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Master of Business Administration - MBA Semester 4
Subject Code –MF0006

Subject Name –International Financial Management

2 Credits

(Book ID: B0889)
Assignment Set- 2 (30 Marks)

Note: Each question carries 10 Marks. Answer all the questions.

Q1. What is meant by BOP? How are capital account convertibility and current account

convertibility different? What is the current scenario in India?

Q2. What are foreign exchange markets? Who are the players in the foreign exchange

market? What is meant by exchange rate quotations?

Q3. Distinguish between Eurobond and foreign bonds? What are the unique characteristics

of Eurobond markets?


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Q3. Distinguish between Eurobond and foreign bonds? What are the unique characteristics of Eurobond markets?
Foreign Bonds
A country’s foreign bond market is that market in which the bonds of issuers not domiciled in that country are sold and traded. For example, the bonds of a German company issued in the U.S. or traded on the U.S. secondary markets would be part of the U.S. foreign bond market. The definition of "foreign" refers to the nationality of the issuer in relation to the market place. For example, a US dollar bond sold in the United States by the Swedish car producer Volvo is classified as a foreign bond while one issued by General Motors is a domestic bond.
Features of the Foreign Bonds:
1. Foreign bonds are sold in the currency of the local economy.
2. Foreign bonds are subject to the regulations governing all securities traded in the national market and sometimes special regulations governing foreign borrowers (e.g., additional registration).
3. Foreign bonds provide foreign companies access to funds they often use to finance their operations in the country where they sell the bonds.
4. Foreign bonds are regulated by the domestic market authorities. The issuer must satisfy all regulations of the country in which it issues the bonds.

Eurobond
A Eurobond is a bond issued outside the country in whose currency it is denominated. A Eurodollar bond that is denominated in U.S. dollars and issued in Japan by an Australian company would be an example of a Eurobond. The Australian company in this example could issue the Eurodollar bond in any country other than the U.S. Usually, a Eurobond is underwritten by a multi-national syndicate of investment banks and simultaneously placed in many countries. For example, to raise funds to finance its European operations, a U.S. company might sell a bond denominated in British pounds throughout Europe.
Features of the Eurobonds:
1. Currency denomination: The generic, plain vanilla Eurobond pays an annual fixed interest and has a long-term maturity. There are a number of different currencies in which Eurobonds are sold. The major currency denominations are the U.S. dollar, yen, and euro. (70 to 75 percent of Eurobonds are denominated in the U.S. dollar.) The central bank of a country can protect its currency from being used. Japan, for example, prohibited the yen from being used for Eurobond issues of its corporations until 1984.
2. Non-registered: Eurobonds are usually issued in countries in which there is little regulation. As a result, many Eurobonds are unregistered, issued as bearer bonds. (Bearer form means that the bond is unregistered, there is no record to identify the owners, and these bonds are usually kept on deposit at depository institution). While this feature provides confidentiality, it has created some problems in countries such as the U.S., where regulations require that security owners be registered on the books of issuer.
3. Credit risk: Compared to domestic corporate bonds, Eurobonds have fewer protective covenants, making them an attractive financing instrument to corporations, but riskier to bond investors. Eurobonds differ in term of their default risk and are rated in terms of quality ratings.
4. Maturities: The maturities on Eurobonds vary. Many have intermediate terms (2 to 10 years), referred to as Euronotes, and long terms (10-30 years), and called Eurobonds. There are also short-term Europaper and Euro Medium-term notes.
5. Other features:
1. Like many securities issued today, Eurobonds often are sold with many innovative features. For example:
a. Dual-currency Eurobonds pay coupon interest in one currency and principal in another.
b. Option currency Eurobond offers investors a choice of currency. For instance, a sterling/Canadian dollar bond gives the holder the right to receive interest and principal in either currency.
1. A number of Eurobonds have special conversion features. One type of convertible Eurobond is a dual-currency bond that allows the holder to convert the bond into stock or another bond that is denominated in another currency.
2. A number of Eurobonds have special warrants attached to them. Some of the warrants sold with Eurobonds include those giving the holder the right to buy stock, additional bonds, currency, or gold.


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Q2. What are foreign exchange markets? Who are the players in the foreign exchange market? What is meant by exchange rate quotations?
foreign exchange markets
The foreign exchange market is the largest and most liquid market in the world. The estimated worldwide turnover of this market is at around $1½ trillion a day, which is several times the level of turnover in the U.S. Government securities market, which is the world’s second largest financial market. The turnover in the foreign exchange market is equivalent to more than $200 in foreign exchange market transactions, every business day of the year, for every man, woman, and child on earth!
The foreign exchange market is a twenty four hour market. Each business day arrives first in the financial centers of Asia-Pacific —first Wellington, then Sydney followed by Tokyo, Hong Kong, and Singapore. A few hours later, while markets are still active in these Asian centers, trading begins in Bahrain and at other places in the Middle East. Later, when it is late in the business day in Tokyo, markets open for business in Europe. When it is early afternoon in Europe, trading in New York and other U.S. centers begin. Finally, completing the circle, when it is mid or late afternoon in the United States, the next day has arrived in the Asia-Pacific area, the first markets there have opened, and the process begins again.
The foreign exchange market consists of both an over-the-counter (OTC) market and an exchange-traded segment of the market. The OTC market is an international OTC network of major dealers – mainly but not exclusively banks – operating in financial centers around the world, trading with each other and with customers, via computers, telephones, and other means. The exchange-traded market covers trade in a limited number of foreign exchange products on the floors of organized exchanges.
The OTC market accounts for well over 90 percent of total foreign exchange market activity, covering both the traditional (pre-1970) products (spot, outright forwards, and FX swaps) as well as the more recently introduced (post-1970) OTC products (currency options and currency swaps). On the “organized exchanges,” foreign exchange products traded are currency futures and certain currency options.

the players in the foreign exchange market
There are three types of participants in the foreign exchange market: customers, banks and brokers. Customers, such as multinational corporations, are in the market because they require foreign currency in the course of their cross border trade or investment business. For example, an engineering firm based in the United Kingdom might use the foreign exchange market to buy the dollars it needs to pay to a firm in the USA that is selling it capital goods; in this case, it would sell pounds and buy dollars. Commercial banks are by far the most active participants in the foreign exchange market. They deal with other financial institutions and corporations who contact them, typically by telephone, to ask for their rates, and may then buy foreign currency from, or sell, to the bank at those rates. This process is known as market making: the banks will at all times quote buying (bid rates) or selling rates (ask rates) for pairs of currencies – dollars to the pound, Japanese yen to the euro and so on. The market makers earn a profit on the difference between their buying and selling rates (spread). The third type of participant, the brokers, who act as intermediaries between the banks. They are specialist companies with computer links or telephone lines to banks throughout the world so that at any time they know which bank has the highest bid (buying) rate for a currency, and which the lowest offer (selling) rate.

exchange rate quotations
Direct and Indirect Quotes
Exchange rate quotes, as the price of one currency in terms of another, come in two forms:
a) “Direct” quotation is the amount of domestic currency per unit of foreign currency. Example: Rs. 77.30 / £ in India, $1.7676 / £ in US and
b) “Indirect” quotation is the amount of foreign currency per unit of domestic currency. Example Swedish Kroner 0.1763/Rs in India, 0.8251 Euro/$ in US.

European and American Terms
The phrase “American terms” means a direct quote from the point of view of someone located in the United States. For the dollar, that means that the rate is quoted in variable amounts of U.S. dollars per one unit of foreign currency (e.g., $1.2119 per Euro). The phrase “European terms” means a direct quote from the point of view of someone located in Europe. For the dollar, that means variable amounts of foreign currency per one U.S. dollar (or Euro 0.8251 per $1).
In daily life, most prices are quoted “directly,” so when you go to the shop you pay x dollars and y cents for one loaf (unit) of bread (in US). For many years, all dollar exchange rates also were quoted directly. That meant that the dollar exchange rates were quoted in European terms in Europe, and in American terms in the United States of America. However, in 1978, as the foreign exchange market was integrating into a single global market, for convenience, the practice in the U.S. market was changed – at the initiative of the international broker community – to conform to the European convention. Thus, OTC markets in all countries now quote dollars in European terms against nearly all other currencies (amounts of foreign currency per $1). That means that the dollar is nearly always the base currency, one unit of which (one dollar) is being bought or sold for a variable amount of a foreign currency. The only exceptions to this convention are quotes in relation to the euro, the pound sterling and the Australian dollar – these three are quoted as dollars per foreign currency.


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Q1. What is meant by BOP? How are capital account convertibility and current account convertibility different? What is the current scenario in India?

The balance of payments(or BOP) of a country is a record of international transactions between residents of one country and the rest of the world over a specified period, usually a year.Thus, India’s balance of payments accounts record transactions between Indian residents and therest of the world. International transactions include exchanges of goods, services or assets. Theterm “residents” means businesses, individuals and government agencies and includes citizenstemporarily living abroad but excludes local subsidiaries of foreign corporations.The balance of payments is a sources-and-uses-of-funds statement. Transactions such as exportsof goods and services that earn foreign exchange are recorded as credit, plus, or cash inflows (sources). Transactions such as imports of goods and services that expend foreign exchange arerecorded as debit, minus, or cash outflows (uses).The Balance of Payments for a country is the sum of the Current Account, the CapitalAccount and the change in Official Reserves
.The current account is that balance of payments account in which all short-term flows of payments are listed. It is the sum of net sales from trade in goods and services, net investmentincome (interest and dividend), and net unilateral transfers (private transfer payments andgovernment transfers) from abroad. Investment income for a country is the payment made to itsresidents who are holders of foreign financial assets (includes interest on bonds and loans,dividends and other claims on profits) and payments made to its citizens who are temporaryworkers abroad. Unilateral transfers are official government grants-in-aid to foreigngovernments, charitable giving (e.g., famine relief) and migrant workers’ transfers to families intheir home countries. Net investment income and net transfers are small relative to imports andexports. Therefore a current account surplus indicates positive net exports or a trade surplusand a current account deficit indicates negative net exports or a trade deficit.The capital(or financial) account is that balance of payments account in which all cross-border transactions involving financial assets are listed. All purchases or sales of assets, including directinvestment (FDI) securities (portfolio investment) and bank claims and liabilities are listed in thecapital account. When Indian citizens buy foreign securities or when foreigners buy Indiansecurities, they are listed here as outflows and inflows, respectively. When domestic residents purchase more financial assets in foreign economies than what foreigners purchase of domesticassets, there is a net capital outflow
. If foreigners purchase more Indian financial assets thandomestic residents spend on foreign financial assets, then there will be a net capital inflow
. A capital account surplus indicates net capital inflows or negative net foreign investment. A capital account deficit indicates net capital outflows or positive net foreign investment.

Current scenario in India
The official reserves account (ORA)records the total reserves held by the official monetaryauthorities (central banks) within the country. These reserves are normally composed of themajor currencies used in international trade and financial transactions. The reserves consist of “hard” currencies (such as US dollar, British Pound, Euro, Yen), official gold reserve and IMFSpecial Drawing Rights (SDR). The reserves are held by central banks to cushion againstinstability in international markets. The level of reserves changes because of the central bank’sintervention in the foreign exchange markets. Countries that try to control the price of their currency (set the exchange rate) have large net changes in their Official Reserve Accounts. Ingeneral, a net decrease in the Official Reserve Account indicates that a country is buying itscurrency in exchange for foreign exchange reserves, to try to keep the value of the domestic currency high with respect to foreign currencies. Countries with net increases in the OfficialReserve Account are usually attempting to keep the price of the domestic currency cheap relative to foreign currencies, by selling their currencies and buying the foreign exchange reserves. Whena central bank sells its reserves (foreign currencies) for the domestic currency in the foreignexchange market, it is a credit item in the balance of payment accounts as it makes availableforeign currencies. Similarly, when a central bank buys reserves (foreign currency), it is a debititem in the balance of payment accounts.The Balance of Payments identity states that:
Current Account + Capital Account = Changein Official Reserve Account.
If a country runs a current account deficit and it does not run downits official reserve to cover this deficit (there is no change in official reserve), then the currentaccount deficit must be balanced by a capital account surplus. Typically, in countries withfloating exchange rate system, the change in official reserves in a given year is small relative tothe Current Account and the Capital Account. Therefore, it can be approximated by zero. Thus,such a country can only consume more than it produces (or imports are greater than exports; acurrent account deficit) only if it has a capital account surplus (foreign residents are willing toinvest in the country). Even in a fixed exchange rate system, the size of the official reserveaccount is small compared to the transactions in the current and capital account. Thus theresidents of a country cannot have a current account deficit (imports exceeding exports) unlessthe foreigners are willing to invest in that country (capital account surplus).


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