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MBA 4th Semester

MBA 4th Semester

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Published by: yoursuneel on Dec 31, 2011
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Master of Business Administration - MBA Semester 4MF0015 - International Financial ManagementAssignment Set- 1Q1. What is meant by BOP? How are capital account convertibility andcurrent account convertibility different? What is the current scenario inIndia?Ans:-
balance of payments
) of a country is a record of internationaltransactions between residents of one country and the rest of the world over aspecified period, usually a year. Thus, India’s balance of payments accounts recordtransactions between Indian residents and the rest of the world. Internationaltransactions include exchanges of goods, services or assets. The term “residents”means businesses, individuals and government agencies and includes citizenstemporarily living abroad but excludes local subsidiaries of foreign corporations. The balance of payments is a sources-and-uses-of-funds statement. Transactionssuch as exports of goods and services that earn foreign exchange are recorded ascredit, plus, or cash inflows (sources). Transactions such as imports of goods andservices that expend foreign exchange are recorded as debit, minus, or cashoutflows (uses). The
Balance of Payments
for a country is the sum of the
Current Account
, the
Capital Account
and the change in
Official Reserves
. The
current account
is that balance of payments account in which all short-termflows of payments are listed. It is the sum of net sales from trade in goods andservices, net investment income (interest and dividend), and net unilateral transfers(private transfer payments and government transfers) from abroad. Investmentincome for a country is the payment made to its residents who are holders of foreign financial assets (includes interest on bonds and loans, dividends and otherclaims on profits) and payments made to its citizens who are temporary workersabroad. Unilateral transfers are official government grants-in-aid to foreigngovernments, charitable giving (e.g., famine relief) and migrant workers’ transfersto families in their home countries. Net investment income and net transfers aresmall relative to imports and exports. Therefore a
current account surplus
indicates positive net exports or a trade surplus and a
current account deficit
indicates negative net exports or a trade deficit. The
(or financial)
is that balance of payments account in which allcross-border transactions involving financial assets are listed. All purchases or salesof assets, including direct investment (FDI) securities (portfolio investment) andbank claims and liabilities are listed in the capital account. When Indian citizens buyforeign securities or when foreigners buy Indian securities, they are listed here asoutflows and inflows, respectively. When domestic residents purchase morefinancial assets in foreign economies than what foreigners purchase of domesticassets, there is a
net capital outflow
. If foreigners purchase more Indian financialassets than domestic residents spend on foreign financial assets, then there will be
net capital inflow
. A
capital account surplus
indicates net capital inflows ornegative net foreign investment. A
capital account deficit
indicates net capitaloutflows or positive net foreign investment.
Current scenario in India
official reserves account (ORA)
records the total
held by theofficial monetary authorities (central banks) within the country. These reserves arenormally composed of the major currencies used in international trade and financialtransactions. The reserves consist of “hard” currencies (such as US dollar, BritishPound, Euro, Yen), official gold reserve and IMF Special Drawing Rights (SDR). Thereserves are held by central banks to cushion against instability in internationalmarkets. The level of reserves changes because of the central bank’s intervention inthe foreign exchange markets. Countries that try to control the price of theircurrency (set the exchange rate) have large net changes in their Official ReserveAccounts. In general, a net decrease in the Official Reserve Account indicates that acountry is buying its currency in exchange for foreign exchange reserves, to try tokeep the value of the domestic currency high with respect to foreign currencies.Countries with net increases in the Official Reserve Account are usually attemptingto keep the price of the domestic currency cheap relative to foreign currencies, byselling their currencies and buying the foreign exchange reserves. When a centralbank sells its reserves (foreign currencies) for the domestic currency in the foreignexchange market, it is a credit item in the balance of payment accounts as it makesavailable foreign currencies. Similarly, when a central bank buys reserves (foreigncurrency), it is a debit item in the balance of payment accounts. The Balance of Payments identity states that:
Current Account + CapitalAccount = Change in Official Reserve Account.
If a country runs a currentaccount deficit and it does not run down its official reserve to cover this deficit(there is no change in official reserve), then the current account deficit must bebalanced by a capital account surplus. Typically, in countries with floating exchangerate system, the change in official reserves in a given year is small relative to theCurrent Account and the Capital Account. Therefore, it can be approximated byzero. Thus, such a country can only consume more than it produces (or imports aregreater than exports; a current account deficit) only if it has a capital accountsurplus (foreign residents are willing to invest in the country). Even in a fixedexchange rate system, the size of the official reserve account is small compared tothe transactions in the current and capital account. Thus the residents of a countrycannot have a current account deficit (imports exceeding exports) unless theforeigners are willing to invest in that country (capital account surplus).
Q2. What is arbitrage? Explain with the help of suitable example a tow-way and a three-way arbitrage.Ans:-
Arbitrage is the activity of exploiting imbalances between two or moremarkets. Foreign money exchangers operate their entire businesses on thisprinciple. They find tourists who need the convenience of a quick cash exchange. Tourists exchange cash for less than the market rate and then the moneyexchanger converts those foreign funds into the local currency at a higher rate. Thedifference between the two rates is the spread or profit.

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