International Finance

Answer 1

Introduction

Firms were only restricted to the four walls of the country before this policy. However, the
opportunities for raising money significantly increased once globalisation entered the picture.
Previously, it was not permitted for our country's businesses to look to external funders to meet their
financial needs. They are no longer limited to the national borders; instead, their reach has expanded
and the local market is now exposed to the global capital market.

The area of financial economics known as international financing, often known as international
macroeconomics, is generally concerned with monetary interactions at a worldwide level. The
dynamics of foreign direct investment, exchange rates, balance of payments, global funding
distribution, and other facets of financial management are all examined.

Concept and application

International funding promotes financial transactions between two or more countries. There are
many places in the globe where people can get money, and those places will be described in depth.

1) Commercial Bank:-
Commercial banks provide financial support to companies and businesses worldwide as well
as in their own nation. Foreign currency loans and advances are offered globally by
commercial banks. Loans are a well-known source of international funding for non-trade
operations and are typically given for business objectives. Companies can choose from a
diverse array of loans, advances, and services offered by banks in various nations. Without
commercial banks, the export-import sector of the economy and the global financial market
are both insufficient. A lot of options for overseas finance are provided by commercial banks.
2) International Agencies and development banks:-
Because they were only introduced by the government for developmental purposes, these
banks are known as developmental banks. With the intention of funding international finance,
international agencies and development banks have sprung up over time. These organisations
were created by the governments of industrialised nations to strengthen and grow the weaker
sectors of the economy by making loans freely accessible. For a medium to long period of
time, these loans are typically advanced. These financial institutions are being created on a
local, regional, and international scale. Examples that are frequently used are the Asian
 Developmental Banks (ADB), European Investment Bank (EIB), European Bank for
Reconstruction and Development (EBRD), and EXIM Bank.
3) International Capital Market:-
The purpose of the international capital market is to increase economic efficiency and
produce economies of scale. It is the type of finance that is used the most. Today's
organisations, particularly multinational firms, rely heavily on rupee funds in addition to
foreign currencies. There are a number of financial options accessible under this foreign
financing source, including the ones listed below:
 Global Depository Receipts (GDRs):-
Previously, a nation's finances were typically raised domestically, but they can now
also be raised from abroad. By issuing securities and shares in foreign nations, this is
possible. A financial instrument called GDR exists to make this process convenient.
The shares are initially issued in the native currency. These shares are delivered to a
depository bank, which is subsequently in charge of exchanging these shares for
depository receipts.
These depository receipts, or GDRs, have a US dollar value. In India, GDR is
regarded as a financial instrument issued to raise foreign exchange, i.e., in foreign
denominations rather than in Rupees.
It is a negotiable instrument that is freely tradable like any other. GDR is a security
that can be traded like any other with little difficulty. The foreign stock exchange lists
GDRs. The virtuous entity does not have any voting rights, but it is permitted to claim
any dividends and bonuses due on GDRs. The primary goal of the GDR issuance is to
draw in international investors. A low-cost mechanism where investors can easily
participate is provided by the issuance of GDR. Foreign investors have the
opportunity to engage in or access global financial markets in addition to their home
country's capital markets. Indian businesses including ICICI, Wipro, Reliance, and
Infosys use GDRs to raise foreign currency.
 American Depository Receipts (ADRs):
The Global Depository Receipts and the American Depository Receipts resemble one
another quite a bit. The procedure of issuing local currency shares and then
transferring those shares to the depository bank for conversion into depository
receipts continues to be used.
ADRs can only be issued in the United States, which is the main distinction between
the two depository institutions. Only the American capital market is capable of
 facilitating the selling and acquisition of ADRs. Only the American stock exchange
and nowhere else are these depository receipts listed. A U.S. depository bank issues
American Depository Receipts, which are tradable certificates similar to GDRs.
Any investor must access financial information before they can invest in businesses
around the world. US banks must therefore accurately disclose the company's
financial situation.
American depository receipts, unlike Global depository receipts, can only be issued to
inhabitants of the United States of America and cannot be offered for sale or purchase
to any random foreign country.
ADRs come in two varieties: sponsored ADRs and unsponsored ADRs.
ADRs are treated by Americans who trade on the US stock market just like any other
regular stock.
 Indian Depository Receipts (IDRs):-
In this case, shares are transferred to the depository banks in order to get depository
receipts in return for the relevant shares, much like with GDRs. But because this
depository is Indian-based, it differs slightly from GDRs. The depository receipts
have an Indian rupee value. As a result, it enables any foreign investor to raise money
on the Indian capital market using IDRs instead of shares or other assets.
 Foreign Currency Convertible Bonds (FCCBs):-
Foreign money Bonds with convertible bonds combine debt and equity instruments.
These bonds are convertible, just like any other convertible securities, which mean
that at a future date after the passage of a specified period of time, these bonds may be
changed into any depository receipts or some equity shares. Bond holders have the
option of exchanging their FCCBs for equity shares with predetermined prices or for
any exchange rate. The bearer also has the option of keeping their FCCBs on them.
Always traded on international financial markets are FCCBs.
Conclusion
Overall, it can be said that there are many outside funding avenues available for raising funds, but it's
crucial to select the most advantageous one. However, as we are all aware, no avenue is perfect and
they all have some drawbacks, so on occasion it is necessary to put all the funds together into a
portfolio that combines two or more avenues. The best option among all the possibilities is
determined by a number of factors, including the business's purpose and longevity, risk tolerance, tax
benefits, investor financial strength, and many more.
Answer 2.
Introduction
As with forward contracts, currency futures contracts can be used to hedge foreign exchange
exposures. The primary distinction is the contract size, which is a conventional one but may not
always correspond to actual exposure. The second key distinction is the futures contract maturity
date, which might not match the exposure's actual cash flow. Last but not least, using margining and
the ensuing settlement method make hedging with different from using forwards.
Only if the spot price is the same as the futures price on the day the contracts are squared off will the
hedge is the same as the hedge where the expiry date is the same as the transaction exposure date if
the futures contract expiry date differs from the transaction exposure date. Only on the date of the
contract's expiration, though, will the spot rate and the futures rate be equal. The discrepancy can
result in more losses or gains, which would render the hedging ineffective. The distinction between
the spot price and the futures price on the transaction exposure date is the basis, and this is referred to
as basis risk. If they are available, forward contracts would serve as a stronger hedging instrument in
this situation than currency futures.
Concept and application
For the value date of October 30, 2023, the importer is required to pay USD 5 million. This means
that on October 28, 2023, it would have to make a spot market buy of USD. It has no idea how many
rupees are needed to buy USD 5 million in dollars. The price of imports will go higher if the rupee
weakens versus the dollar. It wants to mitigate the exchange rate risk as a result.
Currency futures are a tool the corporation can use to manage risk. Theoretically, it suggests that the
corporation is entering into a contract to buy USD at the future price of the October contract offered
today if it purchases a USD currency futures contract expiring at the end of October. The answer to
the question is 80.3250 for the applicable future price of USD. It indicates that you are entering into
a contract to buy US dollars at the end of October (for this contract, that is, on October 28) at an
exchange rate of 80.3250. This is equivalent to agreeing to an 80.3250 forward contract rate.
However, as previously mentioned, the settlement of a futures contract is different from that of a
forward contract, which makes the actual operation of futures trading and the hedging process
different.
There are various steps transaction involved in the hedging process will be as follows:
1) Since the importer needs to purchase USD at a future date, it will purchase currency futures
Its liability is USD million. The standard contract size is not given. Hence it needs to
purchase 5 million.
2) There is no initial margin. So the notional contract amount is calculated as follows
= 50, 00,000*(80.3250/100)
= 40, 16,250
3) The contract will be settled at the spot rate of 79.1250 on October 28th, the contract's
expiration date. This is the same as announcing that the future contract will be sold or
squared off at 79.1250 because it is also the settlement price for the future contract on the
expiry date.
The profit/loss from futures transaction will be:
= Sales price – Purchase price
= 50, 00,000*(79.1250/100)-40, 16,250
= 3956250 - 4016250
= INR (60,000)
Thus, there is a loss 60,000 in the case of currency futures transaction.
4) For paying the import bill the importer will purchase USD in the spot market rate 79.1250.
Amount of INR required =50, 00,000*79.1250/100
Total amount of INR spent for the import bill = Spot purchase + Loss on Futures
= 3956250+60000
= 40, 16,250
5) The importer's purchase of the required amount of USD was made at an effective exchange
rate of (4016250/5000000) =0.80325 per USD, or INR 80.3250 for 100 USD. As a result, the
effective exchange rate is identical to the future rate agreed upon at 80.3250.
The lower spot exchange rate in effect on the expiration date makes up the loss caused by
futures transactions. As a result, the importer effectively set the futures exchange rate at the
price of 80.3250.
6) The USD has lost value relative to the INR during the time. This indicates that, looking back,
the importer would have been better off if it had hedged its exposures for a payables position.
If this had been the case, it would have acquired USD on October 28th at a rate of 79.1250
rather than its actual hedged rate of 80.3250.
Hence, its notional/ideal loss is given as follows:
Notional loss due to hedging =50,00,000*(80.3250-79.1250)/100
= 60,000
This is the same as its loss in the future market.
7) The Indian company will settle the futures contract at the spot pricing, which is expected to
be 81.6250 on the expiration date.
 Profit/loss due to futures transactions = Sales price – Purchase Price
= 50, 00,000*(81.6250/100)-40, 16,250
= 65,000
Thus, there is a profit of INR 65,000 in the case of currency futures transactions
The higher spot rate that would be required to buy foreign currency on the spot rate market
would, however, negate this.
The importer would have suffered a loss of INR 65,000 if it hadn't hedged its positions.
Instead of paying the futures contract price of 80.3250, it would have paid a higher spot rate
of 81.6250 to buy USD. Notional loss would have been INR 65,000 if the importer had not
hedged: 5000000*(81.6250-80.3250)/100
It would have spent INR 65000 less for buying USD had it hedged its risk.
Conclusion
By hedging the currency risk through currency futures, the Indian company would have reduced the
uncertainty surrounding the payment requirement and the related risk of currency swings.

Answer 3.a
Introduction
The foreign exchange market, often known as the currencies market, forex, or FX, is an over-the-
counter (OTC) global marketplace that sets the exchange rate for all currencies. Trading, exchanging,
and speculating on the relative exchange rates of different currency pairs are all options available to
participants in these markets.
Banks, forex dealers, business entities, central banks, asset management businesses, hedge funds,
small-time forex traders, and investors are all participants in the foreign exchange markets.
One of the first financial markets created to support the expanding global economy was the foreign
exchange market, sometimes known as forex, FX, or the currency market. In terms of trade volume,
it is by far the biggest financial market in the world. The forex market provides a venue for currency
exchange for investments and cross-border trade payments, as well as for currency buying, selling,
speculating, and exchange. The "value" of each individual currency in a pair is predicated on the
value of the other currency because currencies are always traded in pairs. This has an impact on the
quantity of money that country B can buy from country A, and vice versa.
A classic autonomy problem is illustrated by the escalating asymmetry in the relationship between
national governments and the currency markets. The Mundell-Fleming model lays out the "dilemma"
of economic policy alternatives open to governments. The model demonstrates that governments
must select two of the following three policy objectives: (1) domestic monetary autonomy (the
capacity to control the money supply and set interest rates and thereby control growth); (2) exchange
rate stability (the capacity to lessen uncertainty through a fixed, pegged, or managed regime); and (3)
capital mobility (allowing investment to move within and outside of the country).
The most liquefiable financial market in the world is undoubtedly the foreign currency market. The
global exchange of many different currencies is known as forex. In this market, currency traders are
allowed to buy or sell currencies whenever they want.The structure of the foreign exchange market is
continually evolving. In these markets, exchange rates change every minute of every day.
Concept and application
To calculate the exchange rate between GBP and INR, we can use the indirect method of quoting the
exchange rate, which involves converting GBP to USD and then USD to INR
First, we need to convert GBP to USD using the given Spot rate GBP/USD:
1 GBP=1.2100 USD
Next, we need to convert USD to INR using the spot rate of INR/USD:
1 USD = 1/0.012
=83.33
Therefore,
GBP INR= 1.2100*83.33
=100.833 as per cross rate
Conclusion
With daily transactions totaling trillions of dollars, the FOREX markets have established themselves
as the most active and liquid marketplaces in the entire world. Speculators and hedgers can choose a
tool and a level of leverage that suit their needs whether trading on the futures, options, or spot
markets. The FOREX markets offer a venue for addressing currency rate variations, from
sophisticated speculative plans to conventional hedging techniques.

Answer 3.b
Introduction
Commodities and financial instruments are traded for immediate delivery on a spot market, which is
a financial market. The spot market is frequently referred to as the cash market or the physical
market due to the quick processing of cash payments and the physical exchange of assets. When it
comes to the issue of currency exchange, the needs of businesses and individuals who want to
transact on forex or in a foreign currency influence the spot rate. Forex is also known as the upfront
rate, benchmark rate, or simple rate from the standpoint of foreign currency. Along with currencies,
other assets have spot rates as well. These include items like bonds, gold, cotton, coffee, wheat, gold,
crude oil, petrol and coffee. Demand and supply factors for these goods are used to determine a
commodity's spot rates. On the other hand, bond spot rates have a zero-coupon rate. Spot rate data
can be obtained from a variety of sources, which traders can utilise to make calculated market
moves. In actuality, news outlets frequently publicise spot rate values, notably those for commodity
and currency rates.
Concept and application
The negotiation of a spot rate is referred to as "spot settlement". It is described as the payment that
completes the transaction of the spot contract. It frequently occurs two days after the trade day. This
is the time horizon of it. The day on which the buyer and seller of the spot contract resolve their
disagreement is known as the post date. Regardless of what occurs in the market between the
settlement date and the day of the actual transaction, both parties will stick to the spot contract at the
agreed-upon spot rate.
For this reason, the so-called "forward rate" is frequently determined using the spot rate. The price of
the security during their next financial transaction is known as the forward rate. The projected value
of any investment, commodity, or currency is dependent on its present value, the risk-free rate, and
the remaining time until the spot contract matures. As a result, using these three metrics, traders who
have access to the security can extrapolate its spot rate.
Even if the forward rates are at a discount to the spot rate, it is customary to avoid using the word
"discount" and to avoid mentioning forward points in negative numbers when the forward rates are
reported. If the forward points are higher than the forward ask points, it is known that the forward
rates are being quoted at a discount to the spot rate. Another method is to verify the forward bid and
ask points. If the forward ask points are higher than the forward bid points, the forward points must
be subtracted from the spot exchange rates.
In the given question, the forward bid points are greater than the forward ask points. As per
convention, it means that the forward rates are at discount to the spot rates. The Outright forward
rates can be calculated below as follows:
Outright Forward Bid Rate = 80.74 – (216.25/10000) = 80.72
Outright Forward Ask Rate = 80.87- (218.25/10000) = 80.85
The bid- ask rate spread for spot rate = 80.87 - 80.74 = 0.13
The bid- ask rate spread for Forward rate = 80.85 - 80.75 = 0.1
Conclusion
The cost of a security as it is offered by traders is known as the spot rate. It changes frequently in
response to changes in the market. It can also be used to calculate a security's forward price.