INTERNATIONAL FINANCIAL MANAGEMENT

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ROAD MAP
Forex Markets: Nature and working of forex markets. Understanding exchange rates, quotations and trading. Financial instruments in the international markets - Spots, forwards, futures and options. Foreign exchange markets and money markets Exposure and Risk: The concepts of exposure and risk - Foreign exchange risk, transactions exposure and translation exposure, economic exposure and competitive exposure. The concept of hedging. Exchange Rate and Interest Rate Determination Theories: Interest rate parity and covered interest arbitrage, equilibrium in the exchange and money markets, purchasing power parity, Fisher's effect and international Fisher's effect. Evolution of International Financial Management: Emergence of Multinational companies. The finance functions in MNCs. Dynamics of international markets and financial instruments International Investment: Evaluating international cash flows, project appraisal and currency risk evaluation, cost of capital and capital budgeting decision, international investment strategies, active and passive, optimal international portfolios. International Financing: Rising capital in international markets. Sources of long-term finance for MNCs - Foreign bonds and Euro bonds, international bond markets. Rising finance in the international capital markets - ADRs and GDRs. Working capital financing in MNCs.

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Exchange Rate Management

Forex is round the Clock Market Players in the Market

Authorized Persons
Banks FI Money Changers

Regulatory Framework
FEMA RBI Government Departments
MOF, MOC etc

Brokers Merchants Regulators Speculators/Hedgers

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Export Promotion Councils Exim Bank of India ECGC of India

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Foreign Exchange Markets

What is foreign exchange
Regulatory framework Exchange rate
Concept of Forward rates Forward premium & discount Fixed date forward & Option forwards Early Delivery and Cancellation

Concept of Spot , tom & cash rates & Settlement dates

Currency Swaps
Simultaneous buy & sell of the currency with different maturity dates Receiving the premium & paying the premium

Dealing Room operations

Position Sheet, Long & Short positions Cover operation & Square position Concept of arbitrage Merchant rates
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Gap Position Concept of Revaluation

Record the following transactions

Date 4.03.09
Mr. Samantha is export manager of Landslide inc. The company is exporting garments to Euro zone countries. The Company received export proceeds to their account with ICICI Bank. Amount is Euro 500,000/ The Company submitted export bill to the Bank . Invoice value is US$500,000/. The exporter provided 3 months usance to the buyer. The buyer has to pay US$500,000/ 3 months from now The Company is importing capital equipment worth US$1,000,000. The equipment will be received 6months from now.Mr. Samantha committed to pay US$1,00,000/ as advance payment. Bank is quoting the following rates on March 4th ,2009.
Spot to March 20.00/21.50 April 40.00/40.50 May 60.00/61.00 June 80.00/82.00

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Exchange Rate Management

contd

Concept of Exchange rate US$=Rs48.9000/50 ; US$= Euro0.6000/0.6025 Base Currency & Uniform currency code (swift) Two Way Quotes Bid & Ask rates Spread Level quotes Direct quote Country specific one unit of FC= x units of domestic currency us$=rs50.9000/50direct quote in India ;CHF= $0.6876/86 in US Indirect Quote in India Rs100=US$1.9646/50 Unit of domestic currency is expressed in FC units Rs100=US$2.0202/05 Quotations in European terms/American terms In European terms base currency is US$. In American terms base currency is FC and the other currency is US$ Jpy120.50/US$ ;Rs50.22/US$ European terms ; S$1.6050/GBP; USD1.4500/EUR American Terms

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Indian Forex Market

Flow in FX Markets
RBI

Inter bank Market B

Correspondent Banks

C
Money Changers

Exporters, Importers, remitters,& others

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Dealing Room setup

Client

Branch

Global Markets

Front Office

Domestic Markets

Mid Office

Back Office

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Process flow in a merchant transaction

Remittance

Back office

export imports

Merchant
Market rate

Branch

Front Office

Add margin & Give rate Client takes rate

Records transaction in books

Rate is given

Not OK reject

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Functions Of Dealing Room

Front Office Merchant Inter Bank Transactions Spot Outright Cross Currency deals Swaps Back Office Merchant & Inter Bank Transactions Funds settlements Maintenance Of Bank Accounts Reconciliation of Bank accounts Mid-office Control functions Policy Guidelines MIS

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Exercise on exchange rates

Compute the exchange rates 1. US$/Rs:51.7500/00 Rs/Yen:.2.11/2.15 Find US$/Yen : 2. US$/Rs:Rs52.4550/75 100Yen= Rs.47.6875/00 Find Rs/Yen 3. US$/CHF:1.5675/79 CHF/GBP:0.8810/15 Find US$/GBP

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Real Time Currency Rates

13 March 2009
USD USDGBP EUR JPY GBP EUR 1.2886 0.9234 xxx 126.6320 Jpy 0.01018 0.00729 0.00790 xxx xx 1.3956 0.7165 xx 0.7760 1.0830 98.2750 137.1525

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Forward Rates
Any Day after Spot Factors Influence Forward Rates
Supply and Demand for Currency Interest Rate Differential Fundamentals of the Economy Balance of Payments Political Issues Market Perception

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Types of Transactions & Settlement dates

Cash/ Ready Rate Tom Rate Spot Rate Forward Rate Arriving to settlement dates Spot deal done on Monday $/Yen . Wednesday is a holiday in Tokyo/or New York. Spot is on Thursday Deal done between London bank and Paris Bank Tuesday is a holiday in London but not in Paris . Two business days in Paris work out to be Wednesday and in London it would be Thursday. If London bank calls for the quote the value date would be Wednesday as that day is a working day for market . If London Bank is market maker Thursday would be the settlement date One month forward for a deal done on 20th Feb would be 22nd March
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Notation in Forward premium / discount

Premium=> ascending from left to right Spot to end December 15/17 Jan 30/33 Feb 46/49 Mar 61/64 Apl Spot first week 04/05 First fortnight 08/09 First month 16/18 Second month 32/35 Third month 46/ 49 Arrive to forward bid ask rates Discount => descending from left to right Spot to end December 19/17 Jan 36/33 Feb 53/49 Mar 65/64 Spot first week 07/05 First fortnight 11/09 First month 20/18 Second month 36/35 Third month 53/49 Arrive to forward bid ask rates

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Computation of premium & discount

Interest rate differential is reason for forward premium or discount (covered interest arbitrage) Spot $/Rs 48.9000/9100. Interest rate in India 10% in US 5%. Arriving to Swap points for 90 day period Invest Rs48.9050 millions at 10% for 90 days. You get interest of Rs1.222625 millions. Invest US1Million @5%for 90day period. You get US$ 12500 At the end of 90 day period you will have Rs50.127625mio and US$1.012500 We can arrive forward rate US$1,012,500=Rs50,127,625=>$=49.5087Swap points Rs.49.5087Rs48.9050=0.6037 (no adj of pips) Dollar is in premium, rupee is in discount. To buy a dollar in future I have to part more rupees Rate of interest in India > rate of Interest in US Currency of the economy where interest rate is lower will be in premium with respect to the other currency In annualized rates 0.6037*360* x100/90*48.9050=Annualized premium 4.937724%

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Forward points-Another example Spot rate Euro=Rs73.3500/50

Interest in euro zone 7% Interest rate in India 5%

Find out swap points for 90 day period

Interest on rupee investment .91690625millions ( take mid rate) Interest in euro investment 0.0175 millions Euro1.0175 million=Rs74.26940625=>euro=Rs72.9920 Euro is in discount with respect to Rupee, Rupee is in premium Annualized discount rate 1.965816%

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Some computations of forward rates

1. Compute INR/Yen rates
USD/INR one month forward 51.5075/00 USD/JPY one month forward 110.50/75 Inverse rate USD/INR:0.0194137/0.01941 46 INR/JPY:2.14521385/2.1501 6695 2. Compute forward bid/ask rates USD/Rs: 51.2350/75 Forward premium one month 12/13 two months 23/24 three months 33/34
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3.Compute forward rates USD/CHF spot: 1.7855/59 USD/CHF one month forward: 1.6825/29 Mid rate spot :1.7857 Mid rate fwd : 1.7682 Forward points (1.76821.7857):175pips per month (discount) Annualized (.0175x12x100)/1.7857=11.76%( discount) 4. Spot USD/INR:51.2500/2650

two month forward 51.4200/4300 Forward premium 1.96%

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Basics on rate computations

Merchant Quotations Margins
TT Buying/Selling Bill Buying /Selling ( with concept of usance) TC Buying /Selling

Why Merchants book Forward Contract Outright Forward quotations

Fixed forward Option Forward Broken date contracts

Short date contracts Mechanics of Forwards In Position Sheet Indian Scenario Forward Purchase Forward Sale Mathematics of Forwards Delivery on due date /Early Delivery/Cancellation and Roll Over

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Dealers Terminology
Buy/ Sell Mine/Yours Long/Short Square Position Cover Operation Receive/ Pay Overnight Limits/Day Light Limits/ Intra Day Limits Gap Limits-IGL/AGL Stop Loss Limits Revaluation Profit

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Some Important Issues

Rolling forward should not go into next calendar month
Deal done on Jan 26 (outside India) for one month forward Spot is Jan 28th from there one month would be 28th feb if , it happens to be holiday 27th feb would be maturity date.

Odd date contracts

Broken date contracts other than month end or week end , separate computation would be done.

Outright forwards
Either purchase or sale will be booked . This forward can be option forward or fixed forward

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Two point arbitrage

Market quotes are /$ =1.6556/60 at bank A; /$=1.6548/1.6550 at bank B  What do I do ?  I buy pound sterling from B by giving 1.6550 and sell to bank A and take $1.6556 from bank  Arbitrage takes place  Market quotes are /$ =1.6556/60 at bank A;/$=1.6550/1.6558 at bank B , will arbitrage take place?  Two point arbitrage takes place depending on quotes, buying one currency at one market and selling in another market is two point arbitrage

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Two point arbitrage contd

Check the rates available give scope to arbitrage or not ? $/=0.6590/95 in New York
Inverse quote at Frankfurt Euro=$1.5163/1.5174(implied rates)

Quote at NY : =$1.5178/1.5178 Buy euro at NY paying 1.5174 dollars and sell at Frankfurt and get 1.5178 dollars and make money.

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Concept of boundaries
Take two pairs of currencies US$/CHF: 1.5525/35
Implied rates of CHF/US$:0.6437/0.6441

CHF/Rs:34.5025/75
Implied rates of Rs100/CHF:2.8979/83

What should be my quote for US$/Rs Method 1:1.5525x34.5025; 1.5535x34.50 =53.5650;53. 5950
bid bid
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ask ask
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Cross rates & three point arbitrage

US$/JPY= 95.00/96.00 ; US$/=0.6570/75 in NY /jpy=140.50/141.50 in Frankfurt Is there any arbitrage opportunity? Option 1: give 0.6575 euro and take $, give $ and take jpy95 then for one euro you will get 144.48 yen. Option 2 : give 141.50 yen get one euro .if you give one euro you will get 1/0.6575 $ . i.e 1.5209 $ if you give 1.5209 $ you will get 144.48 yen there is a margin of 144.48 141.50= yen 2.98 No arbitrage conditions & computing synthetic rates

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Currency Swaps Concept of Swap

Buy-Sell swap Sell-Buy Swap

Application of Swap
Cover the Merchant Forward position Speculation on Interest rate Movements Forex & Money market arbitration

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Application of swaps

Speculation on Interest rate movement Cover Operations Money market arbitrage

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Foreign Exchange Contracts

Contracts should be for Specific amount and period If the Bill is for different maturities, book different contracts Option delivery must state start date and end date Ready or Cash Transaction shall be deliverable on same day Value Next contract shall be deliverable on immediate next working day Spot Contract is deliverable on 2nd succeeding business day

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Building A Position Book

Opening balance $/Rupee +523400 on 2/1/09 Sold April $500,000 Sold $ to importer A $200,000 value date spot Bought $ from B $ 300,00 value date 31/1/09 Sold to bank C $300,000 value date 25/1/09 Sold to ban D $500,000 value date cash Sold to bank E $ 500,00 value date Feb 09 Taken a buy-sell swap March / April of $5,000,000 @48.6500&48.9600 Reversed buy-sell swap March/April @Rs.48.4350 & Rs.48.6500 Bought option forward 2nd week March to client E $320,000 Sold option forward 2nd fortnight March to client F $220,000 Spot 48.2500/50 ; Forward Points spot Jan 0.3025/75 Feb 0.6200/75 March 0.9200/75 April 1.2200/50 Prepare a Position Book for $/Rupee.

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Derivatives - a hedging tool

Derivatives are financial instruments that derive their value from the value of some other, more basic, underlying financial instrument or variable.

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Basics on Futures & Options

Derivative products are Financial Instruments derived from an underlying asset or Index Some of the derivative products are
Forwards Swaps
Currency Swaps Interest Rate Swaps

Futures & Options Credit Derivatives Weather Derivatives Swaptions

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Features of Futures Contracts

Generally through Organized Exchanges Standardized Contracts Mature on specific dates Settled through Clearing House Margin requirements mandatory Mark to Market Delivery mode

Physical Cash settlement

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Concepts on Futures
Initial Margin: Minimize margin is to be deposited by the trader with the exchange. Exchange will stipulate the margin requirements. Initial margin is to be paid by both buyer and seller. Mark to market: A futures account is marked to market daily. Margin Call :If the margin drops below the margin maintenance requirement established by the exchange listing the futures, a margin call will be issued to bring the account back up to the required level. Open Interest : Cumulative Open positions on buy & sell side Margin-equity ratio: Ratio of the amount of their trading capital that is being held as margin at any particular time. Return on margin (ROM): This performance indicator of the traders efficiency. ROM is calculated (realized return) / (initial margin). The Annualized ROM is equal to (ROM+1)(year/trade duration

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Hedging an exposure with Currency Futures

On 30th May 2008,Firm has US$ payable 2 million, to be settled on 1st September 2008 spot $/CHF=1.6525 ( inverse 0.6051.Three month forward 1.6740 .Lot size is 125000 CHF CME Swiss franc futures are quoted as follow June 0.6031; September 0.5970; December 0.5898 March 0.5806 In US$ terms( inverse rates) June 1.6581;September 1.6750 December 1.6955; March 1.7224 To meet payable obligation in September the firm has to buy September Futures 20,000,000/125000x.0.5970=26.80 . Fraction of contracts are not available so buy 26 futures Every thing depends on Spot price as on 30th August. On August 30 spot CHF is $=chf1.6810 that means CHF=0.5949. The firm buys $ by paying 2,000,000/.5949=CHF3,361,910 and settles Futures. The Basis is (0.5970-0.5949=0.0021x125000x27=$7762.50=CHF13048.76 Net out flow would be 3,361,910-13049=3348861

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Settlement of Futures
Settlement of futures contract is of two types. Physical delivery The futures contract will specify of the underlying asset of the contract (Number of equity shares in one unit of stock future, number of barrels in one unit if crude oil future, or so many grams of gold in one unit of gold future. The exchange will seee through the transaction. Cash settlement: The cash payment is made based on the underlying reference mark to market price of the underlying asset on the settlement date Pricing: Basis : The difference between the cash price &futures price is Basis Contango : The situation where the price of a commodity for future delivery is higher than the spot price, or where a far future delivery price is higher than a nearer future delivery, is known as contango. This is called normal market. Backwardation: If the price of a commodity for future delivery is lower than the spot price, or where a far future delivery price is lower than a nearer future delivery, is known as backwardation.
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Financial building blocks

All Derivatives can be thought of as being a combination of three basic building blocks
Credit Extension Price Fixing Contracts Price Insurance Contracts

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Price Insurance Products (1)

Price Fixing Products are two-sided obligations. Both the parties to the product have to perform. The buyer and seller of the Price Fixing Product are obligated to deliver assets or cash flows at the predetermined rate. Price insurance products are one-sided obligations. A Price Insurance Product gives the owner the right, but not the obligation to exchange value at a predetermined rate at a future date Price Insurance Products thus provide price insurance to the owner of the product against adverse movements in the price of the underlying variable or asset

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Price Insurance Products (2)

Example of Price Insurance Products

Options Warrants

A Price Insurance Product that protects the purchase price is a Call Option A Price Insurance Product that protects the selling price is a Put Option

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Making money(?) with Futures :scrip Infosys lot size 100 ;expiry date :30 November; margin 10% bought the futures one lot. Figures in the bracket indicate spot price Examples of Contango & Backwardation
Date Open. price 1520 (1500) 1540 (1510) 1570 (1540) 1600 (1580) high low Closing price 1580 1570 1670 1600 +900 Initial Margin 15200 Margi n call +600 Profit /loss +6000 -1000 +10000 -7000

Nov 26 Nov 27 Nov 28 Nov 29

158 0 158 0 167 0 160 0

152 0 153 0 157 0 153 0

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Derivatives -Options
Options are financial instruments that convey the right, but not the obligation, to engage in a future transaction on some underlying asset at specific price Options are two types
Call option : Buying a call option provides the right to buy a specified quantity of a security at a set strike price at some time on or before expiration Put Option: Buying a put option provides the right to sell. Upon the option holder's choice to exercise the option, the party who sold option (or wrote) must fulfill the terms of the contract.

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Features of Options
The quantity of the underlying asset is specified. The strike price/ the exercise price is the agreed price of the option contract. Option buyer pays premium to the option writer. Major models of options
European Option - an option that can be exercised only on expiration. American Option - an option that may be exercised on any trading day on or before expiration. Bermudan option - an option that may be exercised only on specified dates on or before expiration. Barrier option - any option with the general characteristic that the underlying security's price must reach some trigger level before the exercise can occur.

As per the settlement terms the writer must deliver the actual asset on exercise, or may simply tender the 1/27/2012 41 equivalent cash amount

Option Terminology
Option Premium
- Price paid by the buyer to acquire the right

Strike Price / Exercise Price

- Price at which the underlying may be purchased or sold

Expiration Date
- Last date for exercising the option

Exercise Date
- Date on which the option is actually exercised
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Option Terminology
Call Option
- Option to buy

Put Option
- Option to sell

Option Buyer
- has the right but not the obligation

Option Writer/Seller
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- has the obligation but not the right

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Call Option
Right to BUY a specified underlying at a set price on or before an expiration date. The holder of a RIL March 900 call option has the right to buy (or go long) a RIL share at a price of 900 anytime between purchase and
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expiration.

Put Option
Right to SELL a specified underlying at a set price on or before an expiration date. The holder of a RIL March 925 put option has the right to sell (or go short) a RIL share at a price of 925 1/27/2012 45 anytime between purchase and

Call Buyer V/s Seller

Call Buyer
- Pays premium - Has right to exercise resulting in a long position in the underlying - Time works against buyer

Call Seller
- Collects premium - Has obligation if assigned resulting in a short position in the underlying - Time works in favor of seller

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Put Buyer V/s Seller

Put Buyer
- Pays premium - Has right to exercise resulting in a short position in the underlying - Time works against buyer

Put Seller
- Collects premium - Has obligation if assigned resulting in a long position in the underlying - Time works in favor of seller
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Long Option
The Right (but not the obligation) to buy or sell a specified underlying at a set price on or before an expiration date. Long Call Options are Bullish oriented positions - they become more valuable as the underlying market price increases. Long Put Options are Bearish oriented positions - they become more valuable as the underlying market price decreases.

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Short Option
The obligation (if assigned) to BUY (short put option), or SELL (short call option) a specified underlying at a set price on or before an expiration date.

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Option Class and Series

All options of the same type (calls or puts) and same expiration are referred to as an Option Class. An option series consists of all the options of a given class with the same expiration date and strike price. In
1/27/2012 50 other words, an option series refers to

a particular contract that is traded.

Option Premium

The market price of an option negotiated between buyer and seller Option Premium = Intrinsic Value + Time Value Option Premium >= 0 Intrinsic Value >= 0 Time Value >= 0

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Intrinsic Value
Difference between Exercise Price and Spot Price Cannot be negative

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Strike Price or Exercise Price

The price at which the seller of a call option is obliged (if assigned) to sell the underlying. The price at which the seller of a put option is obliged (if assigned) to purchase the underlying. If the Current spot price is S and K is the strike price Call option is said to -At the Money if S=K; In the Money if S>K;Out of the Money if S<K Put Option is said to be at the money if S=K;in the money if S<K, and out of money if S>K
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American V/s European Option

Minimum value of an in-the-money American style option is the intrinsic value (due to early exercise possibility). Value of a deep in-the-money European style option may be less than the intrinsic value (due to lack of early exercise possibility and time value of money).
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Option Strategies
Call Option Pay off Profile for a Buyer .Strike Price CHF is $ 0.6700 Premium 1.98cents or $0.0198 Spot prices for 9 working days Pay Off Profile .6000 loss 0.0198 .6500 loss 0.0198 .6600 0.0198 .6700 0.0198 .6800 0.0098 .6898 0.0000 .6900 gain 0.0002 1/27/2012 .6958 gain 0.0060 .7098 gain 0.0200 Put Option payoff for a buyer Strike price Put option Sterling /$ $1.7800 premium paid $ 0.0500 Spot prices for 9 working days Pay Off Profile
$1.6900 gain 0.0400 $1.6925 gain 0.0375 $1.7000 gain 0.0.0300 $1.17100 gain 0.0200 $1.73000 gain 0.0000 $1.7400 loss 0.0100

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Settlement Type
Settled in cash
- on exercise results in flow of cash stream depending on the settlement price

Settled in delivery
- on exercise results in delivery / position
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of the underlying

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Settlement Of Options
Daily Premium Buyer pays the premium and seller receives the premium. The premium payable and the premium receivable are netted to compute the net premium payable or receivable for each client for each option contract. Exercise Process Index options are European style and are only subject to automatic exercise on the expiration day only. Options on securities are American style and can be exercised any time during the tenure of the option. Automatic exercise on exercise day means that all inthe money options would be exercised by Exchange on the 57 1/27/2012 expiration day.

Exercise Settlement Computation

The exercise settlement price is the closing price of the underlying (index or security) on the exercise day (for interim) or the expiry day of the relevant option contract (final exercise) The exercise settlement value is the difference between the strike price and the final settlement price of the relevant option contract. Call options - exercise settlement value receivable by a buyer is the difference of final settlement price and the strike price. Call = Closing price of the security - Strike price Put options - exercise settlement value receivable by a buyer is difference between strike price and final settlement price for each unit of the underlying 1/27/2012 Put = Strike price - Closing price of the security 58

Option Valuation
As at maturity
- Call Option Pc = MAX (0, Sm - K) - Put Option Pp = MAX (0, K - Sm) Pc = Value of call option Pp = Value of put option Sm = Spot price of asset at maturity 1/27/2012 K = Strike price of option

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Pay Off profiles

Profit profiles of a Put option
Buyers Profit p for S is > or equal to K ; for S<K profit will be K-S-p Sellers Profit +c for S < or = to K ; for S>K profit will be (S-Kc)
Put seller

Premium p

K
Put Buyer

K-p

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Pay off profiles Profit profiles

profit

strike price
Premium c

k+c loss

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Spread Strategies Option Strategy involves simultaneous buy and sell of two different option contracts Strategy facilitates to realize profit if the movement of price is in a particular direction and limit the loss if it does not move in that expected direction Bullish Call Spread 1/27/2012 62
Sell the Call with higher strike price and

Some of the other Strategies

Straddle

Buying a Call & Put with identical strike prices and maturity dates
If the depreciation is there money is made on Put If appreciation is there money is made on Call Some times moderate loss will be there Strangle

Buying call and Put at different prices 1/27/2012 with same maturity dates

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Money Market
The money market can be defined as a market for short-term money and financial assets that are near substitutes for money. It is basically concerned with the issue and trading of securities or quasi-money instruments with short term maturities. The Instruments traded in the money-market are Call/Notice Money, Treasury Bills, Certificates of Deposits (CDs), Commercial Paper (CPs), Bills of Exchange and other such instruments of short-term maturities (i.e. not exceeding 1 year with regard to the original maturity). There are also money market mutual funds. 1/27/2012 64 Characteristics of Money Market 64 Dhruva It is not a single market but a collection of markets for various

Players in Money Market

Main players include Banks, Financial institutions, Insurance companies, Mutual Funds, Large Corporate, Reserve Bank of India, Discount and finance house of India, State as well as Central Government, Non Resident Indians, Overseas Corporate bodies, Primary Dealers, Non Banking Financial companies, Securities Trading Corporation of India. Principal Feature of Monet Market is the creditworthiness of the participants. It is screen based or Phone based Market. Most of the trade happens over the counter.

Components of Money Market

The money market has two components - the organized and the unorganized. The organized market is dominated by commercial banks. The core of the money market is the inter-bank call money market whereby short-term money borrowing/lending is effected to manage temporary liquidity mismatches. The Central bank of the Country occupies a strategic position of managing market liquidity through open market operations of government securities, access to its 65 1/27/2012 65 Dhruva accommodation, cost (interest rates), availability of credit and other monetary management tools. Unorganized money market involves

Components of Money Market

The money market has two components - the organized and the unorganized. The organized market is dominated by commercial banks. The core of the money market is the inter-bank call money market whereby short-term money borrowing/lending is effected to manage temporary liquidity mismatches. The Central bank of the Country occupies a strategic position of managing market liquidity through open market operations of government securities, access to its accommodation, cost (interest rates), availability of credit and other monetary management tools. Unorganized money market involves private lending. Call/Notice Money :Call money usually serves the role 66 of 1/27/2012 66 Dhruva equilibrating the short-term liquidity position of banks. Banks borrow in this money market to fill the gaps or temporary

Money Markets
Treasury Bills

contd

Short term (up to one year) borrowing instruments of the union government. It is an IOU of the Government. It is commonly referred to as T Bills of tenor less than 365 days. It is a promise by the Government to pay a stated sum of money after expiry of the stated period from the date of issue (14/91/182/364 days i.e. less than one year). They are issued at a discount to the face value, and on maturity the face value is paid to the holder.

Government Securities Market (G-Sec Market)

G-Secs or Government of India dated Securities are Rupees One hundred face-value units / debt paper issued by Government of India in lieu of their borrowing from the market. These can be referred to as certificates issued by Government of India through the Reserve 67 1/27/2012 67 Dhruva Bank acknowledging receipt of money in the form of debt, bearing a fixed interest rate (or otherwise) with interests payable semi-annually

Certificate of Deposits
CDs are short-term borrowings in the form of Usance Promissory Notes having a maturity of not less than 15 days up to a maximum of one year. CD is subject to payment of Stamp Duty under Indian Stamp Act, 1899 (Central Act). Similar conditions are there in other countries also. They are like bank term deposits accounts. Unlike traditional time deposits these are freely negotiable instruments and are often referred to as Negotiable Certificate of Deposits .CDs are short-term borrowings in the form of Usance Promissory Notes having a maturity of not less than 15 days up to a maximum of one year. They are like bank term deposits accounts. Unlike traditional time deposits these are freely negotiable instruments and are often referred to as Negotiable Certificate of Deposits.

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Commercial paper
Commercial Paper
Commercial paper is a money market security issued by large banks and corporations. It is generally used to finance short-term investments/working capital to purchase inventory or to manage other working capital requirements. Commercial paper maturities do not exceed nine months and proceeds typically are used only for current transactions, the notes are exempt from registration as securities with the United States Securities and Exchange Commission.

Features of CP

CP is a note in evidence of the debt obligation of the issuer. On issuing commercial paper the debt obligation is transformed into an instrument. CPs are issued subject to minimum of Rs 5 lakhs and in the multiples of Rs. 5 Lac thereafter with a maturity of 15 days to 1 year. In US market maximum tenor is 270 days, beyond this period the issuer has to follow the guide lines of SEC It is freely negotiable by endorsement and delivery. Price of CP is computed through a formula : Issue price of CP= F/{1+ (I*N)/100*365} Example :Face value Rs.100.Effective rate 10% for 90days. Issue price is =100/ {1+ (.1*90/36500)=Rs97.5396.Issuer will incur the expenses on: Stamp duty, brokerage, IPA fees, rating agency fees, redemption fees payable to banks. Underwriters may be there for the CP issue. Commercial 1/27/2012 is always cheaper than using a bank line of credit. 69 paper
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T-Bills
Treasury Bills
Treasury bills are issued by Central Government Securities against their short term borrowing requirements with maturities ranging between 14 to 364 days. T-Bills are issued at a discount-to-face value. For example a Treasury bill of Rs. 100.00 face value issued for Rs. 91.50 gets redeemed at the end of it's tenure at Rs. 100.00. 91 days T-Bills are auctioned under uniform price auction method where as 364 days TBills are auctioned on the basis of multiple price auction method. Banks, Primary Dealers, State Governments, Provident Funds, Financial Institutions, Insurance Companies, NBFCs, FIIs (as per prescribed norms), NRIs & OCBs can invest in T-Bills.
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 French Auction System

After receiving bids at various levels of yield expectations, a particular yield level is decided as the coupon rate. Auction participants who bid at yield levels lower than the yield determined as cut-off get full allotment at a premium. The premium amount is equivalent to price equated differential of the bid yield and the cut-off yield. Applications of bidders who bid at levels higher than the cut-off levels are out-right rejected. This is primarily a Yield based auction.

Dutch auction Price

This is identical to the French auction system as defined above. The only difference being that the concept of premium does not exist. This means that all successful 1/27/2012 71 bidders get a cut-off price of Rs. 100.00 and do not need to 71 Dhruva pay any premium irrespective of the yield level bid for.

MM instruments
Repo /Reverse Repos
A Repo deal is one where eligible parties enter into a contract with another to borrow money at a pre-determined rate against the collateral of eligible security for a specified period of time. The legal title of the security does change. The motive of the deal is to fund a position. Though the mechanics essentially remain the same and the contract virtually remains the same, in case of a reverse Repo deal the underlying motive of the deal is to meet the security / instrument specific needs or to lend the money. Indian Repo Market is governed by Reserve Bank of India. At present Repo is permitted between 64 players against Central & State Government Securities (including T-Bills) only at 1/27/2012 72 Mumbai. 72 Dhruva

Multi National Corporations

Also called as Trans National Corporations MNCs are firms that control productive assets in more than one country MNCs acquire their foreign assets by investing in affiliate or subsidiary firms in host countries foreign direct investment (FDI) (management rights and control) produce and distribute goods and services across national boundaries 1/27/2012 ideas, tastes, and technology throughout spread 73 12/13/2008 Dhruva the world

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Characteristics of MNCs
It operates in many countries at different level of economic development Its local subsidiaries are managed by nationals It maintains complete industrial organization including research & development facilities in several countries 1/27/2012 It has multinational central

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Country of Origin?????
Coca Cola Company Dell Ford Google Hitachi HSBC LG Nestle Samsung Sony Virgin Vodafone 1/27/2012 Nokia

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Country of Origin
Coca Cola Dell Ford Google Hitachi HSBC LG Nestle Samsung Sony Virgin Vodafone 1/27/2012 Nokia USA USA USA USA Japan UK South Korea Switzerland South Korea Japan UK UK Finland

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Types of MNCs
MNCs are of 5 organizational types 1. Vertically integrated MNC: produces goods and services at different stages of the production process ; the outputs of some affiliates serve as inputs to other affiliates of the MNC ;avoid uncertainty and reduce transaction costs; limit competition.. Example: in petroleum, they are often involved in the extraction and distributive stages i.e.., owning many petrol stations. 2. Horizontally integrated MNC: extends its operations abroad by producing the same product or product line in its affiliates in different countries; has the same sort of plant in many countries. Defend and increase their market shares; get behind external barriers imposed by national governments Example: Union Carbide which has many chemical subsidiaries 1/27/2012 around the globe.
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Types of MNCs contd

3. Conglomerate firms: have interests in many sectors. Example: General Electric Joint ventures: MNCs gain entry into a foreign country only by agreeing to form joint ventures with local firms
 the various partners own less than 100% of the equity of the joint venture firm

4.

5.

Example: automobile industry, telecommunications equipment and aircraft Strategic alliances: are partnerships between separate, sometimes competing companies
 they are drawn together because each needs the complementary technology, skills or facilities of the other; but the scope of the relationship is strictly defined, leaving the companies free to compete outside the relationship
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Explaining the rapid growth in MNC activity

Changes in technology and organizational sophistication created the possibility of expansion new communications technologies, cheaper and more reliable transportation networks. Government policies that actively encourage multinational expansion = elimination of restraints on capital flows, the reduction of tariffs. The product cycle theory: every technology product evolves through 3 phases in its life history
the introductory or innovative phase: production is located in most advanced industrial country(ies) the maturing or process-development phase: production shifts to other advanced countries the standardized or mature phase: production shifts to LDCs, whose comparative advantage is their lower wages rates. From 1/27/2012 79 these export platforms either the product itself or component 12/13/2008 Dhruva parts are shipped toward markets.

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Explaining the rapid growth in MNC activity .contd

Internalization theory contends that firms expand abroad
in order to internalize activities in the presence of market imperfections which are represented in the idea of transaction costs

Oligopoly theory contends that firms move abroad

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Explaining the rapid growth in MNC activity .contd

Obsolescing bargain theory contends that a firm invested in a host country starts with a good bargaining position withthe host countrys government because of firm-specific advantages (superior technology); later on the bargaining leverage shifts towards the host state because the MNC commits itself to immobile resources.

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The divergent opinions on MNCs

Liberals believe that FDI contributes to increased efficiency in the use of the worlds resources by stimulating innovation, competition, economic growth, and employment MNCs provide countries with numerous benefits, such as capital, technology, managerial skills, and marketing networks. .

Marxists view that MNCs as predatory monopolists that overcharge for their goods and services, limit the flow of technology, and create dependency relationships with host countries in the Third World as having a negative impact on home countries by exporting jobs and imposing downward pressures on labor and on environmental standards
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The divergent opinions on MNCs contd

MNCs in their home countries are favored Home country policies towards their MNCs have been generally favorable, but they also marked by ambivalence Home countries often give their MNCs favorable treatment and protect them from hostile actions of foreigners .But home governments also sometimes view their MNCs as tools of foreign policy and are willing to coerce the MNCs if necessary to affect their behavior.

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The divergent opinions on MNCs contd

Labor Issues Labor groups are Liberals argue that unconvinced by this the impact of MNCs evidence = in their on labor groups is view the mobility of generally positive = capital and MNCs puts MNCs have better immobile workers at a record than domestic distinct disadvantage firms with regard to = the transfer of MNC job creation, export activities to affiliates performance and in LDCs with lower technological wages and standards innovations in the produce a home country; MNCs deterioration of pay higher wages than working conditions in domestic firms 1/27/2012 84 the home country + (inconclusive evidence) 84 12/13/2008 Dhruva de-industrialization

The divergent opinions on MNCs contd

MNCs economic impact on host countries (LDCs) : Proponents argue that MNCs and their foreign investment have a positive effect on Southern economic development because they fill resources gaps in developing countries and improve the quality of factors of production. The positive view of the role of the MNCs in growth, efficiency and welfare has been challenge by critics of the MNCs Empirical studies examining the economic impact of MNCs on LDCs appear to indicate that while the inflows of foreign investment have a generally positive effect on economic growth, the extent of 1/27/2012 85 85 the impact depends on other 12/13/2008 Dhruva variables especially the policies pursued by host

The divergent opinions on MNCs contd

MNCs political impact on host countries (LDCs)
Evidence suggests that MNCs have at times intervened in political processes in their host states in the Third World by taking actions that are
legal (contribution to political parties, lobby with local elites, carry out public relations campaign) and/or illegal (illegal contributions to political parties, bribe to local officials, refusals to comply with host laws and regulations) actions within host states

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What the MNCs want the most is political stability rather than a particular form of government. MNCs cultural impact on LDCs : The presence of MNCs is characterized as constituting a form of cultural imperialism or Coca-Cola-ization of the society, through which the developing country loses control over its culture and its 1/27/2012 development= it receives partial support 86 social
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Finance functions in MNCs

Treasurer Functions Financial planning Cash management Funds acquisition Investments (funding & deployment) Risk management
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Controller Functions External reporting Accounting Budget Controls Tax planning Tax management MIS Accounts Receivable 87
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Concepts of Risk & Exposure

Definition of Risk  Risk is the possibility of the actual outcome being different from the expected outcome. It includes both down side and upside potential  Examples of Risk Difference between Risk & Uncertainty  Certainty is the situation where 100% probability is known on happening or non happening of an event  Risk is the situation where we know there are number of specific , probable outcomes but not sure about which one will actually happen  Uncertainty is a situation where we do not know even the 88 1/27/2012 Dhruva probable outcomes 12/13/2008

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Some Basics on Risk

Risk is function of the probability of the outcome being different from the outcome & the potential intensity of the event Examples 2001 Gujarat Earthquake 2001 September 11 2004 Tsunami in India 2006 Bombay Local train bomb Blasts 2008 Terrorist Attack at Taj Hotel & other places in Mumbai Risk is different from the terms peril and hazard Peril is cause of Loss .......Fire is peril. It causes loss Hazard is a factor that may create or increase the possibility of a loss in face of an undesired event or may increase the possibility of happening of the undesired event....... Inappropriate structure of a building is a hazard that increases the loss in case of a fire

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Some Basics on Risk

contd

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Degree of Risk It is dependent on the information available with the Entity facing Risk This information helps the entity to assess the expected value and probability of the event The interpretation of the available information is crucial to the entity Same information can be interpreted by different entities differently. Role of Risk Manager in International Financial Management Risk Manager Has to identify the Risk 1/27/2012 identify the remedial measures available for Managing 90 Has to the Risk 12/13/2008 Dhruva Has to measure the cost of managing the Risk

Business Entities are Exposed to Many Risks

Interest Rate Risk Exchange Risk Liquidity Risk Default Risk Internal Business Risk External Business Risk Financial Risk Market Risk Marketability Risk Credit Risk Operational Risk Environmental Risk Production Risk Events of God AND MANY RISKS

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Differentiating risk & exposure

The business entity is exposed to many risks Exposure is a measure of the sensitivity of the firms performance to fluctuations of the relevant risk factors Risk is the possibility of the actual outcome being different from the expected outcome. It includes both down side and upside potential

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Drivers of Key Risks

Financial Risks
Interest Rates FOREX Credit

Strategic Risks
Competition Customer Changes Industry Changes Customer Demand

M & A Integration Liquidity & Cash Flow R&D Intellectual Capital

Internally Driven
Accounting Controls Information System Recruitment Supply Chain Regulations Culture Board Composition

Some risks can have both external and internal drivers. Hence, those risks overlap in two areas. To combat these risks, Risk Management has become a core business process.

Products & Services Public Access Employees Properties Contracts Natural Events Supplies Environment

Operational Risks

Hazard Risks

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Risk Analysis Methods and Techniques

Pricing Optimization

Scenario Analysis

Profitability and Productivity Analysis

HAZOP
(Hazard & operability Studies)

Data Analysis

Cluster Analysis

Asset Management

FMEA
(Failure Mode & Effect Analysis)

Fault Tree Analysis

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Risk Management pertaining to the Business Environment

Environment

Constituents of the Business Environment

External

Internal

SocioEconomic

Regulations Technology Competition

Structure

Processes

Culture

Companies operate in a dynamic business environment which forces them to adopt risk management measures. The business environment is both external and internal to a company and an adverse change in any of the above mentioned constituents can increase the risk levels for the company.

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Risk Management Process

The Organization's Strategic Objectives

Risk Assessment
Risk Analysis Risk Identification Risk Description Risk Estimation

Data Analysis

Risk Evaluation
Risk Reporting Threats and Opportunities Decision

Business Research

Risk Treatment

Residual Risk Reporting

Monitoring

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Concept of Risk Management Tools

Avoidance When you hold assets or liabilities you are exposed to risk. If dont hold assets or liabilities you are avoiding the risks associated with them Loss Control You hold the assets or liabilities but prevent or reduce the probability of loss . Take Insurance / Introduce systems and procedures/ Take audit help/Move from fixed rate of interest to /floating rate of interest or vice versa. Separation Distribute assets/liabilities to different locations

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Concept of Risk Management Tools

Combination Diversify the activities. Do not keep too many eggs in the same basket Transfer Reduce the Risk by transfer i) Transfer the risk by transferring the asset or liability ii) Transfer the risk by buying a derivative instrument iii) Transfer the risk by taking Insurance 1/27/2012 98
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Concept of Risk Management Tools

CONTD

Risk Retention Risk is retained when nothing can be done to avoid , reduce or transfer it Risk Sharing This a combination of Risk retention & risk transfer

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RISKS CAN BE MINIMISED BUT CAN NOT BE 1/27/2012 COMPLETELY 12/13/2008 ERASED Dhruva

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