UNIT-1

INTERNATIONAL FINANCE

1) Foreign Exchange Risk: When different national currencies are exchanged for each other,
there is a definite risk of volatility in foreign exchange rates. The present International Monetary
System set up is characterized by a mix of floating and managed exchange rate policies adopted
by each nation keeping in view its interests.

2) Political Risk: Another risk that firms may encounter in international finance is political
risk. Political risk ranges from the risk of loss (or gain) from unforeseen government actions or
other events of a political character such as acts of terrorism to outright expropriation of assets
held by foreigners.

3) Expanded Opportunity Sets: When firms go global, they also tend to benefit from
expanded opportunities which are available now.

4) Market Imperfections: The final feature of international finance that distinguishes it from
domestic finance is that world markets today are highly imperfect. There are profound
differences among nations, laws, tax systems, business practices and general cultural
environments.

SCOPE OF INTERNATIONAL FINANCE

1) Foreign Exchange Market : The foreign exchange market is the place where money
denominated in one currency is cought and sold with money denominated in another currency.

2) 1 Currency Convertibility: The discussion of the foreign exchange market was based on
the assumption that the currencies of various countries are freely convertible into other
currencies.

A countrys currency is said to be freely convertible when the countrys government allows
both residents and non-residents to purchase unlimited amounts of foreign currencies with the
local currency.
3) International Monetary System: Monetary system facilitates trade and investment. India
has its own monetary policy that is administered by the Reserve Bank of India. Primarily, RBI
aims at controlling inflation and money supply and maintaining an interest rate regime that is
helpful to economic growth.

4) Balance of Payments: Balance of Payments (BOP) is a statistical statement that

systematically summarizes, for a specified period of time, the monetary transactions of an
economy with the rest of the world.

5) International Financial System: The international financial system consists of the

numerous rules, customs, instruments, facilities, markets, and organizations that enable
international payments to be made and funds to flow across borders.

EVOLUTION OF INTERNATIONAL MONETARY SYSTEM

Gold Standard (1876-1913) : In the early days, gold was used as storage of wealth and as a
medium of exchange. The gold standard, as an international monetary system, gained acceptance
in Western Europe in the 1870s and existed as a historical reality during the period 1875-1914.
The majority of countries got off poldin 1914 when World War I broke out. The classical gold
standard thus lasted for approximately 40 years The centre The international financial system
during this period was London reflecting its important position in international business and
trade.

1) Price-Specie-Flow Mechanism: The gold standard functioned to maintain equilibrium

through the so-called price-specie-flow mechanism When a countrys currency inflated too
fast, the currency lost competitiveness in the world market. The deteriorating trade balance due
to imports being greater than exports led to a decline in the confidence of the currency.

As the countrys exports exceeded its imports, the demand for its currency pushed the value
toward the gold import point. By gaining gold, the country increased its gold reserves, enabling
the country to expand its money supply. The increase in money supply forced interest rates to go
lower, while heating up the economy. More employment, increased income and subsequently,
increased inflation followed.
2) Decline of the Gold Standard : Another rule is that the flow of gold between countries
cannot be restricted. The last rule requires the issuance of notes in some fixed relationship to a
countrys gold holdings. Such rules, however, require the nations willingness to place balance of
payments and foreign exchange considerations above domestic policy goals and this assumption
is, at best, unrealistic.

FEATURES OF GOLD STRANDARD :

Following are the features of gold standard:

1) Monetary unit is defined in terms of gold. For example, before World War I, sovereign was
the standard coin in the U.K. Its weight was 123. 17447 grains with 11/12 purity.

2) Other forms of money (e.g. token coins and paper money) are also in circulation. But they
are convertible into gold.

3) Coinage is unlimited and free of cost.

4) There is free and unlimited melting of gold coins.

5) The government buys and sells gold at fixed prices and thereby maintains parity between the
face value and intrinsic value of the standard coin.

6) There is free import and export and export of gold.

7) Gold is unlimited legal tender for all types of payments. All values are expressed in terms of
gold

INTER WAR YEARS (1914-1944) : The gold standard as an international monetary system,
worked well untill World War I interrupted trade flows and disturbed the stability if exchange
rates for currencies of major countries. There was widespread fluctuation in currencies in terms
of gold during World War I and in the early 1920s. The role of Great Britain as the worlds major
creditor nation also came to an end after World War I. The United States began to assume the
role of the leading creditor nation.
As countries began to recover from the war and stabilize their economies, they made several
attempts to return to the gold standard.

BRETTON WOODS SYSTEM (1945-1972)

The depression of the 1930s, followed by another war, had vastly diminished commercial trade,
the international exchange of currencies and cross-border lending and borrowing. Revival of the
system was necessary and the reconstruction of the post-war financial system began with the
Bretton Woods Agreement that emerged from the International Monetary and Financial
Conference of the united and associated nations in July 1944 at Bretton Woods, New
Hampshire.

FEATURES OF BRETTON WOODS SYSTEM

1) US Dollar-based System: The Bretton Woods system was a gold-based system which
treated all countries symmetrically, and the IMF was charged with the responsibility to manage
this system. By contrast, all other countries had the obligation to intervene in the currency
market to fix their exchange rates against the US dollar.)

2) Adjustable Peg System: This means that exchange rates were normally fixed but permitted
to be adjusted infrequently under certain conditions. As a consequence, exchange rates were
supposed to move in a stepwise fashion

3) Capital Control : Capital control was tight. This was a big difference from the Classical
Gold Standard of 1879-1914, when there was free capital mobility. Although the US and
Germany had relatively less capital account regulations, other countries imposed severe
exchange controls.

4) Macroeconomic Performance : Macroeconomic performance was good. In particular, global

price stability and high growth were simultaneously achieved under deepening trade
liberalization. In particular, stability in tradable prices (wholesale prices or WPI) from the mid
1950s to the late 1960s was almost perfect and globally common. This macroeconomic
achievement was historically unprecedented.
ADVANTAGES OF BRETTON WOODS SYSTEM

The advantages of Bretton Woods system of exchange rate are as follows:

1) Economizes on scarce resources (gold) by allowing foreign reserves ($s) to be used for IMS
payments. Easier to transfer dollars versus shipping gold overseas under pure gold standard.

2) By holding $ instead of gold as reserves, foreign central banks can earn interest versus non-
interest bearing gold.

3) Ex-rate stability reduced currency risk, provided a stable IMS and facilitated international
trade and investment, led to strong economic growth around the world in 50s and 60s.

DISADVANTAGES OF BRETTON WOODS SYSTEM

In long-run, Bretton Woods (gold-exchange system) was unstable. There was no way to:

1) Devalue the reserve currency ($) even when it was over-valued, or

2) Force a country' to revise its ex-rate upward. A country could agree or be pressured into
devaluation, but there was no way to revalue a currency upward (appreciate through
concretionary' policy.

EXCHANGE RATE REGIMES

The exchange rate regime is the way a country manages its currency in respect to foreign
currencies and the foreign exchange market. It is closely related to monetary policy and the two
are generally dependent on many of the same factors.

Different Exchange Rate Regimes

Fixed Exchange Rate System

Floating Exchange Rate System

The fluctuating exchange rate regime, which is also referred to as the floating / flexible exchange
rate regime is one of several kinds or regime in which the value of a currency can fluctuates
according to movement of the foreign exchange market.

ADVANTAGES OF FLEXIBLE EXCHANGE RATE SYSTEMS

The advantages of flexible exchange rate are as follows:

1) Shock Absorption: A flexible rate acts as an absorber of shocks originating from other
countries. To a certain extent, it provides an automatic adjustment and insulation against foreign
disturbances.

2) Effectiveness of Monetary and Fiscal Policies: It increases effectiveness of monetary

policy for domestic stability which can be achieved with less forceful monetary and fiscal
measures.

3) BOP Adjustment: It helps in restoring balance of payments equilibrium.

4) Foreign Exchange Reserves: If the rate responds to market forces within limits, the
authorities need not intervene at all. And even if they do, they shall need comparatively less of
foreign exchange reserves to act as a buffer since such forces are usually self-regulatory.

5) No Need for International Management of Exchange Rate: Unlike fixed exchange rate
based on a metallic standard, floating exchange rates do not require an international manager
such as International Monetary Fund to look over current account imbalances. Under the floating
system, if a country has large current account deficits, its currency depreciates.

6) No Need for Frequent Central Bank Intervention: Central banks frequently must
intervene in foreign exchange markets under the fixed exchange rate regime to protect the gold
parity, but such is not the case under the floating regime. Here there is no parity to uphold.

7) No Need for Elaborate Capital Flow Restrictions: It is difficult to keep the parity intact in
a fixed exchange rate regime while portfolio flows are moving in and out of the country. In a
floating exchange rate regime, the macroeconomic fundamentals of countries affect the exchange
rate in international markets, which, in turn, affect portfolio flows between countries. Therefore,
floating exchange rate regimes enhance market efficiency.

8) Greater Insulation from Other Countries Economic Problems: Under a fixed exchange
rate regime, countries export their macroeconomic problems to other countries. Suppose that the
inflation rate in the U.S. is rising relative to that of the Euro-zone.

DISADVANTAGES OF FLEXIBLE EXCHANGE RATE SYSTEMS

1) Risk to the Economy: Exchange rate determined by free operation of market forces carries
several risks for the economy. If it fluctuates violently over a wide range, it can cause severe
economic disruption in the domestic economy.

2) Business Risk: In international transactions, each contract is denominated in a single

currency which is a foreign currency to at least one of the transacting parties.

3) Money Supply: In most countries, supply of 'high-powered money' (H) varies in direct
proportion to changes in foreign exchange reserves of monetary authorities; each variation in H
results in a multi fold variation in the supply of total money and credit.

4) Higher Volatility: Floating exchange rates are highly volatile. Additionally, macroeconomic
fundamentals cannot explain especially short-run volatility in floating exchange rates.

5) Use of Scarce Resources to Predict Exchange Rates: Higher volatility in exchange rates
increases the exchange rate risk that financial market participants face. Therefore, they allocate
substantial resources to predict the changes in the exchange rate, in an effort to manage their
exposure to exchange rate risk.

6) Tendency to Worsen Existing Problems: Floating exchange rates may aggravate existing
problems in the economy. If the country is already experiencing economic problems such as
higher inflation or unemployment, floating exchange rates may make the situation worse.

CURRENCY BOARD
A currency board is a monetary authority that issues notes and coins convertible into a foreign
anchor currency at a fixed exchange rate.

FEATURES OF CURRENCY BOARDS

1) The first and foremost condition that has to be met by a national currency board is that the
reserves foreign currency which it holds should be enough to convert all notes and coins held by
them into atleast 110% to 115% of the base value.

2) The board has an absolute control over the convertibility foreign currency in coins and notes
at a fixed exchange rate in relation to the domestic rates, and there may be no restriction in the
case of current or capital account transactions.

3) The board can earn profit through interest only from foreign currency held by it.

4) The currency board does not have any discretionary power and it cannot lend any money to
the government. Likewise, the government cannot print extra money for its expenses and has to
acquire this through taxes or borrowing. '

5) The board cannot lend money to commercial banks.

6) Finally, the currency board cannot manipulate interest rates by applying discounts to certain
banks. The pegging system is what controls the rates and keeps them closely aligned with the
countries concerned.

DISADVANTAGES OF CURRENCY BOARDS

Following are the disadvantages of currency boards:

1) Real Appreciation: When the inflation rates after fixing the exchange rate under a currency
board do not converge quickly and completely to the inflation rates of the anchor currency, the
country experiences a real appreciation, which induces a loss of competitiveness. This problem
occurs when the currency board is not completely credible (i.e., when the private sector assumes
that it is repealed with a certain probability) or when the tax system is inefficient.
2) Procyclical Money Supply: A problem which is likely to appear under a currency board is
that the money supply behaves procyclical. In good times, money flows in and the interest rate
falls, this leads to more private consumption and investments and may contribute to an
overheating of the economy. In bad times, the opposite is true. Money flows-out, interest rates
rise and private demand is crowded-out, which makes recession more severe.

3) Start-Up Problem: Another problem is the start-up problem, i.e., how to solve the question
where the foreign reserves come from to issue the own currency and fulfill the 100% reserve-
backing criterion.

4) Seigniorage Problem: The last problem is the seigniorage problem. The currency boards
100% backing-rule requires that the monetary base is completely backed by liquid reserve-
currency assets. The revenues of these assets are usually lower compared to that of a common
central bank, which also holds higher interest-bearing domestic assets and government bonds as
reserves. ^

REASONS FOR FOREIGN EXCHANGE MARKET

INTERVENTION

There are four broad based reasons why central banks intervene in the foreign exchange market:

1) Misalignment: Central banks intervene in the foreign exchange market to influence the level
of exchange rate. Usually, central banks believe that the market is driving the exchange rate away
from its equilibrium value and intervenes to break the momentum.

2) Calming a Disorderly Market: Central banks intervene to calm the market and so it from
becoming disorderly. Rapid movement in the exchange rate may at times threaten the orderly
functioning of the market, leading to a widening of spreads and at times loss of liquidity. This
action serves to discourage the market from becoming one-sided.

3) Signaling/Accommodating Monetary Policy: Intervention may be used to signal future

changes to monetary policy or possibly calm expectations if monetary policy is changed
unexpectedly, which might otherwise lead to a loss in confidence and thereby induce an
unwarranted move in the exchange rate.

4) Reserve Building: Central banks intervene to maintain an inventory of net foreign currency
assets,

TYPES OF FOREIGN EXCHANGE MARKET INTERVENTION

There are foreign exchange market interventions which are as follows:

1) Sterilized Intervention

2) Unsterilized Intervention

STERILIZED INTERVENTION

It is a method used by monetary authorities to equalize the effects of foreign exchange

transactions on the domestic monetary base by offsetting the purchase or sale of domestic assets
within the domestic markets. This process limits the amount of domestic currency available for
foreign exchange. In other words, sterilized intervention is a way for a country to alter its debt
composition without affecting its monetary base.

In the case of heavy inflow of foreign currency resulting in build-up of foreign exchange
reserves and the increase in money supply the Central Bank sterilizes the impact through
pursuing tight monetary policies.

These can take form of:

1) Open market sale of government securities;

2) Increase in the policy rate, i.e., bank rate, repo/reverse repo rate; and

3) Impounding of bank reserves through increase in CRR.

On the other hand, impact of heavy outflow of foreign currency resulting in sharp depletion
foreign exchange reserves and consequently sharp reduction in money supply is sterilized
through pursuing easy monetary policy. This can take the form of:
1) Open market purchase of government securities;

2) Reduction in the policy rate, i.e., bank rate, repo/reverse repo rate; and

3) Releasing of bank reserves through reduction in CRR.

UNSTERILIZED INTERVENTION : Unsterilized intervention is an attempt by a countrys

monetary authorities to influence exchange rates and its money supply by not buying or selling
domestic or foreign currencies or assets. This is a passive approach to exchange rate fluctuation,
and allows for fluctuations in the monetary base.

MEANING OF EURO CURRENCY MARKET

The Eurocurrency market consists of banks (called Eurobanks) that accept deposits and make
loans in foreign currencies. A Eurocurrency is a freely convertible currency deposited in a bank
located in a country which is not the native country of the currency. The deposit can be placed in
a foreign bank or in the foreign branch of a domestic US bank.

FEATURES OF EURO CURRENCY MARKET

1) Coins and Banknotes: All euro coins have a common side and a national side chosen by
the respective national authorities. The euro is divided into 100 cents.

2) Payments Clearing, Electronic Funds Transfer: All intra-EU transfers in euro are
considered as domestic payments and bear the corresponding domestic transfer costs.

3) Currency Sign: A special euro currency sign () was designed after a public survey had
narrowed the original ten proposals down to two. The European Commission then chose the
design created by the Belgian Alain BilIiet. The European Commission also specified a euro logo
with exact proportions and foreground/background color tones.

4) Regulatory Authorities: Eurocurrencies are outside the direct control of the regulatory'
authorities but still they are subject to indirect controls by authorities since all the settlements in
the currency have to take place in the country of issue.
5) (Provide Free Access to New Entrants: Eurocurrency markets are highly sophisticated and
provide free access to new entrants. This resulted in competition of the highest order and the
players in the market operate on very thin margins.

6) Floating Interest Rate: Another interesting feature of Eurocurrencies markets is the

floating interest rate concept.

ADVANTAGES OF EURO CURRENCY MARKET

Following are the benefits of euro currency market:

1) It has provided global short-term capital market, owing to a high degree of mobility of the
Euro-dollars.

2) Euro-dollars are useful for the financing of foreign trade.

3) It has enabled the financial institutions to have greater elasticity in adjusting their cash and
liquidity positions.

4) It has enabled importers and exporters to obtain credit for financing trade at cheaper charge
than otherwise available.

5) It has helped in plummet the profit margins between (deposit rates and lending rates.

6) It has promoted international monetary cooperation.

7) It is a major source of short-term loans to finance corporate working capital needs and
foreign trade.

8) Euro-currency markets are becoming a major source of long-term investment capital for
MNCs.

INTERNATIONAL MONEY MARKET

MEANING OF INTERNATIONAL MONEY MARKET

The international money market is the market that handles the international currency transactions
between the various central banks of the nations. In the international money market, the
transactions are carried-out mainly in gold or in U.S. dollar. The international money market is
governed by the international monetary transactions between various nations currency. The
international money market mainly handles the currency trading between the countries. The
trading of one countrys currency for another one is also named as the foreign exchange currency
trading or for ex trading.

INTERNATIONAL MONEY MARKET INSTRUMENTS

1) Eurocurrency: The emergence of the Eurocurrency markets was one of the most important
developments in post-war international banking. Originally serving as a source of short-term
funds for trade financing, the markets expanded to facilitate banks foreign exchange transactions
and to provide money market trading facilities.

2) Euro Credits: The term Eurocredit refers to loans in a currency that is not the lending
banks national currency.

3) Euro Certificate of Deposit: Certificate of deposit is a certificate issued by a bank

evidencing receipt of money and carries the banks guarantee for the repayment of principal and
interest.

4) Euro Commercial Papers: Commercial paper is a short term unsecured promissory note
that is generally " sold by large corporations on discount basis to institutional investors and other
corporates for maturities ranging from 7 to 365 days.

5) Euronotes: Euro Notes are the notes of the euro, the currency of the euro zone. They have
been in '"circulation since 2002 and are issued by the European Central Bank (ECB), each
bearing the signature of the President of the European Central Bank.

6) Floating Rate Notes: The floating-rate note is, as the name implies, an instrument whose
interest rate floats with prevailing market rates.

7) Bankers Acceptances: This is an instrument widely used in the US money market to

finance domestic as well as international trade.
TYPES OF INTERNATIONAL CAPITAL MARKET

International Bond Markets

International Equity Markets

International Bond Markets

Types of International Bond Market

Following are the types of international bond market:

1) Foreign Bond Market: The foreign bond market is that in which bonds are brought-out by
foreign borrowers. The foreign bonds are normally designated in the local currency. The local
market authorities look after the issuing and selling of foreign bonds.

2) Eurobond Market: Euro bonds constitute a major source of borrowing in the Eurocurrency
market, bond is a debt security' issued by the borrower, which is purchased by the investor and it
involves in the process some intermediaries like underwriters merchant bankers etc. The bonds
are issued on behalf governments, big multinational corporations, etc.

INTERNATIONAL DEBT SOURCES

The international debt sources are as follows:

1) International Bank Loans: International bank loans have traditionally been sourced in the
Eurocurreni markets. Eurodollar bank loans are also called Eurodollar credits or simply
Eurocredits.

There are two components of international bank loans:

i) Eurocredits: Eurocredits are bank loans to MNEs, sovereign governments, international

institution and banks denominated in Eurocurrencies and extended by banks in countries other
than the country i whose currency the loan is denominated.

ii) Syndicated Credits: The syndication of loans has enabled banks to spread the risk of very
large loan among a number of banks. Syndication is particularly important because many large
MNEs need credit in excess of a single banks loan limit. A syndicated bank credit is arranged by
a lead bank on behalf c its client.

2) Euro Notes Market: The Euro note market is the collective term used to describe short to
medium-tern debt instruments sourced in the Eurocurrency markets. The euro note market has
four main components:

i) Euro Notes: Euro notes are like promissory notes issued by companies for obtaining short-
term funds They are denominated in any currency other than the currency of the country where
they are issued They represent low-cost funding route.

ii) Euro Note Facilities: A major development in international money markets was the
establishment of facilities for sales of short-term, negotiable, promissory notes-Euronotes.

iii) Euro Commercial Papers: It is an another attractive form of short-term debt instrument. It
is a

promissory note like the short-term Euro notes although it is different from Euro notes in some
ways. It is not underwritten, while the Euro notes are underwritten.

iv) Medium-Term Euro Notes: Medium-term Euro notes are just an extension of short-term
Euro notes as they fill the gap existing in the maturity structure of international financial market
instruments.

3) Euro Bonds: Following are the important kinds of bonds which are being issued to
mobilize debt internationally:

i) Straight Euro Bond: These bonds have fixed maturities and carry a fixed rate of interest
Straight Eurobond are repaid by amortization or in a lump sum at the maturity date.

ii) Convertible Euro-Bond: These bonds are convertible into parent common stock and have
become increasingly popular because the market for straight Euro-bonds has weakened.
iii) Bond with Warrants: Some Euro-bonds are issued with warrants. A warrant is an option to
buy a Stated number of common shares at a stated price during a prescribed period. Warrants pay
no

dividends, have no voting rights, and become worthless at expiration unless the price of the
common stock exceeds the exercise price.

iv) Currency Option Bonds/Multiple Currency-Bonds: Currency option bond allows the
bondholder receive the interest payment and the principle in any of the currencies specified in
the bond.

v) Currency Cocktail or Currency Basket Bonds: Currency basket bonds have been
developed to stabilize the purchasing power of the coupon. This is accomplished by combining
various currencies as per some weighting process. The amount of each currency in basket
generally remains constant but the value of the basket changes, as some of the currencies
depreciate or appreciate relative to each other.

vi) Yankee Bonds: Yankee bonds are a dollar bond issued in U.S. by non-U.S.
borrowers/companies. It may be any of the above kinds.

vii) Samurai Bonds: Samurai Bond is a yen denominated bond issued in Japan by non-Japanese
companies. This bond can also be of any of the above kinds.

viii) Floating Rate Bonds: These bonds are frequently called Floating-Rate Notes. The rate of
return on these notes is adjusted at regular intervals, usually every six months, to reflect changes
in short-term market rates.

ix) Stripped Bonds: These bonds are bearer form bonds, easy to sell. U.S. government first
issued these for foreign investors. Treasury' regulations permit U.S. corporations to sell bearer
bonds to foreign residents.

INTERNATIONAL EQUITY MARKET

Global equity market is the worldwide markets of funds for equity financing the stock exchanges
throughout the world where investors and firm meets to buy and sell shares of stocks.

TYPES OF INTERNATIONAL EQUITY/STOCK MARKET

1) Euro Currency Market: The term Eurocurrency describes deposits of currency, which are
owned by non-residents of the country, whose legal tender the currency is and which are lent by
the owners.

2) Euro Credit Market: Euro credit market is the market where financial banking institutions
provide banking services denominated in foreign currencies. They may accept deposits and
provide loans. Loans provided in this market are medium-term loans, unlike loans made in the
Eurocurrency market.

International Equity Sources

1) American Depository Receipts (ADRs): An American Depositary Receipt (or ADR)

represents ownership in the shares of a non-U.S. company and trades in U.S. financial markets.
The stock of many non-U.S. companies trade on U.S. stock exchanges through the use of ADRs.

2) Global Depository Receipt (GDRs): Global Depository Receipt (GDR) - certificate issued
by international bank. Global Depository Receipt is a bank certificate given in more than one
country for shares in a foreign company. It is a financial instrument used by private markets to
increase capital denominated in either U.S. dollars or Euros.

3) Foreign Currency Convertible Bond (FCCB): Foreign Currency Convertible Bond is just
a convertible bond that is issued in foreign currency. FCCB is a quasi-debt instrument that is
issued in a currency different than the issuers domestic currency with options to either redeem it
at maturity or convert it into issuing companys stock. It gives two options. One is, to get the
regular interest and principal and the other is to convert the bond in to equities. It is a hybrid
between bond and stock.

FUNCTIONS / ROLE OF INTERNATIONAL MONETARY FUND

1) Regulatory Functions: In its regulatory aspect, the IMF administers a code of good
behavior in international payments. It regulates exchange rate practices and international
payments.

2) Financial Functions: As a financial institution, the IMF offers medium - term loans to the
national monetary authorities to enable them to make up their balance of payment deficits.

3) Consultative Functions : As a consultant, the IMF provides a forum for international

cooperation and is a cource of counsel and technical assistance to its members

ADVANTAGES OF INTERNATIONAL MONETARY FUND

1) Establishment of a Monetary Reserve Fund: Under this system, the fund is able to
accumulate a sizeable "stock of the national currencies of different countries.

2) Scaling up a Multilateral Trade and Payments System: The establishment of the fund has
given stimulus to the setting up of a multilateral trade and payments system.-No doubt, the
member countries have been allowed to impose exchange control on commercial transactions.

3) Improvement is Short Term Disequilibrium in Balance of Payments: By lending foreign

currencies to member countries against their national currency, the fund helps them to eliminate
short term disequilibrium in their balance of payments.

4) Stability of Foreign Exchange Rates: Till recently the fund had succeeded in attaining a
certain amount of lability in foreign exchange rates. The rate of exchange under the I.M.F. has
not circulated as much as they used to before its establishment. This stability in foreign exchange
rates had the effect of promoting the flow of international trade among different countries.

5) Check in Competitive Currency Devaluation: Before the establishment of the fund,

different countries of the world often resorted to competitive currency devaluation to boost their
exports which naturally produced strains in their economic and political relationship. But after
the existence of the IMF no member country has allowed to devalue its currency without the
prior consent of the fund except under certain special circumstances.
6) No Interference in Domestic Economic Affairs: The fund does not interfere in the internal
economic affairs of member countries nor does it try to influence their economic and monetary
policies in any way.

DISADVANTAGES OF INTERNATIONAL MONETARY FUND

1) No Solution of the Liquidity Problem: One of the main objectives of the fund was to
promote the international liquidity of its members by lending to them the required foreign
currencies out of its stock. But, in actual practice, the fund found it difficult to meet the foreign
exchange requirements of its members because of its limited resources.

2) No Elimination of Multiple Exchange Rates: The elimination of these exchange rates was
one of the main objectives of the fond. But the fond has miserably failed to achieve this
objective.

3) Discriminatory Treatment: Another shortcoming is that the fund discriminates in favor of

certain countries in its day-to-day functioning. It gives special concessions to western countries
while neglecting the genuine interests of the backward and under developed countries.

IMF FINANCIAL FACILITIES AND POLICIES

1) Regular Lending Facilities: Regular facilities for IMF lending differ significantly from
concessional facilities. Interest rates, fees, and other terms associated with the concessional
facilities are significantly lower or easier to meet than the terms of regular facilities.

2) Special Leading Facilities and Policies: Supplemental Reserve Facility (SRF) was
introduced in 1997 to supplement resources made available under Stand-By and Extended
Arrangements in order to provide financial assistance for exceptional balance of payments
difficulties owing to a large short-term financing need resulting from a sudden and disruptive
loss of market confidence, such as occurred in the Mexican and Asian financial crises in the
1990s).
BANK FOR INTERNATIONAL SETTLEMENT

Banks for international settlement (BIS) is an international organization fostering the cooperation
of central banks and international monetary policy - markets. It was established 17 May 1930. It
is the oldest international financial organization, and was created to administer the transaction of
money according to the Treaty of Versailles. Among others, its main goals are to promote
information sharing and to be a key center for economic research.

The BIS fulfils this mandate by acting as:

1) A forum to promote discussion and policy analysis among central banks and within the
international financeial community.

2) A center for economic and monetary research

3) A prime counter party for central banks in their financial transactions; and

4) Agent or trustee in connection with international financial operations.

OBJECTIVES OF BANK FOR INTERNATIONAL SETTLEMENT

1) To act as trustee or agent in regard to international financial settlements, particularly in

regard to German reparations under the so-called Young Plan adopted at the 1930 Hague
conference.

2) To promote central bank cooperation.

3) To provide additional facilities for international financial operations.

FUNCTIONS AND POWERS OF BIS

The Statutes state that the objects of the Bank are to promote the cooperation of central banks
and to provide additional facilities for international financial operations; and to act as trustee or
agent in regard to international financial settlements entrusted to it under agreements with the
parties concerned.
General Meetings of Member Central Banks : The BIS currently has 56 member central
banks, all of which are entitled to be represented, and vote in the General Meetings.

Board of Directors : The Board of Directors has at present 18 members (January 2011). The
Board has six ex officio directors, comprising the Governors of the Central Banks of Belgium,
Finance, Germany, Italy and the United Kingdom, and the Chairman of the Board of Governors
of the U.S Federal Reserve System. Each ex.officie members may appoint another member of the
same nationality.

The Board of Directors elects a Chairman from among its members fora three-year term. The
board alsoelects a Vice Chairman.

INTERNATIONAL BANKING

MEANING & DEFINITION OF INTERNATIONAL BANKING

International banking means opening of banks outside country of origin. It is a mechanism by

which one can maintain bank accounts outside their country of residence.

FEATURES OF INTERNATIONAL BANKING

1) Banking Activities are Carried across Different Geographical Borders: When branches
and subsidiaries are carrying-out operations in different countries, then question is to which
supervisory authority will have jurisdiction over these arise.

2) Risks in International Banking are both Pecuniary as well as Political: Apart from the
financial risks v inherent in all business, fluctuating rates of currencies of different countries can
also pose problems giving rise to the need for hedging and other measures.

3) Non-Interest Income is Substantially more than Interest Income: Income from fund
based activities like commission on bills, guarantees, letters of credit, syndication fees, loan
processing, and counseling fees, etc., are more than the interest earned from lending operations.

Factors Leading to the Growth of International Banks

The following are the reasons for the growth of international banking:

1) Low Marginal Costs: Managerial and marketing knowledge developed at home can be
used abroad with low marginal costs.

2) Knowledge Advantage: The foreign bank subsidiary can draw on the parent banks
knowledge of personal contacts and credit investigations for use in that foreign market.

3) Home Nation Information Services: Local firms in a foreign market may be able to obtain
more complete information on trade and financial markets in the multinational banks home
nation than is otherwise obtainable from foreign domestic banks.

4) Prestige : Very large multinational banks have high perceived prestige, liuidity, and deposit
safety that can be used to attract clients abroad.

5) Regulation Advantage : Multinational banks are often not subject to the same regulations
as demestic banks. There may be reduced need to publish adequate finacial information, lack of
required deposit insurance and reserve requirements on foreign currency deposits, and the
absence of tessitorial restrictions (that is, U.S. banks may not be restricted to state of origin).

6) Wholesale Defensive Strategy : Banks follow their multinational customer abroad to

prevent the erosion of their clientele to foreign banks seeking to service the multiinationals
foreign subsidiaries.

7) Retail Defensive Strategy : Multnational banks prevent erosion by foreign banks of the
travels check,tourist, and foreign business market.

8) Transaction Costs : By maintaining foreign branches and foreign currency balances, banks
may reduce transction costs and foreign exchange risk on currency conversion if government
controls can be circumvented.

9) Growth : Growth prospects in a home nation may be limited by a market largely saturated
with the services offered by domestic banks.
10) Risk Reduction: Great stability of earnings is possible with international diversification.
Offsetting business and monetary policy cycles across nations reduces the country specific risk
of any one nation.

EURO BANK

A Euro Bank is defined as a financial intermediary that simultaneously bids for time deposits
and makes loans in a currency or currencies, other than that of the country in which it is located.
It accepts Euro currency deposits and gives Euro currency loans. A Euro Banks balance sheet
consists of deposits and loans in other currencies. A Bank in Singapore, accepting deposits of
Euros by a British Company is called a Euro Bank. Thus, Euro Bank refers to a function rather
than an institution,

Euro Banks are international banks with the minimum of host government interference any
dealing in any convertible currency other than currency of the host country.

These Banks deal with both the residents and the non-residents but dealings are essentially in any
currency other than the currency of the host country.

However, in the late 1950s and especially in the early 1960s, banks with pUrely international
character emerged on the global financial scene. This new variety of banks came to be known as
Euro banks. The Euro banks emerged on a footing quite different from the traditionally known
international banks.

The Euro banks deal with both the residents and the non-residents, but they deal essentially in
any currency other than the currency of the host country. For example, if Euro bank is located in
London, it will deal in any currency other than the British Pound.

EURO COMMERCIAL PAPER (ECP)

It is a promissory note like the short - term Euro notes although it is different from Euro notes in
some ways. It is not underwritten, while the Euro notes are underwritten. The reason is that ECP
is issued only by those companies that possess a high degree of rating. Again, the ECP route for
raising funds is normally inverstordriven, while the Euro note is said to be borrower - driven.
FEATURES OF EURO COMMERCIAL PAPERS

Following are teh features of euro papers :

1) Euro commercial papers are unsecured as they are backed only by the general credit
standing of the siiusing companies and by the lines of credit that they might be in a
position to obtain from banks.

2) Euro commercial papers are negotable by endorsement and delivery.

3) Euro commercial papers are regarded as highly safe and liquid instrument.

4) Euro commercial papers are also known to be a simple and flexible instrument in respect

of documentation needed and the spread of maturities available.

5) Euro commercial papers are normally issued in a bearer form on dicount to face value basis.

6) Euro commercial papers are primarily issued by public utilities, bank holding companies,
insurance companies, transportation companies and finance companies.

ADVANTAGES OF EURO COMMERCIAL PAPERS

Euro commercial papers provide the following advantages :

1) Cheaper Source of Funds,

2) Simplicity in Documentation, low cost of arrangement, absence of rating requirements

3) Flexible maturity,

4) Diversification of short term funding through market that is found attractive by wide variety
of investors, Flexibility in limits determined by the issuer's cash flow requirements at any
point of time,

6) A successful Euro CP program will enhance the reputation of the issuer world wide among
the investing community.
 EURO BONDS

Eurobonds constitute a major source of borrowing in the Eurocurrency market. A bond is a debt
security issued by the borrower, which is purchased by the investor and it involves in the process
some intermediaries like underwriters merchant bankers etc. Eurobonds are bonds of
international borrowers sold in different markets simultaneously by a group of international
banks. The bonds are issued on behalf of governments, big multinational corporations, etc.

FEATURES OF EURO BONDS

Following are the features of euro bonds:

1) Euro bond issues are not subject to the costly and time-consuming registration procedure.
Disclosure requirements are also less stringent than those which apply to domestic issues.
This feature appeals to many MNCs, which often do not wish to disclose detailed and highly
sensitive information.

2) Euro bonds are issued in bearer form, which facilitates their negotiation in the secondary
market. This feature also means that the country of the ultimate owner of the bond is not a matter
of public record.

3) Euro bonds offer investors, exemption from tax-withholding provisions applicable to

domestic and foreign bonds. This feature allows US MNCs to reduce their borrowing cost by
having their offshore financing subsidiaries issue Eurodollar bonds, with payment of interest and
principal guaranteed by the parent company.

4) Euro bonds are commonly denominated in a number of currencies.

5) Euro bonds carry a convertibility clause allowing them to be converted into a specified
number of shares of common stock.

6) In euro bonds coupon payments are made yearly.

FOREIGN BONDS
Foreign bond is a bond that is issued in a domestic market by a foreign entity, in the domestic
market's currency. Foreign bonds are regulated by the domestic market authorities and are
usually given nicknames that refer to the domestic market in which they are being offered.

FEATURES OF FOREIGN BONDS

A foreign bond has following characteristics:

1) The bond is issued by a foreign entity (such as a government, municipality or corporation).

2) The bond is traded on a foreign financial market.

3) The bond is denominated in a foreign currency.

4) Issuers of foreign bonds include national governments and their sub-divisions, corporations,
and supra-national (an entity that is formed by two or more central governments through
international treaties).

5) They can be publicly issued or privately placed.

GLOBAL BONDS

It is the World Bank which issued the global bonds for the first time in 1989 and 1990. Since
1992, such bonds are being issued also by companies. These bonds are usually issued by large
multinational organizations and sovereign entities, both of which regularly carry-out large
fundraising exercises. By issuing global bonds, an issuing entity is able to attract funds from a
vast set of investors and reduce its cost of borrowing. These bonds are specifically designed to be
traded in any financial market.

FEATURES OF GLOBAL BONDS

The speciabfeatures of the global bonds are:

1) They carry high ratings.

2) They are normally large in size.

3) They are offered for simultaneous placement in different countries.

4) They are traded on "home market" basis in different regions.

BENEFITS OF GLOBAL BONDS

Following are the benefits of global bond:

1) Global Bonds Help in Diversify ing an Investment Portfolio: Investment in global bonds
helps reduce exposure to economic or political instability in a specific country and improves a
portfolio's risk profile. For example, returns to a U.S. investor who has invested in Japanese and
European bonds will not be impacted by fluctuations in the U.S. interest rates.

2) Global Bonds Improve the Rate of Return: Returns from global bonds are typically higher
than returns offered by traditional government bonds and securities.1^

RISK ASSOCIATED WITH GLOBAL BONDS

The risks associated with global bond investing are:

1) Capital gains can erode when an investor's domestic currency appreciates vis-a-vis the
currency in which the bond is issued.

2) The risk of the issuer defaulting on interest and principal payments is high due to the lack of
government data on these bonds.

High taxes are levied on profits generated through these bonds. These taxes, at times, make
global bonds unattractive.

EURO EQUITY

International equities or the Euro-equities do not represent debt, nor do they represent foreign
direct investment. They are comparatively a new instrument representing foreign portfolio equity
investment. In this case, the investor gets the dividend and not the interest as in case of debt
instruments. On the other hand, it does not have the same pattern of voting right that it does have
in the case of foreign direct investment. In fact, international equities are a compromise between
the debt and the foreign direct investment.

DOCUMENTATION OF EURO EQUITY

There are many documents used in the process of the issue of international equity. These are:

1) Prospectus: The prospectus containing detailed information about the issue and the issuer.

2) Depository Agreement: The agreement between the issuing company and the depository -
that contains, among other things, the rules followed for converting the shares into GDRs and
back.

3) Underwriting Agreement: The underwriting agreement concluded between the issuing

company and the underwriter, normally the lead manager, accompanies the issue.

4) Agreement: A copy of the agreement concluded between the custodian and the depository is
also enclosed.

5) Trust Deed: A copy of the trust deed is enclosed which provides for the duties and
responsibilities of the trustee regarding servicing of the issue.

6) Agreement with the Listing Stock Exchange: A copy of the agreement with the listing stock
exchange is annexed so that the investors are well aware of the secondary market for the issue.

(AMERICAN DEPOSITARY RECEIPTS (ADR'S)

FEATURES OF ADRS

The characteristics of ADR are as follows:

1) ADR can be listed on any American Stock Exchange.

2) A single ADR can represent more than one share, e.g., one ADR = two shares.

3) The holder of the ADRs can get them converted into shares.
4) The holder of the ADRs has no right to vote in the company.

5) The dividend on them is similar to the dividend on shares.

6) ADRs are in U.S. dollar denomination.

MECHANISM/PROCESS OF ISSUE OF ADR

Investors can purchase ADRs from broker/dealers. These broker/dealers- in turn can obtain
ADRs for their clients in one of two ways: they can purchase already-issued ADRs on a U.S.
exchange, or they can create new ADR.

To create .an ADR, a U.S.-based broker/dealer purchases shares of the issuer from question in the
issuer's home market. The U.S. broker/dealer then deposits those shares in a bank of that market.

The bank then issues ADRs representing those shares to the broker/dealer's custodian or the
broker-dealer itself, which can then apply them to the client's account.

1) Benefits to the Issuing Company:

i) An ADR programme can stimulate investor interest, enhance a company's visibility, broaden
its shareholder base, and increase liquidity

ii) ADRs can provide enhanced communications with shareholders in the United States.

iii) Features such as dividend reinvestment programmes can help ensure a continual stream of
investment into an issuer's programme.

2) Benefits to the Investors:

i) Depository Receipts are US Securities

ii) Depository Receipts are easy to Buy and Sell

iii) Depository Receipts are Liquid

iv) Depository Receipts are Global

v) Depository Receipts are Convenient to Own

vi) Depository Receipts are Cost-Effective

GLOBAL DEPOSITARY RECEIPTS (GDR'S)

It is a global finance vehicle that allows an issuer to raise capital simultaneously in two or more
markets through a global offering. GDRs may be used in either the public or private markets
inside or outside the US. They are marketed internationally, mainly to financial institutions.

FEATURES OF GDR

The characteristics of GDR are as follows:

1) GDRs can Be4isted oft any American and European Stock Exchange.

2) One GDR can represent more than one share, e.g., one GDR = two shares..

3) The bearer or holder of the GDRs can get them convened into sharesT

4) The holder of the GDRs has not right to vote in the company. However, the shareholders do
have this right.

5) The dividend on these GDRs is quite like the dividend on shares.

6) GDRs are in U.S. dollar denomination.

ADVANTAGES OF GDRS

The chief advantages of issuing GDR are the following:

1) Getting Foreign Capital: The Indian companies can get foreign capital through the
medium of GDR. It makes sufficient finance available to them. It thus increases the foreign
exchange reserve in the country. Both these factors help in the economic development.

2) More Liquidity: There is more liquidity in the GDRs as compared to the shares because
they are issued by the financially sound companies. In other words, they can be sold easily.
3) Increase in Goodwill of Company: A company that issues the GDR gains reputation in the
market. This reputation directly affects the sales of the company.

4) Lower Floating Costs: A company has to bear less expense in issuing GDR as compared to
the issuing of shares.

5) Better Share Price: A company earns more price by issuing GDR instead of issuing shares
in the domestic market because the GDR is an indicator of the good financial position of the
company.

6) Scattered Shareholders: The issue of the GDR makes it possible for the shareholders to
cross the domestic boundaries and spread far and wide. This ends the financial problem of the
company and it comes to be recognized on global basis.