
usually sold in the stock market to raise funds for a business. The price
at which the investor buys the share is known as share price. The
shareholders are qualified to receive the dividend as mentioned by an
organisation because they are the owner of a portion of share iv the
company.
• The shares are transferrable/movable and are broadly categorized into
two different sections
• Equity share
• Preference share
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Shares and Debentures
• Debenture- It is a debt tool used by a company that supports long term
loans. Here, the fund is a borrowed capital, which makes the holder of
debenture a creditor of the business. The debentures are both redeemable
and unredeemable, freely transferable with a fixed interest rate. It is
unsecured and sustained only by the issuer’s credibility.
• Unlike shareholders, the debenture holders who are the creditor of the
company do not hold any voting rights. The debentures are of following
types:
• Secured Debentures
• Convertible Debentures
• Unsecured Debentures
• Registered Debentures
• Non-convertible Debentures
• Bearer Debentures
25

Bonds
• Bonds are the most common debt instrument. Usually private
companies, governments and other financial institutions issue them.
They are loans that are secured by collateral. The organisation that
issues bonds becomes the borrower who promises the repayment of
principal and interest at specified maturity date. Also, they fix the
interest rate for the duration of the bond’s term.
28

Unit No-2 International Flow of Funds and
International Monetary System
• Concept, principles and components of Balance of
Payment
• International Monetary System:
Evolution, Gold Standard, Bretton Woods System,
• The flexible Exchange rate regime,
• The current exchange rate arrangement
31

Balance of Payment (BOP)
• The balance of payment is the statement that files all the transactions between the
entities, government anatomies, or individuals of one country to another for a given
period of time. All the transaction details are mentioned in the statement, giving the
authority a clear vision of the flow of funds.
• After all, if the items are included in the statement, then the inflow and the outflow
of the fund should match. For a country, the balance of payment specifies whether
the country has an excess or shortage of funds. It gives an indication of whether the
country’s export is more than its import or vice versa.
32

Types of Balance of Payment (BOP)
• Current account: This account scans all the incoming and outgoing of goods and services
between countries. All the payments made for raw materials and constructed goods are
covered under this account. Few other deliveries that are included in this category are from
tourism, engineering, stocks, business services, transportation, and royalties from licenses
and copyrights. All these combine together to make a BOP of a country.
• Capital account: Capital transactions like purchase and sale of assets (non-financial) like
lands and properties are monitored under this account. This account also records the flow of
taxes, acquisition, and sale of fixed assets by immigrants moving into the different country.
The shortage or excess in the current account is governed by the finance from the capital
account and vice versa.
• Finance account: The funds that flow to and from the other countries through investments
like real estate, foreign direct investments, business enterprises, etc., is recorded in this
account. This account calculates the foreign proprietor of domestic assets and domestic
proprietor of foreign assets, and analyses if it is acquiring or selling more assets like stocks,
gold, equity, etc.
33

Importance of Balance of Payment (BOP)
• It examines the transaction of all the exports and imports of goods and services for a
given period.
• It helps the government to analyze the potential of a particular industry export
growth and formulate policy to support that growth.
• It gives the government a broad perspective on a different range of import and
export tariffs. The government then takes measures to increase and decrease the tax
to discourage import and encourage export, respectively, and be self-sufficient.
• If the economy urges support in the mode of import, the government plans
according to the BOP, and divert the cash flow and technology to the unfavorable
sector of the economy, and seek future growth.
• The balance of payment also indicates the government to detect the state of the
economy, and plan expansion. Monetary and fiscal policy are established on the
basis of balance of payment status of the country. 34

INTERNATIONAL MONETARY SYSTEMS
• International monetary systems are sets of internationally agreed rules,
conventions and supporting institutions, that facilitate international
trade, cross border investment and generally their allocation of capital
between nation states.
• International monetary system refers to the system prevailing in world
foreign exchange markets through which international trade and
capital movement are financed and exchange rates are determined
35

Features that IMS should possess
• Efficient and unrestricted flow of international trade and investment.
• Stability in foreign exchange aspects.
• Promoting Balance of Payments adjustments to prevent disruptions
associated.
• Providing countries with sufficient liquidity to finance temporary
balance of payments deficits.
• Should at least try avoid adding further uncertainty.
• Allowing member countries to pursue independent monetary and fiscal
policies.
36

Requirements of good international monetary
system
• Adjustment : a good system must be able to adjust imbalances in
balance of payments quickly and at a relatively lower cost
• Stability and Confidence: the system must be able to keep exchange
rates relatively fixed and people must have confidence in the stability
of the system
• Liquidity: the system must be able to provide enough reserve assets
for a nation to correct its balance of payments deficits without making
the nation run into deflation or inflation.
37

Evolution in International Monetary System
• Bimetallism: Before 1875
• Classical Gold Standard: 1875-1914
• Interwar Period: 1915-1944
• Bretton Woods System: 1945-1972
• The Flexible Exchange Rate Regime: 1973-Present
38

Bimetallism: Before 1875
• The international monitory system consisted of bimetallisim, where
both gold and silver coins were used as the international modes of
payment.
• The exchange rates among currencies were determined by their gold of
silver contents. Some countries were either on a gold or silver
standard.
• Defect- Unstable ; Due to Greham’s Law, i.e. bad money drives away
good money, lending to unimetallism.
39

CLASSICAL GOLD STANDARD(1875-1914)
• During this period in most major countries:-
i)Gold alone was assured of unrestricted coinage
ii)There was two-way convertibility between gold and national currencies
at a stable ratio.
iii)Gold could be freely exported or imported.
• The exchange rate between two country’s currencies would be
determined by their relative gold contents.
• Highly stable exchange rates under the classical gold standard provided
an environment that was favorable to international trade and investment
• Misalignment of exchange rates and international imbalances of
payment were automatically corrected by the price-specie-flow
mechanism
40

Rules of the Gold Standard system
• Each country defined the value of its currency in terms of gold.
• Exchange rate between any two currencies was calculated as X
currency per ounce of gold/ Y currency per ounce of gold.
• These exchange rates were set by arbitrage depending on the
transportation costs of gold.
• Central banks are restricted in not being able to issue more
currency than gold reserves
41

Arguments against Gold Standard system
• The growth of output and the growth of gold supplies are
closely linked.
• Volatility in the supply of gold could cause adverse shocks to
the economy
• In practice monetary authorities may not be forced to strictly
tie their hands in limiting the creation of money.
• Countries with respectable monetary policy makers cannot use
monetary policy to fight domestic issues like unemployment.
42

BRETTON WOODS SYSTEM / Interwar Period
(1915-1944)
• Named for a 1944 meeting of 44 nations at Bretton Woods, New
Hampshire.
• The purpose was to design a postwar international monetary system.
• The goal was exchange rate stability without the gold standard.
• This period was described as of de-globalization.
• Countries have abandoned the gold standaed, the international trade &
capital flows shrank & started printing money to pay for war related
expenses.
• During this period the US replaced Britain as the dominant financial power
of the world.
• The US returned to a gold standard in 1919. Sterlisation of gold was
followed.
43

BRETTON WOODS SYSTEM
• Named for a 1944 meeting of 44 nations at Bretton Woods,
New Hampshire.
• The purpose was to design a postwar international monetary
system.
• The goal was exchange rate stability without the gold standard.
44

Features of Bretton Woods System
• Under the Bretton Woods system, the U.S. dollar was pegged
to gold at $35 per ounce and other currencies were pegged to
the U.S. dollar.
• Each country was responsible for maintaining its exchange rate
fixed : within ±1% of the adopted par value by buying or
selling foreign reserves as necessary.
• The Bretton Woods system was a dollar-based gold exchange
standard.
• This condition was often coined the Triffin paradox(Import
more). Eventually in the early 1970s, the gold exchange
standard system collapsed because of these reasons.
45

THE FLEXIBLE EXCHANGE RATE REGIME
A)Flexible exchange rates were declared acceptable to the IMF members -Central banks were
allowed to intervene in the exchange rate markets to iron out unwarranted volatilities.
B)Gold was abandoned as an international reserve asset.
C)The currencies are no longer backed by gold Current Exchange Rate Arrangements-
• Free Float
• The largest number of countries, about 48, allow market forces to determine their currency’s
value.
• Managed Float
• About 25 countries combine government intervention with market forces to set exchange
rates.
• Pegged to another currency
• Such as the U.S. dollar or euro etc..
• No national currency
• Some countries do not bother printing their own, they just use the U.S. dollar. For example,
Ecuador, Panama, and have dollarized
46

Unit No-3 Foreign Exchange Market and
Foreign Exchange Risk Management
• Functions and Structure of Foreign Exchange Market
• Major Participants
• Types of transactions
• Foreign Exchange Exposure
• Various tools and techniques of Foreign exchange risk
management
• Foreign Exchange Rate Determination
47

FOREIGN EXCHANGE MARKET
• Definition: Foreign Exchange Market is the market where the buyers
and sellers are involved in the buying and selling of foreign currencies.
Simply, the market in which the currencies of different countries are
bought and sold is called as a foreign.
• Features:
1) It is aa global market which is opened for 24 hrs
2) There is wide fluctuation in this market
3) this settlement are affected by the time period
4) It is a market that supports large capital and trade follows
5) It is affected by government rules and controls
48

learing system to facilitate international trade and capital movement
• It provides short term credit to the importers for the smooth flow of
goods and service from one country to another.
• It facilitate hedging function it means to protect the participants from the
exchange risk
49

Major Participants:
• Central Banks
• Major commercial banks
• Investment banks
• Corporations for international business transactions
• Hedge funds
• Speculators
• Pension and mutual funds
• Insurance companies
• Forex brokers
50

Types of transaction:
• Spot transaction
• Forward transaction-
a) Premium
b) Discount
• Future
• Options
51

STRUCTURE OF FOREX MARKET
Foreign exchange management act, 1999 there is tie-up between
A) Central government
B) RBI –
i) Foreign exchange dealer association of India (FEDAI)
ii) Authorized person –
a) Authorised dealer (AD)
b) Authorised money changes –
1) Full-fledged
2) Restricted
52

VARIOUS TOOLS AND TECHNIQUES
OF FOREX MARKET
Qualitative:-
• Changing in the currency
• Netting
• Leads and Lays
• Indexing
• Changing the manufacturing
base
Quantitative:-
• Forward market
• Money market operation
• Derivative instrument such as
Option and Future
• Swap
53

FACTORS INFLUENCING FOREIGN EXCHANGE RATE
1. Inflation Rates
Changes in market inflation cause changes in currency exchange rates. A country with a lower
inflation rate than another's will see an appreciation in the value of its currency. The prices of goods
and services increase at a slower rate where the inflation is low. A country with a consistently lower
inflation rate exhibits a rising currency value while a country with higher inflation typically sees
depreciation in its currency and is usually accompanied by higher interest rates
2. Interest Rates
How do interest rates affect exchange rates? Changes in interest rate affect currency value and dollar
exchange rate. Forex rates, interest rates, and inflation are all correlated. Increases in interest rates
cause a country's currency to appreciate because higher interest rates provide higher rates to lenders,
thereby attracting more foreign capital, which causes a rise in exchange rates
3. Country's Current Account / Balance of Payments
A country's current account reflects balance of trade and earnings on foreign investment. It consists of
total number of transactions including its exports, imports, debt, etc. A deficit in current account due
to spending more of its currency on importing products than it is earning through sale of exports
causes depreciation. Balance of payments fluctuates exchange rate of its domestic currency. 54

4. Government Debt
Government debt is public debt or national debt owned by the central government. A country with government
debt is less likely to acquire foreign capital, leading to inflation. Foreign investors will sell their bonds in the
open market if the market predicts government debt within a certain country. As a result, a decrease in the value
of its exchange rate will follow.
5. Terms of Trade
A trade deficit also can cause exchange rates to change. Related to current accounts and balance of payments, the
terms of trade is the ratio of export prices to import prices. A country's terms of trade improves if its exports
prices rise at a greater rate than its imports prices. This results in higher revenue, which causes a higher demand
for the country's currency and an increase in its currency's value. This results in an appreciation of exchange rate.
6. Political Stability & Performance
A country's political state and economic performance can affect its currency strength. A country with less risk for
political turmoil is more attractive to foreign investors, as a result, drawing investment away from other countries
with more political and economic stability. Increase in foreign capital, in turn, leads to an appreciation in the
value of its domestic currency. A country with sound financial and trade policy does not give any room for
uncertainty in value of its currency. But, a country prone to political confusions may see a depreciation in
exchange rates.
55

7. Recession
When a country experiences a recession, its interest rates are likely to fall, decreasing its chances to
acquire foreign capital. As a result, its currency weakens in comparison to that of other countries,
therefore lowering the exchange rate.
8. Speculation
If a country's currency value is expected to rise, investors will demand more of that currency in order
to make a profit in the near future. As a result, the value of the currency will rise due to the increase in
demand. With this increase in currency value comes a rise in the exchange rate as well.
56

FOREIGN EXCHANGE RATE QUOTATION
A)Direct quotation-
1)Gives the units of currency of domestic country per unit of a foreign currency
2)Price of foreign currency is quoted in terms of home currency.
3)In this system variable units of home currency equivalent to a fixed unit of foreign currency are quoted.
4)Domestic currency is quoted currency
5)For Eg – USD/INR = 70 Rs. / $
B)Indirect quotation-
1)Gives the units of currency of foreign country per unit of the domestic currency
2)Price of home currency is quoted in terms of foreign currency
3)In this system variable units of foreign currency equivalent to a fixed unit of home currency are quoted.
4)Foreign currency is the quoted currency
5)For Eg – INR/USD = 0.0220 $ / Rs
57

FOREIGN EXCHANGE RATE QUOTATION
C)Cross quotation-
1)USD is the most widely traded currency and is often used as the vehicle currency
2)This helps in reduction of no. of quotes in the market, as exchange rate between two currencies can
be determined through their quotes against the USD.
3)Any quote not against the USD is a Cross Quote
4)Availability of USD quote for all currencies can help in determining the exchange rate for any pair
of currencies by using the cross rate
5)For eg. Cross quote for EUR-GBP = EUR/USD * USD/GBP
58

INTERNATIONAL ARBITRATION
International arbitration is similar to domestic court litigation, but instead of taking place before a
domestic court it takes place before private adjudicators known as arbitrators.
It is a consensual, neutral, binding, private and enforceable means of international dispute resolution,
which is typically faster and less expensive than domestic court proceedings.
Unlike domestic court judgments, international arbitration awards can be enforced in nearly all
countries of the world, making international arbitration the leading mechanism for resolving
international disputes.
Arbitration is one of the most effective ways to resolve a conflict, offering a final and binding solution
when parties are unable to agree upon settlement and without taking a matter into court.
This technique involves one or more arbitrators reviewing the dispute and making a final and binding
decision.
When arbitration awards are rendered in international disputes, they are typically enforceable
throughout the 149 States that are Parties to the New York Convention.
59

Benefits of INTERNATIONAL ARBITRATION
• International Arbitration can resolve disputes more swiftly than traditional court litigation since there are only limited
appeals from arbitration awards.
• International Arbitration can be less expensive than traditional court litigation.
• International Arbitration can provide better-quality justice, since many domestic courts are overburdened, which does
not always allow judges sufficient time to produce legal decisions of high quality.
• Clients can play an active role in selecting an arbitrator who is an industry expert in International Arbitration, rather
than a generalist like many domestic court judges.
• International Arbitration is flexible, and the individual parties to a dispute play a significant role in selecting the
procedure that is most appropriate for resolving their international dispute, deciding on whether to include procedures
such as document production.
• International Arbitration can be confidential, which is useful if the parties wish to continue their business relationship
or to avoid negative publicity.
• International Arbitration is neutral. This is very important for cross-border transactions, since it avoids the possibility
of a “home court” advantage for one party.
• In certain countries, judges do not rule independently. In International Arbitration an award must be independently
made, or it cannot be enforced.
• In certain cases, such as investor-State disputes, International Arbitration offers the sole remedy for the violation of a
legal right. 60

INTEREST RATE PARITY
Meaning- The Interest Rate Parity states that the interest rate difference between two
countries is equal to the percentage difference between the forward exchange rate
and the spot exchange rate.
Implications of IRP-
1)If domestic interest rates are less than foreign interest rates, you will invest in
foreign country at higher interest rates.
2)Domestic investors can benefit by investing in the foreign market
3)If domestic interest rates are more than foreign interest rates, you will invest in
domestic market at higher interest rates
4)Foreign investors can benefit by investing in the domestic market
61

INTEREST RATE PARITY
Violation of IRP- If interest rate parity is violated, then investors would:
1)borrow in the currency with the lower rate
2)convert the cash at spot rates
3)enter into a forward contract to convert the cash plus the expected interest at the
same rate
4)invest the money at the higher rate
5)convert back through the forward contract
6)repay the principal and the interest, knowing the latter will be less than the interest
received.
62

PURCHASING POWER PARITY (PPP)
Meaning- The purchasing power of a country’s currency. The number of
units of currency required to purchase a basket of goods in Pakistan and
the same basket of goods and services that a USD would buy in United
states.
Need for PPP- Because the exchange rates only reflects when goods are
traded. Also, currencies are traded for purposes other than trade in goods
and services, e.g., to buy capital assets. Also, different interest rates,
speculation or interventions by central banks can influence the foreign-
exchange market.
63

PURCHASING POWER PARITY (PPP)
Purpose- Differences in living standards between nations because PPP
takes into account the relative cost of living and the inflation rates of the
countries.
Assumption- In the absence of transportation and other transaction
costs, competitive markets will equalize the price of an identical good in
two countries when the prices are expressed in the same currency.
64

RELATION BETWEEN INFLATION
Inflation and interest rates are in close relation to each other, and frequently
referenced together in economics. Inflation refers to the rate at which prices
for goods and services rise. Interest rate means the amount of interest paid by
a borrower to a lender, and is set by central banks. To clarify what interest
rates are, let’s pretend you deposit money into a bank. The bank uses your
money to give loans to other customers. In return for the use of your money,
the bank pays you interest. Similarly, when you purchase something with a
credit card, you pay the credit card company interest for using the money that
paid for your purchase. In general, interest is money that a borrower pays a
lender for the right to use the money. The interest rate is the percentage of the
total due that is paid by the borrower to the lender.
65

Unit No-5 INTERNATIONAL TRADE
SETTLEMENT (ITS)
• Concept, objective and importance of International Trade
• Risks involved in International Trade
• Factors influencing International Trade
• Settlement Methods of International Trade viz. open
Account, Advance Payment, Documentary Credit,
Documentary Collection, Consignment Trading
66

INTERNATIONAL TRADE
SETTLEMENT (ITS)
The aim of international trade is to increase
production and to raise the standard of living of
the people. International trade helps citizens of
one nation to consume and enjoy the possession
of goods produced in some other nation.
67

ITS Classification:
Import Trade: The inflow of goods in a country
is called import trade.
Export Trade: The outflow of goods from a
country is called export trade.
Entrepot Trade: Many times goods are
imported for the purpose of re-export after some
processing operations. This is called entrepot
trade.
68

ITS Types:
Direct Business: In direct business the importer
places order with manufacturer of the exporting
country.
Consignment Business: Under consignment
business the exporter sends the goods to an agent in
the importing country.
Indent Firms: The indent firms charge a
commission for their services. The indent firms are
also called commission agents.
Merchant Shippers: This is a class of businessmen
who buy goods on their own account and sell them
in a foreign country at a profit.
69

ITS Characteristics:
•Territorial specialization
•International competition
•Separation of sellers from buyers
•Long chain of middlemen
•International rules and regulations
•Mutually acceptable currency
•Government control
•Several documents
70

ITS Role or Importance:
•Division of labor and specialization
•Optimum allocation and utilization of resources
•Raises Standard of Living of the people
•Generate employment opportunities
•Equality of prices
•Ensures quality and standard goods
•Facilitate economic development
•To improve quality of local products
•Availability of multiple choices
71

ITS Benefits:
•Efficient Allocation and Better Utilization of
Resources
•Variety of Goods Available for Consumption
•Promotes Efficiency in Production
•Utilization of Surplus Produce
•Consumption at Cheaper Cost
•More Employment
•Reduces Trade Fluctuations
72

Barriers to ITS :
•Cultural and social barriers
•Political barriers
•Tariffs and trade restrictions
•Standards
•Boycotts
•Anti-dumping Penalties
•Monetary Barriers
73

ITS Reasons for growing globally:
•Reduced dependence on your local market
•Increased chances of success
•Increased efficiency
•Increased productivity
•Economic advantage
•Innovation
•Growth
74

RISK INVOLVED IN INTERNATIONAL
TRADE :
•Short term
•Self-liquidating
•Secured
•Speedily completed
•Bank risk
•Fraud
•The short life of
documentary
completed
•Country risk
•Foreign exchange risk
•Documentary credit
75

FACTORS AFFECTING INTERNATIONAL
TRADE FLOWS:-
• INFLATION-A general increase in prices and fall in the
purchasing value of money. A relative increase in a
country’s inflation rate will decrease its current account, as
imports increase and exports decrease.
• NATIONAL INCOME-A relative increase in a country’s
income level will decrease its current account, as imports
increase.
76

FACTORS AFFECTING INTERNATIONAL
TRADE FLOWS:-
• GOVERNMENT RESTRICTIONS-A government
may reduce its country’s imports by imposing tariffs on
imported goods, or by enforcing a quota. Trade
restrictions.
• EXCHANGE RATES-If a country’s currency begins to
rise in value, its current account balance will decrease as
imports increase and exports decrease.
77

METHODS OF INTERNATIONAL TRADE SETTLEMENT:
Cash-in-Advance:
• With cash-in-advance payment terms, an exporter can avoid credit risk because
payment is received before the ownership of the goods is transferred.
• For international sales, wire transfers and credit cards are the most commonly used
cash-in-advance options available to exporters.
• With the advancement of the Internet, escrow services are becoming another cash-in-
advance option for small export transactions.
• However, requiring payment in advance is the least attractive option for the buyer,
because it creates unfavorable cash flow.
• Foreign buyers are also concerned that the goods may not be sent if payment is made
in advance.
• Thus, exporters who insist on this payment method as their sole manner of doing
business may lose to competitors who offer more attractive payment terms. 78

Letters of Credit:
• Letters of credit (LCs) are one of the most secure instruments available to
international traders.
• An LC is a commitment by a bank on behalf of the buyer that payment will be made
to the exporter, provided that the terms and conditions stated in the LC have been
met, as verified through the presentation of all required documents.
• The buyer establishes credit and pays his or her bank to render this service.
• An LC is useful when reliable credit information about a foreign buyer is difficult to
obtain, but the exporter is satisfied with the creditworthiness of the buyer’s foreign
bank.
• An LC also protects the buyer since no payment obligation arises until the goods
have been shipped as promised.
79

Letters of Credit:
80

STEPS INVOLVED IN LETTER OF CREDIT MECHANISM
AND ROLE PLAYED BY PARTIES:
• Buyer and seller agree to conduct business. The seller wants a letter of credit to
guarantee payment.
• Buyer applies to his bank for a letter of credit in favor of the seller.
• Buyer's bank approves the credit risk of the buyer, issues and forwards the credit to
its correspondent bank (advising or confirming). The correspondent bank is usually
located in the same geographical location as the seller (beneficiary).
• Advising bank will authenticate the credit and forward the original credit to the seller
(beneficiary).
• Seller (beneficiary) ships the goods, then verifies and develops the documentary
requirements to support the letter of credit. Documentary requirements may vary
greatly depending on the perceived risk involved in dealing with a particular
company. 81

STEPS INVOLVED IN LETTER OF CREDIT MECHANISM
AND ROLE PLAYED BY PARTIES:
• Seller presents the required documents to the advising or confirming bank to be
processed for payment.
• Advising or confirming bank examines the documents for compliance with the terms
and conditions of the letter of credit.
• If the documents are correct, the advising or confirming bank will claim the funds by:
i)Debiting the account of the issuing bank.
ii)Waiting until the issuing bank remits, after receiving the documents.
iii)Reimburse on another bank as required in the credit.
• Advising or confirming bank will forward the documents to the issuing bank.
• Issuing bank will examine the documents for compliance. If they are in order, the
issuing bank will debit the buyer's account.
82

ROLE OF PARTIES INVOLVED IN LC TRANSACTION
• Applicant is the party that arranges for the letter of credit to be issued.
• Beneficiary is the party named in the letter of credit in whose favor the letter of credit is
issued.
• Issuing or Opening Bank is the applicant’s bank that issues or opens the letter of credit in
favor of the beneficiary and substitutes its creditworthiness for that of the applicant.
• Advising Bank may be named in the letter of credit to advise the beneficiary that the letter
of credit was issued. The role of the Advising Bank is limited to establish apparent
authenticity of the credit, which it advises.
• Paying Bank is the bank nominated in the letter of credit that makes payment to the
beneficiary, after determining that documents conform, and upon receipt of funds from the
issuing bank or another intermediary bank nominated by the issuing bank.
• Confirming Bank is the bank, which, under instruction from the issuing bank, substitutes its
creditworthiness for that of the issuing bank. It ultimately assumes the issuing bank’s
commitment to pay. 83

Types of Letters of Credit:
• Irrevocable and revocable letters of credit
• Confirmed and unconfirmed / Advised letters of credit
• Transferable letters of credit
• Stand-by letters of credit
• Revolving letters of credit
• Back to Back letters of credit
84

Letters of Credit
Advantages-
• The beneficiary is assured of payment as long as it complies with the
terms and conditions of the letter of credit.
• The credit risk is transferred from the applicant to the issuing bank.
• The beneficiary minimizes collection time as the letter of credit
accelerates payment of the receivables.
• The beneficiary’s foreign exchange risk is eliminated with a letter of
credit issued in the currency of the beneficiary’s country.
85

Letters of Credit
Risks involved:
• Since all the parties involved in Letter of Credit deal with the documents
and not with the goods, the risk of Beneficiary not shipping goods as
mentioned in the LC is still persists.
• The Letter of Credit as a payment method is costlier than other methods
of payment such as Open Account or Collection
• The Beneficiary’s documents must comply with the terms and conditions
of the Letter of Credit for Issuing Bank to make the payment.
• The Beneficiary is exposed to the Commercial risk on Issuing Bank,
Political risk on the Issuing Bank’s country and Foreign Exchange Risk
in case of Usance Letter of Credits. 86

Documentary Collections:
• A documentary collection (D/C) is a transaction whereby the exporter entrusts the
collection of the payment for a sale to its bank (remitting bank), which sends the
documents that its buyer needs to the importer’s bank (collecting bank), with
instructions to release the documents to the buyer for payment.
• Funds are received from the importer and remitted to the exporter through the banks
involved in the collection in exchange for those documents.
• D/Cs involve using a draft that requires the importer to pay the face amount either at
sight (document against payment) or on a specified date (document against acceptance).
• The collection letter gives instructions that specify the documents required for the
transfer of title to the goods.
• Although banks do act as facilitators for their clients, D/Cs offer no verification process
and limited recourse in the event of non-payment. D/Cs are generally less expensive
than LCs. 87

Open Account:
• An open account transaction is a sale where the goods are shipped and delivered before
payment is due, which in international sales is typically in 30, 60 or 90 days.
• Obviously, this is one of the most advantageous options to the importer in terms of cash
flow and cost, but it is consequently one of the highest risk options for an exporter.
• Because of intense competition in export markets, foreign buyers often press exporters for
open account terms since the extension of credit by the seller to the buyer is more common
abroad.
• Therefore, exporters who are reluctant to extend credit may lose a sale to their competitors.
• Exporters can offer competitive open account terms while substantially mitigating the risk
of non-payment by using one or more of the appropriate trade finance techniques covered
later in this Guide.
• When offering open account terms, the exporter can seek extra protection using export
credit insurance.
88

Consignment:
• Consignment in international trade is a variation of open account in which
payment is sent to the exporter only after the goods have been sold by the foreign
distributor to the end customer.
• An international consignment transaction is based on a contractual arrangement
in which the foreign distributor receives, manages, and sells the goods for the
exporter who retains title to the goods until they are sold.
• Clearly, exporting on consignment is very risky as the exporter is not guaranteed
any payment and its goods are in a foreign country in the hands of an independent
distributor or agent.
• Consignment helps exporters become more competitive on the basis of better
availability and faster delivery of goods. 89

Consignment:
• Selling on consignment can also help exporters reduce the direct
costs of storing and managing inventory.
• The key to success in exporting on consignment is to partner with
a reputable and trustworthy foreign distributor or a third-party
logistics provider.
• Appropriate insurance should be in place to cover consigned
goods in transit or in possession of a foreign distributor as well as
to mitigate the risk of non-payment.
90

Comparison:
91

Comparison:
92

Unit No-6 INTERNATIONAL TRADE
FINANCE (ITF)
• Pre shipment finance, Post shipment finance
• Supplier’s Credit, Buyer’s Credit
• Factoring, Forfeiting
• Offshore banking documentary credit mechanism
• Steps involved in Letter of Credit (L.C.) mechanism
along with role played by the parties to L.C.
93

Export Financing
• Exporters naturally wants to get paid as quickly as possible.
• Where as importer usually preferred to delay payment until they have
received good or resold the goods.
• Here need of financing to make the sale.
• Otherwise buyer may prefer buying goods from someone else
• The financing can be- Short Term, Medium and Long Term
• Short term finance is for working capital Which is used for daily
requirement
• Finance is available for sale of goods on credit to International
Importers
• However the exporter can get assistance from any bank and public or
Private sector
94

Sources of Export Financing
• Commercial Bank
• Export- Import Bank of India (EXIM)
• Reserve Bank of India (RBI)
• Export Credit and Guarantee Corporation (ECGC)
95

Types /Forms of Export Financing
• Pre-shipment Finance
• Post-shipment Finance
• Factoring
• Forfaiting
96

Pre shipment finance
Financial assistance extended for execution of an export order
from the date of receipt of an export order till the date of
shipment.
97

Objective of Pre shipment finance
• To purchase raw material and other inputs
• Carry out manufacturing process
• To warehouse of goods and raw material
• To process and pack of goods, Marketing, Labeling
• To shipping of goods to the buyers
• To meet other financial costs of the business
98

Post shipment finance
• Financial assistance from the date of shipment to the date of
realization.
• Post-shipment finance includes any finance that an exporter can access
after they send goods to a buyer.
• Without finance, the exporter would wait for the goods to arrive, an
invoice to be raised and the payment terms period (typically 30, 60 or
90 additional days).
• A financier can accelerate the payment to the exporter, so that payment
is received as the goods are sent (typically loaded onto the ship).
100

Purpose / Importance of Post shipment finance
• Importer don’t pay the amount of goods shipped
• Exporter is now needs to produce another goods for carry on their own
business
• Post-shipment finance can operate in a number of ways, through:
A Letter of Credit (LC)
A Trade Loan
Invoice Factoring or Receivables Discounting: selling the invoice or
receivables document
101

Objectives of Post shipment finance
• Payment to agents and distributors for their services
• Payment for Promotional and advertisement expenses
• Payment for post officers, custom duty and other shipping
expenses
• Payment for after sale services
• Payment for the premium of ECGC
102

Eligibility for Post shipment finance
• Post shipment finance provided to that exporters who has
shipped the goods and who transfer the export documents
103
Amount of Post shipment finance
• Upto 10 Cr - Commercial Banks
• 10 Cr to 50 Cr – EXIM Bank
• Above 50 Cr – EXIM Bank, RBI and ECGC

Rate and Period of Interest under Post shipment finance
• Short Term- 90 Days (13%)
• Medium Term- 90 days to 5 years (Divide by RBI)
• Long Term- 5 years to 12 years (Divide by RBI)
104

Rate and Period of Interest under Post shipment finance
• Short Term- 90 Days (13%)
• Medium Term- 90 days to 5 years (Divide by RBI)
• Long Term- 5 years to 12 years (Divide by RBI)
105

SUPPLIERS CREDIT
It relates to credit for imports into India extended by the overseas suppliers or
financial institutions outside India. Usance Bills under Letter of Credit issued
by Indian Bank Branches on behalf of their importers are discounted by
Indian Bank overseas branches or Foreign bank. Paying your suppliers at
sight against Usance bills under letter of credits.
Requirement-
• Suppliers would ask for sight payment where as you want credit on the
transaction.
• At times, in capital goods, banks would insist on using term loan instead of
buyers credit. By this way you can avail cheap LIBOR rate funds and your
supplier would also not mind as he is getting funds at sight.
107

SUPPLIERS CREDIT
Benefits:
• Availability of cheaper funds for import of raw materials and
capital goods
• Ease short-term fund pressure as able to get credit
• Ability to negotiate better price with suppliers
• Able to meet the Suppliers requirement of payment at sight
• Realize at-sight payment
• Avoid the risk of importer’s credit by making settlement with L/C
108

BUYERS CREDIT
It is short term credit availed to an importer (buyer) from overseas lenders
such as banks and other financial institution for goods they are importing.
The overseas banks usually lend the importer (buyer) based on the letter of
comfort (a Bank Guarantee) issued by the importer's bank. For this service
the importer's bank or buyer's credit consultant charges a fee called an
arrangement fees.
Features
• Suppliers would ask for sight payment where as you want credit on the
transaction.
• At times, in capital goods, banks would insist on using term loan instead of
buyers credit. By this way you can avail cheap LIBOR rate funds and your
supplier would also not mind as he is getting funds at sight.
109

BUYERS CREDIT
Features
• Facilitates exports from little and medium sized Indian corporations by
providing Buyers Credit to overseas purchaser to import product from India.
• Can even be offered for finance capital product or services on credit terms.
• Provides non-recourse finance to Indian Exporter by changing the
postponed credit contract into money contract.
• Can even be extended by process of advance payments to Indian Exporters
on behalf of the overseas purchaser.
• Can be a group action specific finance or a revolving/renewable limit.
• Can be extended to quite one overseas subsidiaries of any Indian company.
• Non-LC transactions resulting in saving of LC charges 110

BUYERS CREDIT
Benefits
• The exporter gets paid on due date; whereas importer gets extended date for
creating an import payment as per the money flows.
• The importer will alter exporter on sight basis, negotiate a more robust
discount and use the consumer credit route to avail funding.
• The funding currency will be in any FCY (INR, USD, GBP, EURO, JPY
etc.) counting on the selection of the client.
• The importer will use this funding for any style of trade viz. open account,
collections, or LCs.
• The currency of imports will be completely different from the funding
currency and Buyers Credit, which allows importers to require a favorable
read of a specific currency. 111

Factoring
• Factoring is defined as a method of managing book debt, in which a business
receives advances against the accounts receivables, from a bank or financial
institution (called as a factor).
• There are three parties to factoring i.e. debtor (the buyer of goods), the client
(seller of goods) and the factor (financier). Factoring can be recourse or non-
recourse, disclosed or undisclosed.
• In a factoring arrangement, first of all, the borrower sells trade receivables to the
factor and receives an advance against it.
• The advance provided to the borrower is the remaining amount, i.e. a certain
percentage of the receivable is deducted as the margin or reserve, the factor’s
commission is retained by him and interest on the advance.
• After that, the borrower forwards collections from the debtor to the factor to settle
down the advances received.
112

Forfaiting
• Forfaiting is a mechanism, in which an exporter surrenders his rights to receive
payment against the goods delivered or services rendered to the importer, in
exchange for the instant cash payment from a forfaiter.
• In this way, an exporter can easily turn a credit sale into cash sale, without
recourse to him or his forfaiter.
• The forfaiter is a financial intermediary that provides assistance in international
trade.
• It is evidenced by negotiable instruments i.e. bills of exchange and promissory
notes.
• It is a financial transaction, helps to finance contracts of medium to long term for
the sale of receivables on capital goods.
• However, at present forfaiting involves receivables of short maturities and large
amounts. 114

Offshoring
• Definition: Offshoring is the process of relocating the business operations unit
(production or services) to a different country (usually in developing nations)
where cheap labor or resources are available.
• Here the company do not seek global retailing; instead, it looks forward to
minimizing the cost of manufacturing and other supporting services.
• Setting up this new business unit for other activities is quite beneficial for the
company since it can now pay more attention to its core business operations.
• Even the tax rate policies and other incentives benefit the organization to a great
extent.
117

Benefits of Offshoring
• Concentrate on Core Business: When the company offshore its other services, it can lay more focus on
its core functions.
• Cost Reduction: The most crucial reason or benefit of offshoring is to cut down labour cost and other
operating expenses.
• Cheap and Skilled Workforce: It is an opportunity to get competent and cost-efficient labour available in
a developing nation.
• Complete Assistance: The offshore team holds expertise in its field, providing a relevant solution to every
problem related to the production or services offshored.
• Better Control: The company can ensure proper management and regulation of all its operations if it opts
for offshoring.
• Streamlines Process: It assures that a dedicated team is working on the offshored production or services
to complete the assignment efficiently and effectively.
• 24/7 Operations: Its another advantage is that the company can continue a 24/7 service (such as customer
support) which is otherwise not possible in the domestic business unit.
• Tax and Other Benefits: Many developing countries provide various types of incentives like tax holidays,
to attract companies for foreign direct investment.
• Risk Mitigation: When the business operations are offshored to multiple countries, the company has a
lower risk of failure or bankruptcy. 118

Types of Offshoring
Production Offshoring
• When a company establishes its
manufacturing unit in a different
country, to import the finished
goods for selling it in the domestic
market, it is termed as production
offshoring.
• For instance; a company
manufacturing heavy machinery
would set up its production unit in a
country where it has an optimum
supply of iron, and the local labour
is cheap and skilled in such a task.
Services Offshoring
• A company performs service
offshoring by setting up the units in
other countries to carry out service-
related operations such as customer
care, information technology,
marketing, human resource,
accounting, sales and many more.
• For instance; a software company
relocates its research and
development unit in a country
where the technical human
resources are highly competent and
comparatively cheaper than the
domestic personnel.
119

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