SPRING DRIVE 2014 ASSIGNMENT

NAME
ROLL NO
SEMESTER

Nandini Biswas
521147058
VI

SUBJECT CODE & NAME BBA603 Role of International Financial Institutions

CREDIT
MARKS
DATE OF SUBMISSION

4
60
22nd June, 2014

Q1. Give introduction to international finance. Explain the benefits, scope of

international finance. List the advantages and disadvantages of globalization.
Ans: International finance is the branch of economics that broadly studies monetary
and macroeconomic relationship between nations. It studies capital flows among
nation, exchange rate fluctuations, balance of trade, tax policies effects, and
other related issues.
The importance of international finance has increased in the last two
decades owing to the technological development and the deregulation of the
financial markets and products. With growing internationalization and globalization of economic
activity across the nations of the world, complex
networks of financial relationships have emerged. International finance plays a
very important role in linking world trade and foreign investment.
Benefits of international finance
Some of the benefits of international finance are mentioned below:
Integrates world economies and facilitates easy flow of capital across
countries worldwide
Moderates domestic regulations through global financial institutions
Leads to healthy competition and hence, more effective banking
Promotes domestic growth and investment through capital import
Leads to effective capital allocation by providing information on vital areas
of investment

 Gives countries access to capital markets across the world and, thus,
enables a country to lend in good times and borrow in bad times
Scope
Multinational corporations have subsidiaries or joint ventures in different countries.
The operations, structures, organizations and lines of business of these
companies depend on the global political, socio-cultural, economic and legal
environment of the countries in which these companies do business. For this
reason, international treaties like, Basel norms, Kyoto Protocol and WTO
guidelines lay down a uniform framework for how business should be conducted
between different countries.
The economics of international trade and international finance are much
the same except that international finance involves greater risks and uncertainties
as the assets being traded are claims to flow of returns that extend for many
years in the future. Besides, the markets of financial assets are more volatile as
compared to market in goods and services as financial decisions in financial
assets are more rapidly revised and implemented.
Advantages
Some of the advantages of globalization are:
Movement of capital: It has been seen that foreign capital flows in the
form of Foreign Direct Investment (FDI) and Foreign Institutional/Portfolio
Investments (FIIs) play a very important role in the development of an
economy by enhancing the production base of a developing economy
especially.
Trade in goods and services: Globalization helps in the growth of emerging
economies by facilitating international trade in goods and services.
Financial flows: The process of globalization leads to financial flows which
further leads to the development of the capital market.
Disadvantages
Some of the disadvantages of globalization are:
Although globalization was responsible for the development of many
countries through increase in the international trade, there were also certain
disadvantages associated with it. Many studies released by UNDP revealed
that it has increased the disparities between the developed and developing
countries, thus increasing the gap between the rich and the poor.
Unequal distribution of international trade gains is another disadvantage
of globalization. Various studies conducted in the past have proved that

there is a cost to this globalization. Findings have proved that since

developing countries have underdeveloped capital markets and high risk
premiums, they cannot fully participate in this growth and increased
investment brought about by globalization. As a result, these inadequacies
tilt the gains of globalization to developed and prospering nations.
It has been found that developing nations have to face problems on
international trade due to rising tariff and trade barriers. Although
commodities produced by developing countries may be given higher value
and generate greater profits due to international trade, yet this may lead to
higher tariffs as well.

Q2. Short note

a) Balance of payment:
Balance of payments (BoP) is an account statement which holds the summation
of all international transactions a country has had with other nations. It reflects a
countrys performance in trade, in attracting foreign capital and the impact on
the foreign exchange reserve of a country. As per the balance of payments manual
of the IMF, BoP comprises current account, capital account, errors and
omissions, and change in foreign exchange reserves.
b) Current account
The trade position of the country is reflected by the current account. It shows
the merchandise exports and imports and also the transfers and grants which
form quite a substantial part of the invisibles. In India, we have always had a
current account deficit meaning that imports have always been greater than
exports as 70 per cent of our oil requirements are imported.
c) Capital account
The investment part of the international transactions is included in the capital
account. This is further categorized into equity and debt investment. The money
of a foreign institutional investor (FII) and Foreign Direct Investment (FDI) are a
part of the equity investments. Debt investments include the External Commercial
Borrowings (ECBs), money deposited in banks by non-resident Indians and
trade credits.
Till recently, a surplus in capital account financed Indias current account

deficit, which led to a steady growth of foreign exchanges reserves. The trend
has reversed lately due to global events, domestic economic factors and the
introduction of General Anti-Avoidance Rules (GAAR) and now even the capital
flows have reduced.
d) Foreign exchange reserve:
These reserves are accumulated when RBI absorbs access foreign
exchange flows through intervention in the foreign exchange market and through
the receipt of aid and interest payments. The International Bank for Reconstruction
and Development (IBRD), International Development Association (IDA) and Asian
Development Bank (ADB) funding also add to the foreign exchange reserves

e) Accounting equilibrium
Since BoP is always constructed on the basis of double-entry book-keeping, credit
is always equal to debit. If the credit on the current account is lower than the debit,
then funds will flow into the country and will be recorded as credit of the capital
account. Thus, the excess of debit on the current account is balanced. Hence
BoP is in equilibrium when the combined balance of current account and capital
account is equal to zero i.e. the sum of debits and credits in the current and
capital account is zero so that the official reserve account balance becomes zero.
Current Account + Capital Account = 0
The accounting balance is an ex post concept. It describes what has actually
happened in a specific period in the past.

Q3.
Give introduction on foreign exchange. Explain on foreign exchange markets and
role of international forex markets.
Ans: Foreign Exchange (FX) refers to money denominated in the currency of another
country or a group of countries. Any short-term negotiable financial claims or
cash, funds available on debit cards and credit cards, travelers cheques and
bank deposits are the various forms of foreign exchange
It is a facilitating mechanism or place where currencies are bought and sold. It
can be further defined in terms of the following points:
It is a virtual market i.e. not located in a physical place.

 It is also an Over-the-Counter (OTC) market. An OTC market is a one

where no single market or organized exchange, electronic or physical
(like Stock Exchange) exists and where brokers/dealers directly negotiate
with one another.
It trades 24 hours a day except on weekends and spans all the time zones
of the world.
Heavy trading is done during overlapping hours when one market is closing
and the other market is opening.
Communication is done through telephone, telexes and electronic means.
Major market centers are London, New York, Frankfurt, Singapore and
Tokyo.
One of the largest financial markets in the world with $4.0 trillion average
daily turnover, equivalent to more than 12 times the average daily turnover
of global equity markets, more than 50 times the average daily turnover of
the NYSE and an annual turnover more than 10 times world gross domestic
product. The spot market accounts for over one-third of the daily turnover
in the foreign exchange market.
Role of International Forex Market
The foreign exchange market provides a single, integrated, cohesive and global
forum by linking individual foreign exchange centers and markets. It also fixes
the relative values of currencies and assists international trade and investment
by allowing businesses to convert one currency to another.
Bid rate: It is the rate at which the dealers or market makers buy currency from
the customers.
Ask rate: the rate at which the dealers or market makers sell currency
Spread: is the difference between the bid and ask rates. The spread may vary
from currency to currency and is more for the thinly-traded currencies. The
spread also varies between the retail and the wholesale customers and is more
for the retail customers since the volume of transaction is low for them.
Note: Ask rate is always greater than the bid rate and the rates are always stated from
the perspective of the banks or dealers. Therefore, the banks bid rate is the customers
ask rate and vice versa
Q4. Explain cash-in-advance and write the process of issuing letter of credit
and different types of letter of credi

Ans: In this type of payment method, the payment is received before the ownership of
the goods is transferred; hence the credit risk is avoided by the exporter. This
type of arrangement is most risky for the buyer and least risky for the seller. The
most frequently cash-in-advance options available to the exporter are credit cards
and wire transfers. This type of payment option is not very attractive to the buyer
as it may create cash flow problems for them. Especially, this type of
arrangement may not work with foreign buyers who may not be sure whether
the goods will be delivered after the payment is made in advance. Thus, if there
is any exporter who insists on using cash-in-advance as the only payment term,
then it is very likely that he may lose out to competitors offering multiple payment
options at attractive terms. Therefore, often other terms such as Free-on-Board
may also be combined with this type of payment option

Letter of Credit (LC) is one of the methods of making trade payment while dealing
with unknown exporters or importers. LC is one of the most secured modes of
payment for international traders, especially when the foreign buyers reliable
credit information is not there. The exporter has to be content with the
creditworthiness of the importers bank. Through this method, the specific
performance of both the parties i.e. exporters and importers is ensured. Also,
the exporter is protected since payment is only made once the goods are
delivered or shipped as promised.
The main parties involved in a letter of credit transaction are the applicant,
the beneficiary, the issuing bank, the confirming bank, and the nominated bank.
The importer sends an application to his bank i.e. the issuing bank to open
a letter of credit in favour of the beneficiary i.e. the exporter through another
bank called the correspondent bank.
Therefore, a Letter of Credit is a commitment by a bank to honour the
payment to the exporter on behalf of the importer, subject to the fulfillment of the
terms and conditions mentioned in the LC. For rendering this service the bank
is paid a fee by the buyer or importer
The different types of Letter of Credit are:
(i) Commercial Letters of Credit: Commercial letters of credit are
used as a primary payment tool in international trade. Majority of
commercial letters of credit are issued subject to the latest version
of UCP (Uniform Customs and Practice for Documentary Credits).
The ICC publishes UCP, which are the set of rules that governs the
commercial letters of credit procedures.

(ii) Standby letters of Credit: Commercial letters of credit are a means

of payment to be utilized when the principal perform its duties. In
standby letters of credit, a payment is made to the beneficiary when
there is a breach of the principals obligation
iii)Back-to-back letter of credit: Back-to-back documentary credit is
used in situations where a transferable documentary credit cannot
or is not allowed to be used for some reason. Upon the intermediarys
request the bank issues a back-to-back documentary credit in favour
of the supplier.
Revolving letter of credit: A revolving documentary credit is suitable
for making payments for regular deliveries made over a longer period
of time. The buyer asks his bank to issue a letter of credit with a socalled
revolving clause that allows the seller to present documents
to the bank after a certain period of time defined in the documentary
credit, submitting then under the same documentary credit without
the buyer having to make any amendments.
(v) Revocable Letters of Credit: Revocable letters of credit give issuer
the amendment or cancellation right of the credit any time without
prior notice to the beneficiary. Since revocable letters of credit do not
provide any protection to the beneficiary, they are not used frequently.
In addition, UCP 600 has no reference to revocable letters of credit.
All credits issued subject to UCP 600 are irrevocable unless otherwise
agreed between the parties.
(vi) Irrevocable Letters of Credit: Irrevocable Letters of Credit cannot
be amended or cancelled without the agreement of the credit parties.
Unconfirmed irrevocable letters of credit cannot be modified without
the written consent of both the issuing bank and the beneficiary.
Confirmed irrevocable letters of credit need also confirming banks
written consent in order any modification or cancellation to be effective

Q5.
Explain the Foreign Direct Investment (FDI). Give the comparison between American
Depository Receipt (ADR) and Global Depository Receipt (GDR). Write the categories for
trade blocs.
Ans: Foreign Direct Investment (FDI) is a direct investment route through which a

foreign company invests in a target company of a host country. This can be

done by setting up a subsidiary company in the overseas company or by acquiring
shares in it. This route is a major source of foreign exchange reserve for a
country and helps to bridge the deficits in balance of trade. It raises the level of
efficiency, competitiveness and technology standards of the host country by
bringing in state-of-art technology. It also provides the host country a better
access to international markets and, thus, helps to improve the export
performance of the country. FDI are long-term capital investments in projects
and are considered vital for a countrys economic development. It is involved in
management control and is less volatile than FIIs which are often referred to as
hot money.

Comparison between ADR and GDR

Instrument
GAAP
Disclosure

Cost

Centre

ADR
Foreign companies have to
reconcile
with US GAAP standards
For US listing , a
comprehensive
disclosure is required for F1(a US
prospective)
NYSE listing is more
expensive.
Initial listing requirement may
be
between $10,00,000$20,00,000
Are listed on NYSE

GDR
No GAAP compatibility
required for
foreign companies
Detailed information is
required for
listing but less complex as
compared
to full equity
LSE listing is less expensive.
Initial
listing requirement may be
between
$2,00,000- $4,00,000
They are listed on LSE which
is not as
big as NYSE but still it is a
global
centre for International
equities

Retail

US retail market can be

assessed
thus maximizing gains, in a
US public
offering

Although 5,000 QIBs are

accessed, but
participation of retail
investors is not
allowed

Categories of trade blocs

Trade bloc can either be a part of a regional organization, say the European
Union, or standalone agreements between states (North American Free Trade
Agreement). Besides, based on the level of economic integration, trade blocs
can also be categorized as:
Free Trade Areas (FTAs): Asia Pacific Economic Corporation (APEC),
Common Market for Eastern and Southern Africa (COMESA), EU
Custom Unions
Preferential Trading Areas
Economic and Monetary unions
Common market
Q6.
Write down the differences between GATT and WTO. Explain the problems and
achievements of GATT & WTO.
Ans: GATT was replaced by amended GATT, i.e. WTO on 1 January, 1995. WTO is
just not an extension of GATT but is different in many ways. Let us study the
differences below:

GATT

WTO

GATT was a multilateral agreement

with a set of rules which were not
enforceable. It had no institutional
framework and a very small secretaria

WTO is a permanent institution with its

own secretariat

It was applied on a provisional basis

initially and continued to be treated like
that even after 40 years of its existence

Its commitments are full and

permanent.

GATT applied to only trade in

merchandise goods

WTO applies to both trade of

merchandise goods and services anf
also trade related aspects of Intellectual
Property Rights
All agreements are multilateral in
nature and involve commitments by all
members.

Agreements constituting GATT were

initially multilateral in nature but by
1980s many new agreements which
were added were pluri-lateral or of
selective nature
GATT dispute settlement was slower
and with a lot of hurdles.
GATT existed until 1995 as GATT
1994-which was an updated version of
GATT 1947

WTO dispute settlement is more

automatic and faster than that of GATT.
WTO agreements still constitutes
GATT 1994 focusing on disciplines
regarding international trade

Achievements of GATT/WTO
The establishment of WTO brought in a new trade order and world trade
expanded. Some of its achievements and drawback are as follows:
Many studies have proven that increased trade promotes peace. There
have been no world wars since 1948.
It led to trade liberalization of industrial products (as per the goal of Kennedy
Round).
GATT has over 100 members and has generated 85-90 per cent of world
trade.
Problems of GATT/WTO
GATT/WTO did not succeed in liberalizing trade in agricultural products
to a large degree (as per the goal of Uruguay Round).
It has not been successful in regulating trade practices which have been
adopted by member countries to handle balance of payment problems.
For example, when the US imposed 10 per cent surcharge on its imports
in 1971 leading to double import duties, GATT could not stop that.
It has led to gradual erosion of the most favored nation (MFN) principle by
European Union (EU) and to a lesser degree by NAFTA. As per article 14

of GATT, member countries could form an FTA. Taking advantage of this

EU adopted VILs, to lower duties to many African and Mediterranean
countries and also to keep out the agricultural products.
GATT has critically managed trade for textiles due to pressure from the
US and automobiles (VERs). Since GATT was just a voluntary agreement
it could not be enforced if members violated the rules. Besides this,
members had the freedom to bypass or sidestep rules which were
inconsistent with their domestic laws at the time of their joining GATT and
narrowly defined commodities for tariff reasons.
GATT has failed to control currency manipulations used by countries to
restrict imports. Example: China.
Pirate activities in Africa could not be eliminated by GATT/WTO