“International Finance is an area of financial economics that deals with monetary interactions between two or more countries”.

MEANING

International Finance has become a specialised subject dealing with the study of –

Foreign Exchange Markets Exchange RatesMNC Financial SystemRisk Management International Accounting System

1.FOREIGN EXCHANGE MARKETS…

Foreign exchange market refers to the market for national currencies of different countries in the world.

Functions of Foreign Exchange Market:a. Transfer functionb. Credit functionc. Hedging function

Types of Transactions

a) SPOT TRANSACTIONSSpot market for foreign exchange is that

market which handles only spot transactions or current transactions.

PRINCIPAL CHARACTERISTICS:a. Period of transaction- daily nature

b. Rate of exchange which is determined in spot market is known as spot rate of exchange

b) FORWARD MARKETForward Market includes transactions that call

for delivery at a fixed future date at an exchange rate that is fixed at the time the contract is entered into.

PRINCIPAL CHARACTERISTICS:a. It only caters to forward transactionsb. The exchange rate at which forward

transactions are to be honoured is knows as foreign exchange rate.

c) SWAP It involves a simultaneous spot purchase and forward sale of a foreign currency against another and vice versa.

d) OPTIONSThese are the instruments that give the holder the right but no obligation to buy or sell an asset at a pre-specified price on or upto a specified date.

e) CURRENCY FUTUREIt is a standardized foreign exchange derivative contract on a recognized stock exchange to buy or sell one currency against another on a specified future date at a specified price.

2. EXCHANGE RATEThe rate at which one unit of currency of a country can be

exchanged for a number of units of currency of another country. Like, $1=63 Rs = 2cents

TYPES OF EXCHANGE RATE

FLOATING

FIXED

a)FIXED EXCHANGE RATE….Fixed rate of exchange refers to the rate of

exchange as fixed by the govt.

Historically it has two important variants:• Gold Standard System of Exchange Rate• Bretton Wood System of Exchange Rate

b) FLEXIBLE EXCHANGE RATE SYSTEM:

Flexible exchange rate is the rate which is determined by the demand for and supply of different currencies in the foreign exchange market.

R=f (D,S) R= exchange rate D= demand for foreign currencies S= Supply of foreign currencies

EXCHANGE QUOTATION

DIRECT QUOTE

INDIRECT QUOTE

DIRECT QUOTE A direct quote expresses the home currency

price of a certain quantity of the foreign currency.

In this method the no of units of foreign currency is kept constant and home currency units are variable.

INDIRECT QUOTE In Indirect quote, any change in the exchange

rate will be shown by variation in the units of foreign currency.

3.MULTINATIONAL FINANCIAL SYSTEM

Mutinationals are the single most largest players responsible for international business and international finance is concerned with studying and understanding the financial system of these multinational corporations.

IMPORTANT VARIABLES:Mode of transfer of fundsPlanning for payment scheduleManaging the firm value

4.RISK MANAGEMENTThe earnings of firms engaged in

international business are subject to fluctuations due to floating exchange rate.

To protect itself from this uncertainty the firm will opt for hedging techniques.

5. INTERNATIONAL ACCOUNTING SYSTEM

International finance also studies the techniques of preparing consolidated financial statements of MNC’s.

NEED AND IMPORTANCE OF INTERNATIONAL

FINANCE

•DIMINISHING NATIONAL BOUNDARIES:

1. Governments are imposing fewer restrictions on movement of goods and services.

2. World trade organization has lowered import duties.

1. Firms have started adopting a World Wide approach to the Markets and Production

2. Entire world is a single market Eg: Honda has moved a considerable

part of its automobile production to China in order to get competitive advantage of low costs.

•RISE OF GLOBAL COMPANIES

1. The world trade volumes have increased sharply over the last few years.

2. Increase in Imports and Exports has resulted in large volume of Cross Border Monetary Movement.

RISING WORLD TRADE ORGANISATION

Growth of world trade (US $ billions)

REGION EXPORTS IMPORTS

2011 2012 2013 2011 2012 2013

World 18329

18405 18817 18415 18526 18797

Developed Economies

9627 9363 9578 10490 10236 10196

Developing Economies

7890 8219 8432 7338 7676 7981

Transition Economies

810 822 805 587 614 618

REGION FDI Inflows

FDI Outflows

2011 2012 2013 2011 2012 2013

World 1700 1330 1451 1711 1346 1410

Developed Economies

880 516 565 1215 852 857

Developing Economies

724 729 778 422 440 454

Transition Economies

94 84 107 73 53 99

FDI Flows by region (in US $ Million )

• INCREASED CROSS-BORDER CAPITAL FLOW

1. Rising volume of commercial transaction at international level has

led to the creation of giant International Financial Market

7.CHANGING NATURE OF CAPITAL AND MONEY

MARKETS

6. EXPANDING TECHNICAL INFRASTRUCTURE

1. Allows massive financial transaction to materialize online with in minutes

2. Allows the bank across the world to access the regional or main server of SWIFT and transfer the information regarding the financial transaction to the appropriate location

7. GLOBAL CONSUMERS AND GLOBAL COMPETITION :

1. Dwindling barriers between the markets, rapid economic development have made consumers expectations similar across countries .

2. Consumers are awakened to the possibilities of newer, better and customized products.

8. DEVELOPMENT OF SUPPORTING FINANCIAL INFRASTRUCTURE

1. Increased pace of international business has led to the development of supporting financial services.

2. Universal banking concept has emerged.3. Geographical and functional integration of

the banks made international finance important.

9. INCREASED COMPETION AT THE GLOBAL LEVEL

1. Companies are facing intense competition and survival has become tough.

2. To become as a global player knowledge and understanding of different economies and their market is essential.

3. International finance identify opportunities and develop them for the company’s benefit.

10. DOMESTIC COMPANIES TOO FEEL THE HEAT

1. Understanding of international finance is needed not just by company having international markets but also by domestic companies.

2. Domestic companies must be exposed to the risks involved in dealing with foreign currencies.

3. Domestic companies having no dealing with international markets would need to understand their competitors strengths and weakness.

RECENT TRENDS ININTERNATIONAL FINANCE

De-regulation of financial marketsCross Border M & A activityRising Popularity of Euro MarketsEmergence of MNC’s from Emerging EconomiesIntegration of Markets Globally

1.De-Regulation of Financial Markets.

There has been a trend towards internationalisation of money and capital markets

The US & most of Europe have almost free financial markets, the rest of the world has gradually move toward it .

At the same time a window has been opened for the companies in the developing countries to tap offshore markets to raise debt and equity finance.

2. Cross Border M & A Activity

The past few years have also seen a rise in the global FDI level and most of this investment has been driven by cross border mergers and acquisitions.

The M&A Activities witnessed an increased till 2007 due to strong economic conditions world wide.

3. Rising Popularity of Euro Markets

The strict regulations in US , along with other factors led to the development of Euro dollar markets, which has now expanded to include other currencies also.

Euro markets are virtually free from any regulation and hence become a popular choice for world MNC to look towards them for financing their plans.

4. Emergence of MNC’s from Emerging Economies

The last two decades have also seen the emergence of a large no of Multinational Corporations from emerging economies.It has been observed that of the top 100 Infrastructure Multinational Corporations of the World, 22 were headquartered in a developing or a transition economy like Hong Kong, Malaysia, Singapore etc,

5. Integration of Markets Globally

The world is witnessing an increasing integration of financial markets. This gives the investors the freedom and opportunity to raise funds from and to invest anywhere in the world, through any type of instruments.

Greater integration of the financial markets has resulted in a redistribution of financial resources from the surplus countries to the deficit countries.

SOURCES OF INTERNATIONAL

FINANCE

EXTERNAL COMMERCIAL BORROWING

ECB refers to commercial loans in the form of bank loans, buyers credit , suppliers credit availed of from non-resident lenders with the minimum average maturity of 3 years.

ECB can be ACCESSED in

two ways:

AUTOMATIC ROUTE

APPROVAL ROUTE

ECB for investment in real sector- industrial sector, infrastructure sector and specified service sectors in India are under the Automatic Route, i.e. do not require Reserve Bank / Govt. of India approval.

In case of doubt as regards eligibility to access the Automatic Route, applicants may take recourse to the Approval Route.

BASIS AUTOMATIC ROUTE APPROVAL ROUTE

1) Eligible borrowers

• Corporate registered under the companies act are eligible to raise ECB.• Individuals, trusts and Non- profit making organisations are not eligible to raise ECB.• Units in SEZ are also allowed to raise ECB for their own requirement.

• Financial institutions dealing exclusively with infrastructure or export finance.• Banks & financial institutions which has participated in the textile or steel sector.• Non Banking financial companies with minimum average maturity of 5 years.• Foreign Currency Convertible Bonds • Multi- State Co-operate Societies.• Industrial sector & Infrastructure sector • Non-Govt. organisations .

BASIS AUTOMATIC ROUTE APPROVAL ROUTE

2)Recognised lenders • International banks

• International capital markets • Multilateral financial institutions • Export credit agencies• Suppliers of equipments• Foreign equity holders

o USD 5 million- minimum equity of 25%o More than USD 5 million- minimum equity of 25% and debt equity ratio not exceeding 4:1

• NGOs engaged in micro finance activities are-

o ECB would have to furnish a Certificate of due diligence

Lender maintains an a/c with the bank for atleast period of 2 yrs.

Submit documents as evidence such as audit statement of accounts & income tax return.

BASIS AUTOMATIC ROUTE APPROVAL ROUTE

3) Amount & maturity

• Maximum amount- USD 750 millions • Min. for 3 yrs- USD 20 million in financial year.• maturity for 5 yrs- USD 20 million to USD 500 million

• More than 10 years- USD 250 millions • Infrastructure sector- ECB upto USD 100 million .o industrial

sector- ECB upto USD 50 million.

• NGOs engaged in micro finance activities can raise ECB upto USD 5 million.• In service sector- ECB upto USD 100 million.

APPROVAL ROUTEAUTOMATIC ROUTEBASIS

4) All- in- cost ceilings

• Rate of interest • Other fees and expenses

o Commitment fee o Pre payment fee

Except:

• For 3 years upto 5 years– 200 basis point• More than 5 years– 350 basis point

Same as in Automatic Route

AUTOMATIC ROUTE APPROVAL ROUTE

5) Guarantees

• Issuance of guarantee• Letter of credit• Letter of undertaking • Letter of comfort by banks

• Same as in Automatic Route

6) Parking of ECB proceeds over seas

• ECB proceeds parked overseas can be invested in liquid assets are- a) deposits with overseas branch of AD in India. b)Treasury bills and other monetary instuments

Same as in Automatic Route.

7) Prepayment

• ECB upto USD 500 millions allowed by AD banks without prior approval of RBI.

• Same as in Automatic Route• ESB exceeding USD 500 million would be considered by the Reserves Bank.

BASIS

BASIS AUTOMATIC ROUTE APPROVAL ROUTE

8) Refinancing of an existing ECB

By raising a fresh ECB subject to the condition that the fresh ECB is raised at a lower all-in-cost and the outstanding maturity of the original ECB is maintained.

Same as in Automatic Route.

9) Debt Servicing

The AD Bank has the general commission to make remittances of installments of principal, interest and other charges in confirmity with ECB guidelines issued by government.

Same as in Automatic Route.

BASIS AUTOMATIC ROUTE

APPROVAL ROUTE

10) Procedure

• Borrowers may enter into loan agreement under ECB guidelines for raising ECB.• Borrower must obtain Loan Registration Number from the RBI.

Applicants are required to submit an application form to ECB through designated AD Bank to the Chief General Manager-in-charge, Foreign Exchange Department, RBI, Central Office along with necessary documents.

BASIS AUTOMATIC ROUTE APPROVAL ROUTE

technical know-how and payment of license fees.• For Acquisition of

shares in the disinvestment process to the public under the government disinvestment program of PSU shares.

11) End-Use

• ECBs are permitted for – a) Investment in industrial sector, infrastructure sector and specified service sectors. b) Overseas can direct investment in joint venture. c) For import of services,

Same as in Automatic Route

BASIS AUTOMATIC ROUTE APPROVAL ROUTE

Purpose and repayment of existing rupee loans.

12) Ends-uses not permitted

• For on-lending or investment in capital market or acquiring a company in India by a corporate.• Not permitted in Real Estate.• Not permitted for working capital, general corporate

Same as in Automatic Route.

Foreign Currency Convertible Bonds (FCCB)

MEANING:- It refers to a bond issued by an Indian

company expressed in foreign currency, and the principal and interest in respect of which is payable in foreign currency.

Conditions for Issuance..

Having the maturity of the FCCB not less than 5 years.The call & put option, if any , shall not be exercisable

prior to 5 yearsIssuance of FCCBs only without any warrants attachedThe issue related expenses not exceeding 4% of issue

size and in case of private placement , shall not exceed 2% of the issue size, etc. as required in terms of Notification FEMA No. 120/RB-2004.

FCCBs are also subject to all the regulations which are applicable to ECBs.

Redemption of FCCBs

TERMS & CONDITIONS:-• Fresh ECBs / FCCBs shall be raised with the stipulated

average maturity period and applicable all-in-cost being as per the extant ECB guidelines.

• The amount of fresh ECB / FCCB shall not exceed the outstanding redemption value at maturity of the outstanding FCCBs.

• The fresh ECCB / FCCB shall not be raised 6 months prior to the maturity date of the outstanding FCCBs.

• The purpose of ECB/ FCCB shall be clearly mentioned as ‘Redemption of outstanding FCCBs’ in form 83 at the time of obtaining loan registration no from the Reserve Bank.

• ECB/FCCB beyond USD 500 million for the purpose of redemption of the existing FCCB will be considered under the approval route;

American Depository Receipts (ADR)

ADR is a stock that trades in stock exchanges in the United States.

A negotiable certificate issued by a U.S. bank representing a specified number of shares in a foreign stock that is traded on a U.S. exchange.

An ADR is listed in the U.S.

ADRs pay dividends in U.S. dollars.

ADRs are traded on either the New York Stock Exchange (NYSE), American Stock Exchange (AMEX) or the National Association of Securities Dealers Automated Quotations (NASDAQ).

The first ADR was introduced by J.P. Morgan in 1927 to allow U.S. investors to invest in share of a British department store.

Today there are more than 2,000 ADRs available representing shares of companies located in more than 70 countries.

How did ADRs start..

Due to complexities involved in buying shares of foreign countries.

These complexities involved trading at different prices and differing currency values.

So U.S. banks (acting as depositories) simply purchase a bulk lot of shares from the foreign company.

This bulk lot is then bundled into groups and re-issued on NYSC, NASDAQ and AMEX.

Then..In return, the foreign company provides

detailed financial information to the sponsor or depository bank.

The depository bank sets the Ratio of ADRs per actual share of the foreign company.

- For example. 10 shares of the foreign company may be equal to 1 ADR. So Ratio is pegged at 10:1

The ratio, typically called “ADR Ratio” could be less than or greater than 1

This ratio is set in such a way that an ADRs price is high enough to show substantial value, yet low enough to make it affordable for individual investors.

Pricing of an ADRLet us take an example – Suppose a recent

boom in the popularity of Bloody Mary drinks has increased the prospectus for the vodka industry. Russian Vodka Ltd. wants to list shares on the NYSE to gain exposure of the US market and to tap into the growing demand for vodka.

Russian Vodka Ltd. , already trades on the Russian Stock Exchange at 127 Russian roubles.

This is equivalent to US $4.58.

Now, a US bank purchases 30 million share of Russian Vodka Ltd. And re-issue them in the US at a ratio of 10:1

This means that each ADR you purchase is worth 10 shares on the Russian Stock Exchange.

A quick calculation tells us that each ADR should have an issue price of US $45.80 (US $ 4.58 per share x 10 shares) – since 10 shares equal to 1 ADR

Once an ADR is priced and sold, its subsequent price is determined by supply and demand factors, like an ordinary share.

Risk to InvestorsHere are some risks that investors should

consider:

Political Risk : The government in the home country of the ADR is not stable.

Exchange Rate Risk : Stability of the home

country’s currency needs to be assessed as well . If the country’s currency is devalued, it will trickle down your ADR. This will result in big loss, even if the company had been performing well.

Inflationary Risk : This is an extension of the exchange rate risk. Currency of a country with high inflation becomes less and less valuable each day. This can be a big blow to a company’s business due to reduced purchasing power and will reflect on its share price.

Types of ADR

TYPES

Sponsored

Level I

Level II

Level IIIUnsponsored

1. Unsponsored ADR Unsponsored shares trade on the over-the-

counter (OTC) market. These shares are issued in accordance with

market demand, and the foreign company has no formal agreement with a depository bank.

Unsponsored ADRs are often issued by more than one depository bank.

2 . Sponsored Level I ADRs (“OTC” facility)

Level I depository receipts are the lowest level of sponsored ADRs that can be issued.

When a company issued sponsored ADRs, it has one designated depository who also acts as its transfer agent.

This is the most convenient way for foreign company to have equity traded in the US.

Level I shares can only be traded in OTC market and the company has minimum reporting requirements with the U.S. (SEC).

3 . Sponsored Level II ADRs (“Listing” facility)

Level II depository receipt programs are more complicated for a foreign company.

When a foreign company wants to set up Level II program, it must file a registration statement with the SEC and is under SEC regulation.

This type of ADR is listed on U.S. Stock Exchange.

If the company fails to meet the exchange’s listing requirements, it may be de-listed and forced to downgrade its ADR program to Level I.

4 . Sponsored Level III ADR’s(“offering” facility)

This is the most prestigious of the three types of ADRs and is the highest level a foreign company can sponsor.

Because of this distinction, the company is required to adhere to stricter rules that are similar to those followed by U.S. companies.

Setting up a Level III program means that the foreign company is not only taking steps to permit shares from its home market to deposited into ADR program and traded into the U.S.; it is actually issuing shares to raise capital.

ADR TerminationMost ADR programs are subject to possible

termination.Termination of the ADR agreement will result in

cancellation of all the depository receipts, and a subsequent delisting from all exchanges where they trade.

Owners of the ADRs are typically notified in writing at least 30 days prior to a Termination.

Once notified, an owner can surrender their ADRs and take delivery of the foreign securities represented by the receipts, or do nothing.

Advantages of ADR1. Access to growth markets Many international markets, especially

emerging markets, have higher GDP growth rates than the U.S. and Europe.

While the American stocks in one’s portfolio may be providing disappointing returns, holding some ADRs could potentially, provide you with better prospectus.

After all, one of the most basic lessons of investing is to ensure that you are adequately diversified.

2. Benefit for currency swingsHolding ADR’s can result in favourable currency

conversions for dividends and other cash contributions.

3. Cost EffectiveADRs are an easy and cost effective way to buy

shares in foreign company. They save money by reducing administrative cost and avoiding foreign taxes on each transaction.

4. More US exposureForeign entities favour ADRs because they get

more US exposures, allowing them to tap into the wealthy North American equity markets.

Disadvantages of ADR

1. Foreign exchange risk It is important to bear in mind that although

your investment is valued in US dollars, and dividends are paid in that currency, the underlying investment is still exposed to foreign exchange fluctuations which can significantly increase the overall volatility of your financial return.

2. Selection Choice Unfortunately, not every foreign company

makes it stock available through this method, often because they do not feel it as necessary to access US markets in this way.

3. IlliquidityEven if a company does offer this type of

instrument, trading may be thin (especially if the company is not well-known in the US) and, as a result, it could be difficult to either acquire or dispose of the investment in accordance with your desired timelines. Accordingly, these investments may not be suitable unless you are looking to hold them for the long-term.

4. Additional FeesThe holding vehicle for the underlying shares

incurs a number of incremental expenses in managing the entire process, compared to regular stocks, and will pass these on to the investors- usually by deducting them from dividends.

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