Concept of International Finance There is a growing tendency among business firms to operate business in other countries.

It is important for finance managers, in particulars, and other managers, in general, to understand the process and methods of dealings in foreign exchange markets. Knowledge of international finance has assumed considerable importance in todays business environment. International Finance: Importance Todays business scenario, companies need to be globally competitive in order to survive for long. Knowledge of

different countries economics and their markets is must for establishing oneself as a global player. Studying international finance helps a finance manager to understand the global market. It is not only important for the companies having international operations, but also equally important for domestic companies. Though they are operating domestically, some of their inputs may be imported from other countries. So, the knowledge of foreign markets and foreign exchange dealings are very necessary. Foreign Exchange Markets

Different countries have different currencies. The foreign exchange market provides a forum where the currency of one country is traded for the currency of another country. Some of the popular currencies ( ) are , , , $, Rs. Foreign exchange (FE) markets deal with a large volume of funds as well as large number of currencies. For this reason, they are not only the world wide markets but also the worlds largest financial markets. Though there are foreign exchange markets in all countries, London, New

York, and Tokyo are the nerve centers of foreign exchange activity. The large commercial/ investment banks and central banks of the countries are principal participants in the FE markets. Business firms normally buy and sell currencies through a commercial banks. Foreign Exchange Dealings Exchange Rate: Different countries have different currencies. Exchange rate is the price of one currency expressed in terms of the currency of another country. For instance, a rate of Rs.54 per US $ implies that one US $ costs Rs. 54 in

Indian Currency. Alternatively, one rupee is equal to US $ 0.0185. Direct and indirect quotation A foreign exchange quotation/rate can be either direct or indirect. Direct quotation: A direct quote is the quote where the exchange rate is expressed in terms of number of units of the domestic currency per unit of foreign currency. Example: Rs. 54 = $ 1, Rs. 76.80 = 1, Rs. 50.55 = 1 etc.

Indirect quotation: An indirect quote is the quote where the exchange rate is expressed in terms of number of units of the foreign currency per unit of domestic currency. Example: $ 0.0185 = Rs. 1 is an indirect quotation in India. Likewise, 0.01302 = Rs. 1, 0.01978 = Rs. 1 etc. Direct quotations are known as European quotations and indirect quotations are known as American quotations In India before August 2, 1993 indirect method of quoting exchange rates were

used. Since that date the direct quote is being used. In other countries, the concept of American and European quotes are more popular in comparison to direct and indirect quotes. Two-way Quotations /Rates In practice, banks (or dealers) quote two way rates: one for buying the foreign currency (known as bid price/rate) and another for selling the foreign currency (known as ask price/rate) Since dealers expect profit in foreign exchange operations, two rates can not

be the same. Generally, bid rate is a lower rate and the ask rate is a higher rate. Some of the conventions of these rates: Suppose a dealer in Delhi quotes: Rs./$: 48.62/48.72 It means 48.62 is the bid price and 48.72 is the ask price The bid price and ask price are separated either by a slash (/) or a dash sign (-) Example: Rs/: 78.00/78.15 or Rs/: 78.00-78.15

Spread: Spread is the difference between the ask price (sales price) and the bid price (purchase price) Spread to the dealer is like the gross profit for a business firm, out of which he/ she is to meet its establishment expenses. In percentage terms, spread can be expressed by the following two equations: Spread (percent) w.r.to ask price = [(Ask Price Bid Price)/ Ask Price] x 100

Spread (percent) w.r. to bid price = [(Ask Price Bid Price)/ Bid Price] x 100 Suppose a 48.62/48.72 dealer quotes: Rs/$:

This implies that Rs.48.62/$ is the bid price and Rs.48.72/$ is the ask price. Now, Spread (percent) w.r.to ask price = [(48.72- 48.62)/48.72]x100 = 0.205% Spread (percent) w.r.to bid price = [(48.72- 48.62)/48.62]x100 = 0.206% Spread appears to be very low, but as the volume of business is very high, total gross return will also be higher.

Spot Rates and Forward Rates Spot exchange rates are applicable to the purchase and sale of foreign exchange on an immediate delivery basis. Though, in practice, delivery actually takes place with in two working days. Thus, spot rate is the rate of day on which the transaction has taken place, though the execution of transaction occurs with a maximum of two working days. Suppose Air India purchased an st Aircraft on 1 March from a US firm. Spot exchange rate is the exchange rate on 1st

March, though actually delivery may take rd place on or before 3 March. On the other hand, Forward Exchange Rates are applicable for the delivery of foreign exchange at a future date. If Air India is to make payment after 90 days, as per the credit terms from the US firm, it has two alternatives: First, on due date of payment (i.e. after 3 months) the company can purchase the due sum of US $ from the spot market, at the spot rate on that time and then remit the payment to the US firm.

Second, to avoid the uncertainty of the exchange rate after three months, the company can purchase the required US $ in the forward market at a forward exchange rate. The agreed forward rate is valid for settlement on the due date (i.e. after 3 months) irrespective of actual spot rate on that time. For example, on 1 March, the 3 months forward rate is Rs. 48 per US $, st while on 1 June ( i.e. after 3 months) the actual spot rate is Rs. 49 per $. If the company purchase the US $ at 3-months forward rate, then on 1st June the exchange rate will be Rs. 48 per $ instead of Rs. 49 per $.
st

Example On 1 January, an Indian firm exports goods of the value of US $ 100 million on st 6 months credit. On 1 January, the six months forward rate is Rs. 49 per US $. The firm agrees to sell Us $ 100 million at st Rs. 49 on 1 July. Suppose the actual spot st rate is Rs. 48.50 per US $ on 1 July. Calculate the actual gain/ loss of the Indian firm for this contract. In general, spot rates as well as forward rates have two way quotes: bid rate and ask rate. Theoretically, forward rates can be for any number of months or even fraction of a month. In practice,
st

forward rates are normally quoted for 1 month, 2 months, 3 months, 6 months, 9 months, and 12 months. Premium or Discount Forward rates can be at a premium or discount. Forward rates are at premium when the forward rates are higher than the spot rates. On the other hand, forward rates are at discount when the forward rates are lower than the spot rates. Forward rate premium or discount can be calculated by the following two equations:

Premium (percent) = Discount (percent) = N= number of months for which forward contract has been made. From the following data calculate forward premium or discount of the US$ in relation of the rupee Prob. : The following rates appear in the foreign exchange market: Spot rate 2 M Forward rate

Rs./$ Rs. 49.50/50.00

48.80/49.05

Rs.

Are forward rates at premium or discount? Determine the percentages also Cross Rate/ Synthetic rate When a direct quote of the home currency or any other currency is not available in the forex market, it is computed with the help of exchange rates of other pairs of currencies, known as cross rate or synthetic rate. Generally dollar is used as the intermediate currency to calculate the exchange rates of other currencies

example: Suppose an Indian importer needs to pay a Canadian export firm in Canadian Dollar (can $). The direct quote of Indian rupee and can $ is not available, but following rates are given: can $/US $: 1.7908 - 1.8510 Rupee/ US $ : 48.0465 48.2111 Determine the exchange rate between Indian rupee and Canadian dollar (Re/Can $) To determine Rs./ Can $ exchange rate, following steps are to be considered: First step:

Buy the US $ at the ask rate of the dealer Second step: Sell the US $ to buy the Canadian $ Third Step: Determine the exchange rate 1 step: The Indian importer is to buy US $ at the rate of Rs. 48.2111, because this is the ask rate of the dealer 2 step: Can $ 1.7908 is the purchase/ bid price of the dealer. So, Indian importer gets 1.7908 can $ by selling 1 US $
nd st

3 Step: The Indian importer gets can $ 1.7908 in exchange for Indian Rs. 48.2111. Therefore, the Rupee/Can $ exchange rate is Rs.48.2111/1.7908 = Rs. 26.9215/Can $ Rs. 26.9215/can $ is the selling rate from the view point of the dealer. This is one quote of the cross rate. To complete the quote, bid rate is required. For this, following steps are to be considered: 1 . The dealer purchase 1 US $ for Rs. 48.0465 2 . The dealer sells 1 US $ for 1.8510 Can $ 3 .: Now 1.8510 Can $ = Rs. 48.0465
rd nd st

rd

Thus the bid rate is : Rs./Can$: 48.0465/ 1.8510 = Rs.25.9570/Can $ The complete code is: Rs./Can$: Rs.25.9570/26.9215 These rates can be generalized as: Synthetic (A/C)bid = (A/B)bid x (B/C)bid Synthetic (A/C)ask = (A/B)ask x (B/C)ask A,B and C are three currencies If instead of (B/C) rates, the (C/B) quote is available then Synthetic (A/C)bid = (A/B)bid x 1/(C/B)ask Synthetic (A/C)ask = (A/B)ask x 1/(C/B)bid

Prob. From the following rates, determine Rs. / Can $ exchange rate: Rs./ Us $: Rs. 47.7568/47.9675 Can$/ US $: 1.5142/ 1.5450 2. Determine CHF/Can $ from the following : CHF/$: 1.5669/1.5676 $/Can $: 0.6527/0.6534 Arbitrage process: The term Arbitrage, in the context of forex markets refers to an act of buying currency in one market (at lower price)

and selling it in another market (at higher market). Thus, the difference in exchange rates in two markets provides an opportunity to the operator to earn profit. Arbitrage process in the spot markets: In the context of spot markets, two types of arbitrages are possible: a) Geographical arbitrage and b) triangular arbitrage Geographical Arbitrage: Geographical arbitrage consists of buying currency from a cheaper market and selling at another market where it is

costly. Since forex transactions primarily take place with the help of IT, the geographical distance does not have much relevance. Example: At two forex centres, the following RS./US $ rates are quoted: London: Rs. 47.5730 47.6100 Tokyo : Rs. 47.6350 47.6675 Find out arbitrage possibilities for an operator who has Rs. 1 cr. Following steps will be taken by the operator: The operator will buy US $ from the London forex market at the rate Rs.

47.6100, as it is cheaper compared to Tokyo market (Rs. 47.6350) where he can sell. He will get Rs. 1 cr. / Rs. 47.6100 = US $ 210039.9 Now he will sell US $ 210039.9 at the rate of Rs. 47.6350 per US $ at Tokyo forex market and will get 210039.9 x 47.6350 = Rs. 10005250 Thus as a result of arbitrage, he will earn a profit of Rs. 5250 (10005250 10000000) Now assume that the Rs./ US $ rate at London remains unchanged, but there is a change in the Tokyo rate.

London : Rs. 47.5730 47.6100 Tokyo : Rs.47.6000 47.6450 Are there possibilities? any arbitrage gain

Though the London Rs/ $ is cheaper compared to that of Tokyo, there are no arbitrage gain possibilities because: The operator buys US $ at the London Forex market at the rate of Rs. 47.6100 per $. Then he can sell $ in the Tokyo market only at the lower rate of Rs. 47.6000. Thus, he will suffer losses. So, there is no arbitrage gain possibility.

For gain in arbitrage process the selling rate in one forex market should be higher than the buying rate. Prob.: Rates of the rupee and euro in the international market are US $ 0.0209 and US $ 1.0768 respectively. What direct quote of US $ and will be provided by a foreign dealer in India? Spot rate of the Euro in New York is US $ 1.0542 and of the rupee is US $ 0.0205 . What will be the price of the Euro in India? Foreign Direct Investment

Foreign Direct Investment (FDI) refers to direct investment by a corporation in a commercial venture in another country. FDI can be done in a number of ways: 1. By establishing a new corporate in the foreign country 2. By making further investments in an existing foreign branch or subsidiary 3. By acquiring an existing foreign business enterprise or purchasing its assets Reasons for FDI

1. Increase sales and profits 2. Reduce costs: If the various inputs like raw materials, human resources etc. are available in foreign countries at lower price, cost of production can be reduced. 3. Competitive advantages: Companies which enjoy competitive advantages through trade mark, brand name, technology etc. go for FDI to take competitive advantages in various foreign markets. 4. Avoid trade barriers: Companies establish production facilities in foreign markets to avoid trade barriers like high export tariffs.

5. Enter fast growing markets: The first growing international markets provide better opportunity to MNC for their business growth 6. Acquire Technological and Managerial Know- how: Better technological and managerial know-how may not be available in the home country. 7. Business Expansion: Companies may sometimes need to expand business in another country due to non- availability of opportunities in the domestic market. 8. Product Life Cycle: Firms establish manufacturing facilities in foreign

countries when the product reaches maturity stage in the home country. FDI INFLOWS during 1996-2005 FDI in India Indian economy was opened up in 1991 Major Sector wise FDI inflows in India (April 2000 December 2009) Status of FDI in different states of India Delhi, Maharashtra, Karnataka, Tamil Nadu and Gujarat are the leading states of India that have attracted maximum FDI.

Other states which are in the receipt of FDI inflows in India include Andhra Pradesh, Haryana, West Bengal, Kerala and Uttar Pradesh.