INTERNATIONAL TRADE & FINANCE

UNIT-I International Trade Meaning: International trade is the exchange of capital, goods, and services across international borders or territories. In most countries, such trade represents a significant share of gross domestic product (GDP). While international trade has been present throughout much of history, its economic, social, and political importance has been on the rise in recent centuries. Industrialization, advanced transportation, globalization, multinational corporations, and outsourcing are all having a major impact on the international trade system. Increasing international trade is crucial to the continuance of globalization. Without international trade, nations would be limited to the goods and services produced within their own borders. What Is International Trade? International trade is the exchange of goods and services between countries. This type of trade gives rise to a world economy, in which prices, or supply and demand, affect and are affected by global events. Political change in Asia, for example, could result in an increase in the cost of labor, thereby increasing the manufacturing costs for an American sneaker company based in Malaysia, which would then result in an increase in the price that you have to pay to buy the tennis shoes at your local mall. A decrease in the cost of labor, on the other hand, would result in you having to pay less for your new shoes. Trading globally gives consumers and countries the opportunity to be exposed to goods and services not available in their own countries. Almost every kind of product can be found on the international market: food, clothes, spare parts, oil, jewelry, wine, stocks, currencies and water. Services are also traded: tourism, banking, consulting and transportation. A product that is sold to the global market is an export, and a product that is bought from the global market is an import. Imports and exports are accounted for in a country's current account in the balance of payments. ADVANTAGES OF INTERNATIONAL TRADE International trade allows countries to exchange good and services with the use of money as a medium of exchange. Several advantages can be identified with reference to international trade. However international trade does have its limitations as well. Discussed below are both advantages and disadvantages of international trade. Advantages Greater variety of goods available for consumption international trade brings in different varieties of a particular product from different destinations. This gives consumers a wider array of choices which will not only improve their quality of life but as a whole it will help the country grow.

 Efficient allocation and better utilization of resources since countries tend to produce goods in which they have a comparative advantage. When countries produce through comparative advantage, wasteful duplication of resources is prevented. It helps save the environment from harmful gases being leaked into the atmosphere and also provides countries with a better marketing power. Promotes efficiency in production as countries will try to adopt better methods of production to keep costs down in order to remain competitive. Countries that can produce a product at the lowest possible cost will be able to gain a larger share in the market. Therefore an incentive to produce efficiently arises. This will help standards of the product to increase and consumers will have a good quality product to consume. More employment could be generated as the market for the countries goods widens through trade. International trade helps generate more employment through the establishment of newer industries to cater to the demands of various countries. This will help countries bring down their unemployment rates.

ADVANTAGES OF INTERNATIONAL TRADE Various advantages are named for the countries entering into trade relations on an international scale such as: A country may import things which it cannot produce International trade enables a country to consume things which either cannot be produced within its borders or production may cost very high. Therefore it becomes cost cheaper to import from other countries through foreign trade. Maximum utilization of resources International trade helps a country to utilize its resources to the maximum limit. If a country does not takes up imports and exports then its resources remain unexploited. Thus it helps to eliminate the wastage of resources. Benefit to consumer Imports and exports of different countries provide opportunities to the consumer to buy and consume those goods which cannot be produced in their own country. They therefore get diversity in choices. Reduces trade fluctuations By making the size of the market large with large supplies and extensive demand international trade reduces trade fluctuations. The prices of goods tend to remain more stable. Utilization of Surplus produce International trade enables different countries to sell their surplus products to other countries and earn foreign exchange.

Fosters International trade International trade fosters peace, goodwill and mutual understanding among nations. Economic interdependence of countries often leads to close cultural relationship and thus avoid war between them. DISADVANTAGES OF INTERNATIONAL TRADE International trade does not always amount to blessings. It has certain drawbacks also such as: Import of harmful goods Foreign trade may lead to import of harmful goods like cigarettes, drugs etc. Which may run the health of the residents of the country? E.g. the people of China suffered greatly through opium imports. It may exhaust resources International trade leads to intensive cultivation of land. Thus it has the operations of law of diminishing returns in agricultural countries. It also makes a nation poor by giving too much burden over the resources. Over Specialization Over Specialization may be disastrous for a country. A substitute may appear and ruin the economic lives of millions. Danger of Starvation A country might depend for her food mainly on foreign countries. In times of war there is a serious danger of starvation for such countries. One country may gain at the expensive of another One of the serious drawbacks of foreign trade is that one country may gain at the expense of other due to certain accidental advantages. The Industrial revolution is great Britain ruined Indian handicrafts during the nineteenth century. It may lead to war Foreign trade may lead to war different countries compete with each other in finding out new markets and sources of raw material for their industries and frequently come into clash. This was one of the causes of first and Second World War.

Foreign Trade & Economic Growth:

The issues of international trade and economic growth have gained substantial importance with the introduction of trade liberalization policies in the developing nations across the world. International trade and its impact on economic growth crucially depend on globalization. As far as the impact of international trade on economic growth is concerned, the economists and policy makers of the developed and developing economies are divided into two separate groups.

One group of economists is of the view that international trade has brought about unfavorable changes in the economic and financial scenarios of the developing countries. According to them, the gains from trade have gone mostly to the developed nations of the world. Liberalization of trade policies, reduction of tariffs and globalization have adversely affected the industrial setups of the less developed and developing economies. As an aftermath of liberalization, majority of the infant industries in these nations have closed their operations. Many other industries that used to operate under government protection found it very difficult to compete with their global counterparts. The other group of economists, which speaks in favor of globalization and international trade, come with a brighter view of the international trade and its impact on economic growth of the developing nations. According to them developing countries, which have followed trade liberalization policies, have experienced all the favorable effects of globalization and international trade. China and India are regarded as the trend-setters in this case. There is no denying that international trade is beneficial for the countries involved in trade, if practiced properly. International trade opens up the opportunities of global market to the entrepreneurs of the developing nations. International trade also makes the latest technology readily available to the businesses operating in these countries. It results in increased competition both in the domestic and global fronts. To compete with their global counterparts, the domestic entrepreneurs try to be more efficient and this in turn ensures efficient utilization of available resources. Open trade policies also bring in a host of related opportunities for the countries that are involved in international trade. However, even if we take the positive impacts of international trade, it is important to consider that international trade alone cannot bring about economic growth and prosperity in any country. There are many other factors like flexible trade policies, favorable macroeconomic scenario and political stability that need to be there to complement the gains from trade. There are examples of countries, which have failed to reap the benefits of international trade due to lack of appropriate policy measures. The economic stagnation in the Ivory Coast during the periods of 1980s and 1990s was mainly due to absence of commensurate macroeconomic stability that in turn prevented the positive effects of international trade to trickle down the different layers of society. However, instances like this cannot stand in the way of international trade activities that are practiced across the different nations of the world. In conclusion it can be said that, international trade leads to economic growth provided the policy measures and economic infrastructure are accommodative enough to cope with the changes in social and financial scenario that result from it.

Balance Of Trade
The balance of trade, or net exports (sometimes symbolized as NX), is the difference between the monetary value of exports and imports of output in an economy over a certain period. It is the relationship between a nation's imports and exports. A positive balance is known as a trade

surplus if it consists of exporting more than is imported; a negative balance is referred to as a trade deficit or, informally, a trade gap. The balance of trade is sometimes divided into a goods and a services balance. BOT The difference between a country's imports and its exports. Balance of trade is the largest component of a country's balance of payments. Debit items include imports, foreign aid, domestic spending abroad and domestic investments abroad. Credit items include exports, foreign spending in the domestic economy and foreign investments in the domestic economy. A country has a trade deficit if it imports more than it exports; the opposite scenario is a trade surplus. The balance of trade is one of the most misunderstood indicators of the U.S. economy. For example, many people believe that a trade deficit is a bad thing. However, whether a trade deficit is bad thing is relative to the business cycle and economy. In a recession, countries like to export more, creating jobs and demand. In a strong expansion, countries like to import more, providing price competition, which limits inflation and, without increasing prices, provides goods beyond the economy's ability to meet supply. Thus, a trade deficit is not a good thing during a recession but may help during an expansion.

Balance of Payment
Balance of payments (BoP) accounts are an accounting record of all monetary transactions between a country and the rest of the world.[1] These transactions include payments for the country's exports and imports of goods, services, financial capital, and financial transfers. The BoP accounts summarize international transactions for a specific period, usually a year, and are prepared in a single currency, typically the domestic currency for the country concerned. Sources of funds for a nation, such as exports or the receipts of loans and investments, are recorded as positive or surplus items. Uses of funds, such as for imports or to invest in foreign countries, are recorded as negative or deficit items. When all components of the BOP accounts are included they must sum to zero with no overall surplus or deficit. For example, if a country is importing more than it exports, its trade balance will be in deficit, but the shortfall will have to be counterbalanced in other ways such as by funds earned from its foreign investments, by running down central bank reserves or by receiving loans from other countries. While the overall BOP accounts will always balance when all types of payments are included, imbalances are possible on individual elements of the BOP, such as the current account, the capital account excluding the central bank's reserve account, or the sum of the two. Imbalances in the latter sum can result in surplus countries accumulating wealth, while deficit nations become increasingly indebted. The term "balance of payments" often refers to this sum: a country's balance of payments is said to be in surplus (equivalently, the balance of payments is positive) by a certain amount if sources of funds (such as export goods sold and bonds sold) exceed uses of funds

(such as paying for imported goods and paying for foreign bonds purchased) by that amount. There is said to be a balance of payments deficit (the balance of payments is said to be negative) if the former are less than the latter.

Under a fixed exchange rate system, the central bank accommodates those flows by buying up any net inflow of funds into the country or by providing foreign currency funds to the foreign exchange market to match any international outflow of funds, thus preventing the funds flows from affecting the exchange rate between the country's currency and other currencies. Then the net change per year in the central bank's foreign exchange reserves is sometimes called the balance of payments surplus or deficit. Alternatives to a fixed exchange rate system include a managed float where some changes of exchange rates are allowed, or at the other extreme a purely floating exchange rate (also known as a purely flexible exchange rate). With a pure float the central bank does not intervene at all to protect or devalue its currency, allowing the rate to be set by the market, and the central bank's foreign exchange reserves do not change. Historically there have been different approaches to the question of how or even whether to eliminate current account or trade imbalances. With record trade imbalances held up as one of the contributing factors to the financial crisis of 20072010, plans to address global imbalances have been high on the agenda of policy makers since 2009. BOP A record of all transactions made between one particular country and all other countries during a specified period of time. BOP compares the dollar difference of the amount of exports and imports, including all financial exports and imports. A negative balance of payments means that more money is flowing out of the country than coming in, and vice versa. Balance of payments may be used as an indicator of economic and political stability. For example, if a country has a consistently positive BOP, this could mean that there is significant foreign investment within that country. It may also mean that the country does not export much of its currency. This is just another economic indicator of a country's relative value and, along with all other indicators, should be used with caution. The BOP includes the trade balance, foreign investments and investments by foreigners.

UNIT-II
OFF-Shore: Located or based outside of one's national boundaries. The term offshore is used to describe foreign banks, corporations, investments and deposits. A company may legitimately move offshore for the purpose of tax avoidance or to enjoy relaxed regulations. Offshore financial institutions can also be used for illicit purposes such as money laundering and tax evasion Import-Export Financing: Import and export financing exists to enable business to take place overseas. Import and export financing provides importers who have orders from customers in the United States, or foreign customers backed by a letter of credit, with the necessary financial backing to provide their overseas supplier with a letter of credit to guarantee payment of goods. There are many reasons for a business to engage in this sort of financing. One big reason is that the financing can be arranged to cover 100% of the transaction. This provides the importer with sufficient financial strength to sell larger orders than they would be able to on their own financial strength. Depending on the strength of the buyer, this may be done on open account with the domestic buyer, allowing the buyer to increase their purchasing power. The whole process works because the importer will supply you with basic information on the import company and their customers. You then evaluate the credit worthiness of the customers. For each of the approved customers, the importer will supply us with copies of purchase orders that are to be filled. We will then arrange a letter of credit to be issued to the suppliers bank with the supplier as the beneficiary. EXIM BANK Export-Import Bank of India is the premier export finance institution of the country, established in 1982 under the Export-Import Bank of India Act 1981. Government of India launched the institution with a mandate, not just to enhance exports from India, but to integrate the countrys foreign trade and investment with the overall economic growth. Since its inception, Exim Bank of India has been both a catalyst and a key player in the promotion of cross border trade and investment. Commencing operations as a purveyor of export credit, like other Export Credit Agencies in the world, Exim Bank of India has, over the period, evolved into an institution that plays a major role in partnering Indian industries, particularly the Small and Medium Enterprises, in their globalization efforts, through a wide range of products and services offered at all stages of the business cycle, starting from import of technology and export product development to export production, export marketing, pre-shipment and postshipment and overseas investment.

FUNCTIONS Corporate Banking Group which handles a variety of financing programmes for Export Oriented Units (EOUs), Importers, and overseas investment by Indian companies. Project Finance / Trade Finance Group handles the entire range of export credit services such as supplier's credit, pre-shipment Agri Business Group, to spearhead the initiative to promote and support Agri-exports. The Group handles projects and export transactions in the agricultural sector for financing. Small and Medium Enterprise: The group handles credit proposals from SMEs under various lending programmes of the Bank. Export Services Group offers variety of advisory and value-added information services aimed at investment promotion. Export Marketing Services Bank offers assistance to Indian companies, to enable them establish their products in overseas markets. The idea behind this service is to promote Indian export. Export Marketing Services covers wide range of exports oriented companies and organizations. EMS group also covers Project exports and Export of Services. Besides these, the Support Services groups, which include: Research & Planning, Corporate Finance, Loan Recovery, Internal Audit, Management Information Services, Information Technology, Legal, Human Resources Management and Corporate Affairs. INTERNATIONAL LIQUIDITY The concept of international liquidity is associated with international payments. These payments arise out of international trade in goods and services and also in connection with capital movements between one country and another. International liquidity refers to the generally accepted official means of settling imbalances in international payments. In other words, the term 'international liquidity' embraces all those assets which are internationally acceptable without loss of value in discharge of debts (on external accounts). In its simplest form, international liquidity comprises of all reserves that are available to the monetary authorities of different countries for meeting their international disbursement. In short, the term 'international liquidity' connotes the world supply of reserves of gold and currencies which are freely usable internationally, such as dollars and sterling, plus facilities for borrowing these. Thus, international liquidity comprises two elements, viz., owned reserves and borrowing facilities. Under the present international monetary order, among the member countries of the IMF, the chief components of international liquidity structure are taken to be:

1. Gold reserves with the national monetary authorities - central banks and with the IMF.

2. Dollar reserves of countries other than the U.S.A. 3. -Sterling reserves of countries other than U.K. It should be noted that items (2) and (3) are regarded as 'key currencies' of the world and their reserves held by member countries constitute the respective liabilities of the U.S. and U.K. More recently Swiss francs and German marks also have been regarded as 'key currencies. 4. IMF tranche position which represents the 'drawing potential' of the IMF members; and 5. Credit arrangements (bilateral and multilateral credit) between countries such as 'swap agreements' and the 'Ten' of the Paris Club. Of all these components, however gold and key currencies like dollar today entail greater significance in determining the international liquidity of the world. However, it is difficult to measure international liquidity and assess its adequacy. This depends on gold and the foreign exchange holdings of a country, and also on the country's ability to borrow from other countries and from international organisations. Thus, it is not easy to determine the adequacy of international liquidity whose composition is heterogeneous. Moreover, there is no exact relationship between the volume of international transactions and the amount of necessary reserves In fact, foreign exchange reserves (international liquidity) are necessary to finance imbalances between international receipts and payments. International liquidity is needed to service the regular How of payments among countries, to finance the shortfall when any particular country's out payments temporarily exceed its in-payments, and to meet large withdrawals caused by outflows of capital. Thus, external or internal liquidity serves the same purpose as domestic liquidity, viz., to provide a medium of exchange and a store of value. And the primary function of external liquidity is to meet short-term fluctuations in the balance of payments. OTHER DEFINITIONS International liquidity is the ability of a given country to purchase goods and services from another country. It is a combination of a country's readily available supply of foreign currency, and the degree to which its assets may be used as a form of payment or converted to the currency of the country with which it is trading.

Liquidity Liquidity is a term which can be used to mean the same as cash, as in liquid assets. Liquidity generally refers to the ease with which assets may be converted into cash or the amount of cash available to an individual or an entity, such as a company or a government, at any given time. Liquid Assets Liquid asset describes resources of cash as well as securities which can be easily sold in order to obtain their cash-equivalent value. Cash resources include physical currency, checking accounts and certain types of savings accounts. Soluble securities include short-term money market items as well as bonds. International Liquidity and Trade The wide effects of globalization have impelled countries to engage in trade on an unprecedented scale. To this extent, global economic growth and consequent regional prosperity are heavily affected by countries' supplies of foreign currency and reserves of liquid assets, such as precious metals. International Liquidity and Exchange Rates For a given country participating in international trade, the relative value of its own currency will heavily impact its purchasing power against another country's currency. In other words, if a country has a stronger currency than a given trading partner, it will be able to leverage the liquidity of its own currency into greater buying power upon conversion. By contrast, if a country's own currency is weaker than that of a given trading partner, its relative liquidity becomes diminished as conversion requires value of the home currency be divided rather than multiplied. International Liquidity and Economic Efficiency The higher the level of liquidity in an economy, the more efficiently it functions and expands. In other words, the greater the availability of extent cash resources and easily soluble assets, the greater the more quickly goods and services can be bought and sold. This principle also holds true in the international economy, since the size and scope of countries' currency reserves have a direct effect on how expediently import transactions can be executed.

UNIT-III
FOREIGN EXCHANGE MARKETS: The foreign exchange market (forex, FX, or currency market) is a form of exchange for the global decentralized trading of international currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. EBS and Reuters' dealing 3000 are two main interbank FX trading platforms. The foreign exchange market determines the relative values of different currencies. The foreign exchange market assists international trade and investment by enabling currency conversion. For example, it permits a business in the United States to import goods from the European Union member states especially Eurozone members and pay Euros, even though its income is in United States dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation based on the interest rate differential between two currencies. In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying some quantity of another currency. The modern foreign exchange market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system. The foreign exchange market is unique because of the following characteristics: its huge trading volume representing the largest asset class in the world leading to high liquidity; its geographical dispersion; its continuous operation: 24 hours a day except weekends, i.e., trading from 20:15 GMT on Sunday until 22:00 GMT Friday; the variety of factors that affect exchange rates; the low margins of relative profit compared with other markets of fixed income; and the use of leverage to enhance profit and loss margins and with respect to account size. Spot A spot transaction is a two-day delivery transaction (except in the case of trades between the US Dollar, Canadian Dollar, Turkish Lira, Euro and Russian Ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a direct exchange between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction.

Forward One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be one day, a few days, months or years. Usually the date is decided by both parties. Then the forward contract is negotiated and agreed upon by both parties. Swap The most common type of forward transaction is the swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange. A deposit is often required in order to hold the position open until the transaction is completed. Future Futures are standardized forward contracts and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts. Option A foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The options market is the deepest, largest and most liquid market for options of any kind in the world.

SPOT PRICES: The current price at which a particular security can be bought or sold at a specified time and place. A security's spot price is regarded as the explicit value of the security at any given time in the marketplace. In contrast, a securities futures price is the expected value of the security, in relation to its current spot price and time frame in question. FORWARD PRICES: The predetermined delivery price for an underlying commodity, currency or financial asset decided upon by the long (the buyer) and the short (the seller) to be paid at predetermined date in the future. At the inception of a forward contract, the forward price makes the value of the contract zero.

The Forward Price can be determined by the following formula: F0 = S0 * e^rt where: S0 represents the current spot price of the asset F0 represents the forward price of the asset at time T er represents a mathematical exponential function Determinants of Exchange Rates Numerous factors determine exchange rates, and all are related to the trading relationship between two countries. Remember, exchange rates are relative, and are expressed as a comparison of the currencies of two countries. The following are some of the principal determinants of the exchange rate between two countries. Note that these factors are in no particular order; like many aspects of economics, the relative importance of these factors is subject to much debate. 1. Differentials in Inflation As a general rule, a country with a consistently lower inflation rate exhibits a rising currency value, as its purchasing power increases relative to other currencies. During the last half of the twentieth century, the countries with low inflation included Japan, Germany and Switzerland, while the U.S. and Canada achieved low inflation only later. Those countries with higher inflation typically see depreciation in their currency in relation to the currencies of their trading partners. This is also usually accompanied by higher interest rates. 2. Differentials in Interest Rates Interest rates, inflation and exchange rates are all highly correlated. By manipulating interest rates, central banks exert influence over both inflation and exchange rates, and changing interest rates impact inflation and currency values. Higher interest rates offer lenders in an economy a higher return relative to other countries. Therefore, higher interest rates attract foreign capital and cause the exchange rate to rise. The impact of higher interest rates is mitigated, however, if inflation in the country is much higher than in others, or if additional factors serve to drive the currency down. The opposite relationship exists for decreasing interest rates - that is, lower interest rates tend to decrease exchange rates.

3. Current-Account Deficits The current account is the balance of trade between a country and its trading partners, reflecting all payments between countries for goods, services, interest and dividends. A deficit in the current account shows the country is spending more on foreign trade than it is earning, and that it is borrowing capital from foreign sources to make up the deficit. In other words, the country requires more foreign currency than it receives through sales of exports, and it supplies more of its own currency than foreigners demand for its products. The excess demand for foreign currency lowers the country's exchange rate until domestic goods and services are cheap enough for foreigners, and foreign assets are too expensive to generate sales for domestic interests. 4. Public Debt Countries will engage in large-scale deficit financing to pay for public sector projects and governmental funding. While such activity stimulates the domestic economy, nations with large public deficits and debts are less attractive to foreign investors. The reason? A large debt encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off with cheaper real dollars in the future. In the worst case scenario, a government may print money to pay part of a large debt, but increasing the money supply inevitably causes inflation. Moreover, if a government is not able to service its deficit through domestic means (selling domestic bonds, increasing the money supply), then it must increase the supply of securities for sale to foreigners, thereby lowering their prices. Finally, a large debt may prove worrisome to foreigners if they believe the country risks defaulting on its obligations. Foreigners will be less willing to own securities denominated in that currency if the risk of default is great. For this reason, the country's debt rating (as determined by Moody's or Standard & Poor's, for example) is a crucial determinant of its exchange rate. 5. Terms of Trade A ratio comparing export prices to import prices, the terms of trade is related to current accounts and the balance of payments. If the price of a country's exports rises by a greater rate than that of its imports, its terms of trade have favorably improved. Increasing terms of trade shows greater demand for the country's exports. This, in turn, results in rising revenues from exports, which provides increased demand for the country's currency (and an increase in the currency's value). If the price of exports rises by a smaller rate than that of its imports, the currency's value will decrease in relation to its trading partners.

6. Political Stability and Economic Performance Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw investment funds away from other countries perceived to have more political and economic risk. Political turmoil, for example, can cause a loss of confidence in a currency and a movement of capital to the currencies of more stable countries. Conclusion The exchange rate of the currency in which a portfolio holds the bulk of its investments determines that portfolio's real return. A declining exchange rate obviously decreases the purchasing power of income and capital gains derived from any returns. Moreover, the exchange rate influences other income factors such as interest rates, inflation and even capital gains from domestic securities. While exchange rates are determined by numerous complex factors that often leave even the most experienced economists flummoxed, investors should still have some understanding of how currency values and exchange rates play an important role in the rate of return on their investments.

UNIT-IV FOREIGN EXCHANGE MANAGEMENT ACT:

The Foreign Exchange Management Act (FEMA) is a 1999 Indian law "to consolidate and amend the law relating to foreign exchange with the objective of facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India". It was passed in the winter session of Parliament in 1999, replacing the Foreign Exchange Regulation Act (FERA). This act seeks to make offenses related to foreign exchange civil offenses. It extends to the whole of India.,[1] replacing FERA, which had become incompatible with the pro-liberalisation policies of the Government of India. It enabled a new foreign exchange management regime consistent with the emerging framework of the World Trade Organisation (WTO). It is another matter that the enactment of FEMA also brought with it the Prevention of Money Laundering Act of 2002, which came into effect from 1 July 2005. Unlike other laws where everything is permitted unless specifically prohibited, under this act everything was prohibited unless specifically permitted. Hence the tenor and tone of the Act was very drastic. It required imprisonment even for minor offences. Under FERA a person was presumed guilty unless he proved himself innocent, whereas under other laws a person is presumed innocent unless he is proven guilty. Switch from FERA FERA, in place since 1974, did not succeed in restricting activities such as the expansion of transnational corporations (TNCs). The concessions made to FERA in 1991-1993 showed that FERA was on the verge of becoming redundant.[2] After the amendment of FERA in 1993, it was decided that the act would become the FEMA. This was done in order to relax the controls on foreign exchange in India, as a result of economic liberalization. FEMA served to make transactions for external trade (exports and imports) easier transactions involving current account for external trade no longer required RBIs permission. The deals in Foreign Exchange were to be managed instead of regulated. The switch to FEMA shows the change on the part of the government in terms of foreign capital. Need for its management The buying and selling of foreign currency and other debt instruments by businesses, individuals and governments happens in the foreign exchange market. Apart from being very competitive, this market is also the largest and most liquid market in the world as well as in India. It constantly undergoes changes and innovations, which can either be beneficial to a country or expose them to greater risks. The management of foreign exchange market becomes necessary in order to mitigate and avoid the risks. Central banks would work towards an orderly functioning of the transactions which can also develop their foreign exchange market.

Whether under FERA or FEMAs control, the need for the management of foreign exchange is important. It is necessary to keep adequate amount of foreign exc from Import Substitution to Export Promotion. Main Features Activities such as payments made to any person outside India or receipts from them, along with the deals in foreign exchange and foreign security is restricted. It is FEMA that gives the central government the power to impose the restrictions. Restrictions are imposed on people living in India who carry out transactions in foreign exchange, foreign security or who own or hold immovable property abroad. Without general or specific permission of the Reserve Bank of India, FEMA restricts the transactions involving foreign exchange or foreign security and payments from outside the country to India the transactions should be made only through an authorised person. Deals in foreign exchange under the current account by an authorised person can be restricted by the Central Government, based on public interest. Although selling or drawing of foreign exchange is done through an authorised person, the RBI is empowered by this Act to subject the capital account transactions to a number of restrictions. People living in India will be permitted to carry out transactions in foreign exchange, foreign security or to own or hold immovable property abroad if the currency, security or property was owned or acquired when he/she was living outside India, or when it was inherited to him/her by someone living outside India. Exporters are needed to furnish their export details to RBI. To ensure that the transactions are carried out properly, RBI may ask the exporters to comply to its necessary requirements

UNIT-V
LETTER OF CREDIT: International trade between an Exporter and Importer would entail multiple transactions in terms of documentation exchange, physical cargo movement as well as settlement of payment which have to be clearly defined and setup in order to ensure smooth business transaction. Over the years international trade has established various methods and payment mechanisms that are accepted globally by all financial institutions and other related parties. Normally when the Customer is new to the Exporter, the business transactions are done either based on advance payment or Letter of Credit option. LC is one of the safest mechanisms available for an Exporter to ensure he gets his payment correctly and the importer is also assured of the Exporters adherence to his requirement in terms of quality, quantity, shipping instructions as well as documentation etc. A letter of Credit is the Buyers Bankers promise to the Bank of the Seller / Exporter that the bank will honor the Invoice presented by the Exporter on due date and make payment, provided that the Seller/Exporter has complied with all the requirements and conditions set by the Importer in the said letter of credit or the Buyers Purchase Order and produced documentary evidence to prove compliance, along with the necessary shipment related documentation. Confirmed Letter of Credit A Letter of Credit is always sent by the Buyers bank to the Sellers Bank or any bank that is becomes an advising bank. Normally the Sellers bank becomes an advising bank when a normal LC is received and it delivers or advises the buyer regarding the receipt of LC with no responsibility towards it. In case of a Confirmed LC, the Sellers bank checks out the authentication of the LC from the Buyers bank and confirms to stand responsible for negotiating, collecting payment from the Buyers bank and making payment to the seller in line with the terms and conditions stipulated in the LC. By adding confirmation to the LC, the Sellers bank too becomes equally responsible to make payment for the transaction under the LC. Sellers Bank in turn will charge and collect service charges from the Seller for the same. Revocable and Irrevocable Letter of Credit Normally the Letter of Credits issued is irrevocable, which means that no single party can unilaterally make any changes to the LC, unless it is mutually agreeable to both the parties involved. However an LC is said to be revocable if the terms allow any one single party to be able to make changes to the LC unilaterally. However it is in the interest of the buyer that he should always insist on irrevocable Letter of Credit.

Sight LC When the LC is opened, stipulating the condition that, on presentation of the negotiable set of shipping document by the seller as per the terms of the LC are made, the buyers bank will make payment at sight meaning immediately to the sellers bank subject to fulfillment of terms and conditions of the LC being fulfilled, the LC is called Sight LC. Future or Credit LC If the payment schedule under the said LC stipulates payment at certain future dates after presentation of negotiable set of shipping documents by the Seller and fulfilling the LC terms and conditions, such an LC is termed Future LC or Credit LC. It is quite normal for sellers to extend credit of 30 days to 60 days under LCs. However the shipping documents would have to be presented to the bank immediately so that they documents reach the buyer well ahead in time before the consignment reaches the foreign shores and the buyer is able to clear the consignment and take delivery. PRESHIPMENT Pre-shipment inspection, also called preshipment inspection or PSI, is a part of supply chain management and an important and reliable quality control method for checking goods' quality while clients buy from the suppliers. After ordering a number of articles, the buyer lets a third party control the ordered goods before they are dispatched to him. Normally an independent inspection company is assigned with the task of the PSI, as it is in the interest of the buyer that somebody not connected with the deal in any way verifies the amount and quality. This way the buyer makes sure, he gets the goods he paid for. Although increasing numbers of clients would like to collect suppliers' information from the Internet, this contains high risks because it is not a face-to-face transaction, and Internet phishing and fraud can corrupt it. Pre-shipment inspection can greatly avoid this risk and ensure clients get quality products from suppliers. POST SHIPMENT FINANCE Post shipment finance is provided to meet working capital requirements after the actual shipment of goods. It bridges the financial gap between the date of shipment and actual receipt of payment from overseas buyer thereof. Whereas the finance provided after shipment of goods is called post-shipment finance.

DEFINITION: Credit facility extended to an exporter from the date of shipment of goods till the realization of the export proceeds is called Post-shipment Credit. IMPORTANCE OF FINANCE AT POST-SHIPMENT STAGE: To pay to agents/distributors and others for their services. To pay for publicity and advertising in the over seas markets. To pay for port authorities, customs and shipping agents charges. To pay towards export duty or tax, if any. To pay towards ECGC premium. To pay for freight and other shipping expenses. To pay towards marine insurance premium, under CIF contracts. To meet expenses in respect of after sale service. To pay towards such expenses regarding participation in exhibitions and trade fairs in India and abroad. To pay for representatives abroad in connection with their stay board. FORMS/METHODS OF POST SHIPMENT FINANCE Export bills negotiated under L/C: The exporter can claim post-shipment finance by drawing bills or drafts under L/C. The bank insists on necessary documents as stated in the L/C. if all documents are in order, the bank negotiates the bill and advance is granted to the exporter. Purchase of export bills drawn under confirmed contracts: The banks may sanction advance against purchase or discount of export bills drawn under confirmed contracts. If the L/C is not available as security, the bank is totally dependent upon the credit worthiness of the exporter. Advance against bills under collection: In this case, the advance is granted against bills drawn under confirmed export order L/C and which are sent for collection. They are not purchased or discounted by the bank. However, this form is not as popular as compared to advance purchase or discounting of bills. Advance against claims of Duty Drawback (DBK): DBK means refund of customs duties paid on the import of raw materials, components, parts and packing materials used in the export production. It also includes a refund of central excise duties paid on indigenous materials. Banks offer pre-shipment as well as post-shipment advance against claims for DBK.

Advance against goods sent on Consignment basis: The bank may grant post-shipment finance against goods sent on consignment basis. Advance against Undrawn Balance of Bills: There are cases where bills are not drawn to the full invoice value of gods. Certain amount is undrawn balance which is due for payment after adjustments due to difference in rates, weight, quality etc. banks offer advance against such undrawn balances subject to a maximum of 5% of the value of export and an undertaking is obtained to surrender balance proceeds to the bank. Advance against Deemed Exports: Specified sales or supplies in India are considered as exports and termed as deemed exports. It includes sales to foreign tourists during their stay in India and supplies made in India to IBRD/ IDA/ ADB aided projects. Credit is offered for a maximum of 30 days. Advance against Retention Money: In respect of certain export capital goods and project exports, the importer retains a part of cost goods/ services towards guarantee of performance or completion of project. Banks advance against retention money, which is payable within one year from date of shipment. Advance against Deferred payments: In case of capital goods exports, the exporter receives the amount from the importer in installments spread over a period of time. The commercial bank together with EXIM bank do offer advances at concessional rate of interest for 180 days.

UNIT-VI COUNTRY RISK ANALYSIS Country risk refers to the risk of investing in a country, dependent on changes in the business environment that may adversely affect operating profits or the value of assets in a specific country. For example, financial factors such as currency controls, devaluation or regulatory changes, or stability factors such as mass riots, civil war and other potential events contribute to companies' operational risks. This term is also sometimes referred to as political risk; however, country risk is a more general term that generally refers only to risks affecting all companies operating within a particular country. Political risk analysis providers and credit rating agencies use different methodologies to assess and rate countries' comparative risk exposure. Credit rating agencies tend to use quantitative econometric models and focus on financial analysis, whereas political risk providers tend to use qualitative methods, focusing on political analysis. However, there is no consensus on methodology in assessing credit and political risks. A collection of risks associated with investing in a foreign country. These risks include political risk, exchange rate risk, economic risk, sovereign risk and transfer risk, which is the risk of capital being locked up or frozen by government action. Country risk varies from one country to the next. Some countries have high enough risk to discourage much foreign investment. Measuring Country Risk Measuring a country's risk can be a tricky endeavor. From tax laws to political upheaval, investors have to take hundreds, if not thousands, of different factors into consideration. For instance, solid moves like a hike in interest rates can dramatically help a country's businesses and stock market. But even a mere comment from a prominent politician hinting at future plans can have just as large of an impact. A country's risk can generally be divided into two groups: Economic Risk: Risk associated with a country's financial condition and ability to repay its debts. For instance, a country with a high debt-to-GDP ratio may not be able to raise money as easily to support itself, which puts its domestic economy at risk. Political Risk: Risk associated with a country's politicians and the impact of their decisions on investments. For instance, desperate politicians supporting nationalizations could pose a risk to investors in certain strategic industries. Analyzing Country Risk There are many different ways to analyze a country's risk. From beta coefficients to sovereign ratings, investors have a number of different tools at their disposal. International investors should

use a combination of these techniques in order to determine a country's risk, as well as the risk associated with the international investment/security itself.

Methods used to assess country risk can be grouped into two categories: Quantitative Analysis: The use of ratios and statistics to determine risk, such as the debt-to-GDP ratio or the beta coefficient of the MSCI index for a given country. International investors can find this information in reports from ratings agencies, magazines like the Economist, and through various online sources like Wikipedia. Qualitative Analysis: The use of subjective analysis to determine risk, such as breaking political news/opinion or realistic market rumors. International investors can find this information in financial publications like the Economist and the Wall Street Journal, as well as by searching on international news aggregators like Google News. But, the most common way that investors assess country risk is through sovereign ratings. By taking these quantitative and qualitative factors into account, these agencies issue credit ratings for each country and give investors an easy way to analyze country risk. The three most-watched ratings agencies are Standard & Poor's, Moody's Investor Services, and Fitch Ratings. Country Risk Checklist & Other Tips International investors can determine country risk using this simple three-step process: Check Sovereign Ratings: Look-up the country's sovereign ratings issued by the S&P, Moody's and Fitch to get a base-line look at the country's level of risk. Read the Latest News: Search on Google News or other international news aggregators for any economic news surrounding a country as a form of qualitative research. Check the Stock's Risk: Determine the specific investment's risk by looking at quantitative factors, such as the beta coefficient - a higher beta coefficient equates to greater risk. But just because a country is risky doesn't mean investors should ignore it. Sometimes increased risk equates to higher potential returns. For instance, a country undergoing an economic reform may be riskier now, but its long-term future may be brighter as a result. International investors can therefore still incorporate risk into a diversified portfolio in order to enhance potential returns.

INTEREST RATE EXPOSURE The amount of financial loss a company or individual could be incurred as a result of adverse changes in interest rates. A risk common to both businesses and individuals involves refinancing debt in an increasing interest rate environment. MANAGING INTEREST RATE RISK Financial intermediaries encounter five general risk types: interest rate risk price risk prepayment risk credit risk exchange-rate risk

INTEREST RATE RISK The risk that an investment's value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship. Such changes usually affect securities inversely and can be reduced by diversifying (investing in fixed-income securities with different durations) or hedging (e.g. through an interest rate swap). PRICE RISK The risk of a decline in the value of a security or a portfolio. Price risk is the biggest risk faced by all investors. Although price risk specific to a stock can be minimized through diversification, market risk cannot be diversified away. Price risk, while unavoidable, can be mitigated through the use of hedging techniques. PREPAYMENT RISK The risk associated with the early unscheduled return of principal on a fixed-income security. Some fixed-income securities, such as mortgage-backed securities, have embedded call options which may be exercised by the issuer, or in the case of a mortgage-backed security, the borrower. The yield-to-maturity of such securities cannot be known for certain at the time of purchase since the cash flows are not known. When principal is returned early, future interest payments will not be paid on that part of the principal. If the bond was purchased at a premium (a price greater than 100) the bond's yield will be less than what was estimated at the time of purchase.

CREDIT RISK The risk of loss of principal or loss of a financial reward stemming from a borrower's failure to repay a loan or otherwise meet a contractual obligation. Credit risk arises whenever a borrower is expecting to use future cash flows to pay a current debt. Investors are compensated for assuming credit risk by way of interest payments from the borrower or issuer of a debt obligation. Credit risk is closely tied to the potential return of an investment, the most notable being that the yields on bonds correlate strongly to their perceived credit risk. FOREIGN EXCHANGE RISK 1. The risk of an investment's value changing due to changes in currency exchange rates. 2. The risk that an investor will have to close out a long or short position in a foreign currency at a loss due to an adverse movement in exchange rates. Also known as "currency risk" or "exchange-rate risk". ****************************************************** Interest rate risk is that which exists in an interest-bearing asset, such as a loan or a bond, due to the possibility of a change in the asset's value resulting from the variability of interest rates. Interest rate risk management has become very important, and assorted instruments have been developed to deal with interest rate risk. This article examines the management of interest rate risk with the use of various interest rate derivative instruments. (For related reading, see How Interest Rates Affect The Stock Market.)

Why Interest Rate Risk Should Not Be Ignored As with any risk management assessment, there is always the option to do nothing, and that is what many people do. However, in circumstances of unpredictability, sometimes not hedging is disastrous. Yes, there is a cost to hedging, but what is the cost of a major move in the wrong direction?

One need only look to OrangeCounty, California, in 1994 to see evidence of the pitfalls of ignoring the daunting threat of interest rate risk. In a nutshell, County Treasurer Robert Citron borrowed money at lower short-term rates and lent money at higher long-term rates. The strategy was great - short-term rates fell and the normal yield curve was maintained - but, when the curve began to turn and approach inverted yield curve status, things got ugly. Losses to OrangeCounty and the almost 200 public entities for which Citron managed money were estimated at $1.6 billion and resulted in the bankruptcy of the municipality - a hefty price to pay for ignoring

interest rate risk. (Read about another financial meltdown in OrangeCounty in The Rise And Demise Of New Century Financial.)

Luckily, those who do want to hedge their investments against interest rate risk have many products to choose from. These will be examined in turn below.

Investment Products Forwards A forward contract is the most basic interest rate management product. The idea is simple, and many other products discussed in this article are based on this idea of an agreement today for an exchange of something at a specific future date. Forward Rate Agreements (FRAs) An FRA is based on the idea of a forward contract, where the determinant of gain or loss is an interest rate. Under this agreement, one party pays a fixed interest rate and receives a floating interest rate equal to a reference rate. The actual payments are calculated based upon a notional principal amount and paid at intervals determined by the parties. Only a net payment is made the loser pays the winner, so to speak. FRAs are always settled in cash. FRA users are typically borrowers or lenders with a single future date on which they are exposed to interest rate risk. A series of FRAs is similar to a swap (discussed below); however, in a swap all payments are at the same rate. Each FRA in a series would be priced at different rates, unless the term structure is flat. Futures A futures contract is similar to a forward, but provides the counterparties with less risk than a forward contract, namely a lessening of default and liquidity risk, due to the inclusion of an intermediary. (Those who are new to futures but want a solid understanding of them should read our tutorial on Futures Fundamentals.) Swaps Just like it sounds, a swap is an exchange. More specifically, an interest rate swap looks a lot like a combination of FRAs and involves an agreement between counterparties to exchange sets of future cash flows. The most common type of interest rate swap is a plain vanilla swap, which involves one party paying a fixed interest rate and receiving a floating rate and the other party

paying a floating rate and receiving a fixed rate. (Learn how these derivatives work and how companies can benefit from them in An Introduction To Swaps.)

Options Interest rate management options are option contracts whose underlying security is a debt obligation. These instruments are useful in protecting the parties involved in a floating rate loan, such as adjustable-rate mortgages (ARMs). A grouping of interest rate calls is referred to as an interest rate cap; a combination of interest rate puts is referred to as an interest rate floor. In general, a cap is like a call and a floor is like a put. Swaptions A swaption, or swap option, is simply an option to enter into a swap. Embedded options Many investors encounter interest management derivative instruments via embedded options. If you have ever bought a bond with a call provision, you too are in the club. The issuer of your callable bond is insuring that if interest rates decline, they can call in your bond and issue new bonds with a lower coupon. (To learn more, read The Four Advantages Of Options.) Caps A cap, also called a ceiling, is a call option on an interest rate. An example of its application would be a borrower going long, or paying a premium to buy a cap and receiving cash payments from the cap seller (the short) when the reference interest rate exceeds the strike rate of the cap. The payments are designed to offset interest rate increases on a floating-rate loan. If the actual interest rate exceeds the strike rate, the seller pays the difference between the strike and the interest rate multiplied by the notional principal. This option will "cap", or place an upper limit, on the interest expense of the holder. The interest rate cap is actually a series of component options, or "caplets," that exist for each period the cap agreement is in existence. A caplet is designed to provide a hedge against a rise in the benchmark interest rate, such as the London Interbank Offered Rate (LIBOR), for a stated period. (For more on using benchmarks to quantify risk, read Measuring And Managing Investment Risk.) Floors

Just as a put option is considered the mirror image of a call option, the floor is the mirror image of the cap. The interest rate floor, like the cap, is actually a series of component options, except that they are put options and the series components are referred to as "floorlets". Whoever is long the floor is paid upon maturity of the floorlets if the reference rate is below the strike price of the floor. A lender uses this to protect against falling rates on an outstanding floating-rate loan.

Collars A protective collar can also be used in the management of interest rate risk. Collaring is accomplished by simultaneously buying a cap and selling a floor (or vice versa), just like a collar protects an investor who is long a stock. A zero cost collar can also be established in order to lower the cost of hedging, but this lessens the potential profit that would be enjoyed by a movement in interest rates in your favor, as you have placed a ceiling on your potential profit. (For related reading, see Don't Forget Your Protective Collar.) Conclusion These products all provide ways to hedge interest rate risk, with different products being appropriate for different scenarios. There is, however, no free lunch. With any of these alternatives, one gives up something - either money (premiums paid for options) or opportunity cost (the profit one would have made without hedging).