Role of International Financial Institutions

BBA (603)
ASSIGNMENT
WINTER 2016-2017

NAME – Saurabh bhalla

ROLL NO - 1405009510

Q1. “Globalization is defined as a concept which connects countries across the

world through information, trade and technology”. Critically explain the
concept.

Ans: Impact of globalization

Globalization is defined as concept which connects countries across the

world through information, trade and technology. In practical terms globalization
means the integration of economies and societies through flow of ideas,
information, technologies, capital, finance, goods, services and people from one
country to another. This is also termed as ‘cross –border integration’ and has
many dimensions such as social, political, cultural and of course economic.
Economic integration can happen through these channels:

 Movement of capital
 Flow of finance
 Trade in goods and services
 Through movement of human resource
 For most of the economies of the world, globalization has led to a large
number of beneficial effects. There is also a section of people who believe
that globalization has only benefited economies whereas the developing
ones are still struggling with inequality and poverty. Thus, we see that
globalization can have both positive and negative impact on the economy
of a nation, its people and the organizations within a specific industry.

Q2. Compare the relationship between Current Account, Capital Account and
Official Reserve Account. Illustrate the concept of BoP Accounting.

Ans: Relationship between 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 from 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 percent of our oil requirement are
imported.

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-residential Indians and trade credits.

Official Reserve Account.

The official reserve account, a part of the capital account, is the foreign
currency and securities held by the central bank of a country and used to
balance the payments from year-to-year. The reserves swell in case of trade
surplus and shrink when there is a deficit. At times, the central banks use it
to change the exchanges rate to what the government perceives as more
favorable.
 Concept of BoP Accounting

Balance of payment also follows a principle of double-entry book-keeping,

like any other accounting statements. This means that every international
transaction should lead to debit and credit of equal magnitude. It is
important to understand that balance of payment statement is neither a
balance sheet nor an income statement. It is a statement of course and use
of funds, which reflects the changes in assets, liabilities and net worth over
a period of time. As per the double-entry book-keeping, sources and uses of
funds should always match.

Q3. Give introduction on foreign exchange. Elaborate on foreign exchange

markets and role of international forex markets.

Ans: Introduction on foreign exchange

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,
traveler’s cheques and bank deposits are to various forms of foreign
exchange.

Elaborate on foreign exchange markets.

 It is virtual markets i.e., not located in 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 markets is
closing and the other market is opening.
 Communication is done through telephones, telexes and electronic
means.
  Major markets centers are London, New York, Frankfurt, Singapore and
Tokyo.

Role of international forex markets

 Bid rate – It is the rate at which the dealers or market makers buy
currency from the dealers or markets makers buy currency from the
customers.
 Ask rate – The rate at which the dealers or market 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.

Q4. 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: Explain FDI

Foreign Direct Investment (FDI) is a direct investment route through which

a foreign company invests in a target company of 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 also provides the host country by access to international markets and

thus, helps to improve the export performance of the country. It is involved
in management control and is less volatile than FIIs which are often
referred to as ‘hot money’
 Comparison between ADR & GDR

GDR ADR
Instrument:
GAAP No GAAP compatibility Foreign companies have
required for foreign to reconcile with US
companies. GAAP standards.
Disclosure Detailed information is For US listing, a
required for listing but comprehensive disclosure
less complex as compared is required for F-1 (a US
to full equity. prospective).
Cost LSE listing is less NYSE listing, a more
expensive. Initial listing expensive. Initial listing
requirement may be requirement may be
between $ 2, 00,000-$4, between $ 10, 00,000-$
00,000. 20, 00,000.
Centre They are listed on LSE Are listed on NYSE
which is not as big as
NYSE but still it is a global
center for international
equities.
Retail Although 5,000 QIBs are US retail market can be
accessed, but assessed thus maximizing
participation of retail gains, in a US public
investors is not allowed. offering.

Introduction on trade blocs

Trade bloc can either be a part of 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 (FTSs) Asia Pacific Economic Corporation (APEC),

Common Market for Eastern and Southern Africa (COMSEA), EU.
 Custom Unions
  Preferential Trading Areas
 Economic and Monetary unions
 Common markets

Q5. Write down the differences between GATT and WTO. Explain the problems
and achievements of GATT & WTO.

Ans: Differences of GATT and WTO

GATT WTO
GATT was a multilateral agreement WTO is a permanent institution with its
with a set of rules which were not own secretariat.
enforceable. It had no institutional
framework and very small secretariat.
It was applied on a provisional basis Its commitments are full and
initially and continued to be treated like permanent.
that even after 40 years of its existence.
GATT applied to only trade in WTO applies to both trade of
merchandise goods. merchandise goods and services and
also trade related aspects of Intellectual
Property Rights.
Agreements constituting GATT were All agreements are multilateral in
initially multilateral in nature but by nature and involve commitments by all
1980s many new agreements which members.
were pluri-lateral or of selective nature.
GATT disputes settlement was slower WTO disputes settlement is more
and with a lot of hurdles. automatic and faster than that that of
GATT.
GATT existed until 1995 as GATT 1994- WTO agreement still constitutes ‘GATT
which an updated version of GATT 1994’ focusing on disciplines regarding
1947. international 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.

 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 from an FTA.

 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.

 GATT has failed to control currency manipulations used by countries to

restrict imports.

 Pirates activities in Africa could not be eliminated by GATT/WTO.

Achievements of GATT & WTO

The establishment of WTO brought in a new trade order and world trade
expanded.

 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 percent of world
trade.

Q6. Write the process of issuing letter of credit.

Describe the different types of letter of credit.

Ans: Cash-in-advance

This type of arrangement is mostly 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. 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.
Therefore, often other terms as Face-on-Board may also be combined with
this type of payment option.

Process of issuing of letter of credit

Letter of Credit (LC) is one of the methods 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 buyer’s
reliable credit worthiness of the importer’s 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.

Types of letter of credit

 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.

 Standby letters of Credit – Commercial letters of credit are means of

payment to be utilized when the principal perform its duties. If this
construction company cannot fulfill its obligations under the project
contract beneficiary of the standby letter of credit can apply to the
 nominated bank for the payment. They are also published by ICC.
However, a standby letter of credit can be issued to either the UCP or
the ISP.

 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. The documentary credit, opened by
intermediary’s bank, is based on documentary credit (so-called initial
documentary credit) previously opened in favour of the intermediary.

 Resolving letter of credit – A resolving 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 so-called
‘resolving clause’ that allows the seller to present documents to the
bank after under 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.

 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 top the beneficiary, they are not used frequently. All
credits issued subject to UCP 600 are revocable unless otherwise agree
between the parties frequently.

 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 bank’s
written consent in order any modification or cancellation to be effective.