APRIL 2019 International Finance Question Paper

Apurva Belapurkar
Roll No. 2K1122
Sub: International Finance
Specialization: Finance

Q1. Explain role of Information & Technology in the process of globalization

Ans. Globalization is a process of interaction and integration among the people, companies, and governments of
different nations, a process driven by international Trade and Investment and aided by information technology.
This process has effects on the environment on culture, on political systems, on economic development and
prosperity, and on human physical well-being in societies around the world.
Globalization is not new, though. For thousands of years, people—and, later, corporations—have been buying
from and selling to each other in lands at great distances, such as through the famed Silk Road across Central
Asia that connected China and Europe during the Middle Ages. Likewise, for centuries, people and corporations
have invested in enterprises in other countries. In fact, many of the features of the current wave of globalization
are similar to those prevailing before the outbreak of the First World War in 1914.But policy and technological
developments of the past few decades have spurred increases in cross-border trade, investment, and migration
so large that many observers believe the world has entered a qualitatively new phase in its economic
development. Since 1950, for example, the volume of world trade has increased by 20 times, and from just 1997
to 1999 flows of foreign investment nearly doubled, from $468 billion to $827 billion. Distinguishing this
current wave of globalization from earlier ones, author Thomas Friedman has said that today globalization is
“farther, faster, cheaper, and deeper.”
This current wave of globalization has been driven by policies that have opened economies domestically and
internationally. In the years since the Second World War, and especially during the past two decades, many
governments have adopted free-market economic systems, vastly increasing their own productive potential and
creating myriad new opportunities for international trade and investment. Governments also have negotiated
dramatic reductions in barriers to commerce and have established international agreements to promote trade in
goods, services, and investment. Taking advantage of new opportunities in foreign markets, corporations have
built foreign factories and established production and marketing arrangements with foreign partners. A defining
feature of globalization, therefore, is an international industrial and financial business structure.
Technology has been the other principal driver of globalization. Advances in information technology, in
particular, have dramatically transformed economic life. Information technologies have given all sorts of
individual economic actors—consumers, investors, businesses—valuable new tools for identifying and pursuing
economic opportunities, including faster and more informed analyses of economic trends around the world, easy
transfers of assets, and collaboration with far-flung partners.
Globalization is deeply controversial, however. Proponents of globalization argue that it allows poor countries
and their citizens to develop economically and raise their standards of living, while opponents of globalization
claim that the creation of an unfettered international free market has benefited multinational corporations in the
Western world at the expense of local enterprises, local cultures, and common people. Resistance to
globalization has therefore taken shape both at a popular and at a governmental level as people and
governments try to manage the flow of capital, labor, goods, and ideas that constitute the current wave of
globalization.

Q1B What do you mean by International Finance? Explain its Nature and scope
Ans. International finance, sometimes known as international macroeconomics, is the study of monetary
interactions between two or more countries, focusing on areas such as foreign direct investment and currency
exchange rates. International finance deals with the economic interactions between multiple countries, rather
than narrowly focusing on individual markets. International finance research is conducted by large institutions
such as the International Finance Corp. (IFC), and the National Bureau of Economic Research (NBER).
Furthermore, the U.S. Federal Reserve has a division dedicated to analyzing policies germane to U.S. capital
flow, external trade, and the development of global markets.
Scope Of International Finance:
Financial management of a company is a complex process, involving its own methods and procedures. It is
made even more complex because of the globalization taking place, which is making the world’s financial and
commodity markets more and more integrated. The integration is both across countries as well as markets. Not
only the markets, but even the companies are  becoming international in their operations and
approach. This changing scenario makes it imperative for a student of finance to study international
finance .When a firm operates only in the domestic market, both for procuring inputs as well as
selling its output, it needs to deal only in the domestic currency. As companies try to increase their
international presence, either by undertaking international trade or by establishing operations in foreign
countries, they start dealing with people and firms in various nations. Since different countries have different
domestic currencies, the question arises asto which currency should the trade be settled in. The settlement
currency may either be the domestic currency of one of the parties to the trade, or may be an internationally
accepted currency. This gives rise to the problem of dealing with a number of currencies. The mechanism by
which the exchange rate
 
between these currencies(i.e., the value of one currency in terms of another) is determined, along with the level
and the variability of the exchange rates can have a profound effect on the sales, costs and profits of a firm.
Globalization of the financial markets also results in increased opportunities and risks on account of the
possibility of overseas borrowing and investments by the firm. Again, the exchange rates have a great impact on
the various financial decisions and their movements can alter the profitability of these
decisions.I n   t h i s   i n c r e a s i n g l y   g l o b a l i z e   s c e n a r i o ,   c o m p a n i e s   n e e d   t o   b e   g l o b a l l y   c o m p e t i
t i v e   i n   o r d e r   t o   s u r v i v e . Knowledge and understanding of different countries’ economies and their
markets is a must for
establishingo n e s e l f   a s   a   g l o b a l   p l a y e r .   S t u d y i n g   i n t e r n a t i o n a l   f i n a n c e   h e l p s   a   f i n a n c e   m a
n a g e r   t o   u n d e r s t a n d   t h e complexities of the various economies. It can help him understand as to how the
various events taking place t h e w o r l d o v e r   a r e g o i n g   t o   a f f e c t t h e   o p e r a t i o n s   o f   h i s f i r m .
It also helps
h i m   t o   i d e n t i f y   a n d   e x p l o i t opportunities, while preventing the harmful effects of international 
events. A thorough understanding of international finance will also assist the finance manager in
anticipating international events and analyzing their possible effects on his firm. He would thus get a chance to
maximize profits from opportunities and minimize losses from events which are likely to affect his firm’s
operations adversely Companies having international operations are not the only ones, which need to be aware of the
complexities of international finance. Even companies operating domestically need to understand the issues
involved. Though they may be operating domestically, some of their inputs (raw materials, machinery,
technological know-how, capital, etc.) may be imported from other countries, thus exposing them to
the risks involved in dealing with foreign currencies. Even if they do not source anything from outside
their own country, they may have foreign companies competing with them in the domestic market. In order to
understand their competitors’ strengths and weaknesses, awareness and understanding of international events again gains
importance .What about the companies operating only in the domestic markets, using only domestically available
inputs and neither having, nor expecting to have any foreign competitors in the foreseeable future?
Do they need to understand international finance? The answer is in the affirmative. Globalization and
deregulation have resulted in the various markets becoming interlinked. Any event occurring in, say Japan, is
likely to affect not only the Japanese stock markets, but also the stock markets and money markets the world
over. For e.g., the forex and money markets in India have become totally interlinked now. As market players try
to profit from the arbitrage opportunities arising in these markets, the events affecting one market also end up
affecting the other market indirectly. Thus, in case of occurrence of an event which has a direct
effect on the forex markets only, the above mentioned domestic firm would also feel its indirect effects
through the money markets. The same holds good for international events, thus, the need for studying
international finance.
Globalization essentially involves the various markets getting integrated across geographical bou
ndaries.Integration of financial markets involves the freedom and opportunity to raise funds from and to invest
any wherein the world, through any type of instrument. Though the degree of freedom differs from country to
country, the trend is towards having a reducing control over these markets. As a result of this freedom, anything
affecting the financial markets in one part of the world automatically and quickly affects the rest of the world
also. This is what we may call the Transmission Effect. Higher the integration, greater is the transmission effect

Q2A Explain role of various participants in foreign exchange

The foreign exchange market is the place where money denominated in one currency is bought and sold with
money denominated in another currency. It provides the physical and institutional structure through which the
currency of one country is exchanged for that of another country, the rate of exchange between currencies is
determined, and foreign exchange transactions are physically completed.The primary purpose of this market is
to permit transfer of purchasing power denominated in one currency to another. For example, a Japanese
exporter sells automobiles to a U.S. dealer for dollars, and a U.S. manufacturer sells instruments to a Japanese
Company for yen. The U.S. Company will like to receive payment in dollar, while the Japanese exporter will
want yen. It would be inconvenient for individual buyers and sellers of foreign exchange to seek out one
another. So a foreign exchange market has developed to act as an intermediary. It is the largest financial market
in the world with prices moving and currencies trading somewhere every hour of every business day. Major
world trading starts each morning in Sydney and Tokyo; moves West to Hong Kong and Singapore; passes on
to Bahrain; shifts to the main European markets of Frankfurt, Zurich and London; Jumps the Atlantic to New
York; goes west to Chicago, and ends in San Francisco and Los Angeles, It is the largest financial market in the
world having daily turnover of over 1600 billions dollar in 2001. Bulk of the trading is accounted for by a small
number of currencies the U.S. dollar, Deutschemark (DM), Yen, Pound Sterling, Swiss Franc, and Canadian
dollar. Foreign exchange market is of two types, viz.; retail market and wholesale market, also termed as the
inter-bank market. In retail market, travelers and tourists exchange one currency for another. The total turnover
in this market is very small. Wholesale market comprises of large commercial banks, foreign exchange brokers
in the inter-bank market, commercial customers, primarily MNCs and Central banks which intervene in the
market from time to time to smooth exchange rate fluctuations or to maintain target exchange rates.Over 90% of
the total volume of the transactions is represented by inter-bank transactions and the remaining 10% by
transactions between banks and their non-bank customers. It is worth noting that central bank intervention
involving buying or selling in the market is often indistinguishable from the foreign exchange dealings of
commercial banks or of other participants.The foreign exchange is similar to the over-the counter market in
securities. It has no centralized physical market place (except for a few places in Europe and the futures market
of the International Monetary Market of the Chicago Mercantile Exchange) and no fixed opening and closing
time.

The trading in foreign exchange is done over the telephone, telexes, computer terminals and other electronic
means of communication. The currencies and the extent of participation of each currency in this market depend
on local regulations that vary from country to country. It is interesting to note that bulk of the turnover in the
international exchange market is represented by speculative transactions. Foreign exchange market in India is
relatively very small. The major players in that market are the RBI, banks and business enterprises. Indian
foreign exchange market is controlled and regulated by the RBI. The RBI plays crucial role in settling the day-
to-day rates.

Participants in Foreign Exchange Market:

Participants in Foreign exchange market can be categorized into five major groups, viz.; commercial banks,
Foreign exchange brokers, Central bank, MNCs and Individuals and Small businesses.

1. Commercial Banks:
The major participants in the foreign exchange market are the large Commercial banks who provide the core of
market. As many as 100 to 200 banks across the globe actively “make the market” in the foreign exchange.
These banks serve their retail clients, the bank customers, in conducting foreign commerce or making
international investment in financial assets that require foreign exchange.

ADVERTISEMENTS:

These banks operate in the foreign exchange market at two levels. At the retail level, they deal with their
customers-corporations, exporters and so forth. At the wholesale level, banks maintain an inert bank market in
foreign exchange either directly or through specialized foreign exchange brokers.

The bulk of activity in the foreign exchange market is conducted in an inter-bank wholesale market-a network
of large international banks and brokers. Whenever a bank buys a currency in the foreign currency market, it is
simultaneously selling another currency.

A bank that has committed itself to buy a certain particular currency is said to have long position in that
currency. A short-term position occurs when the bank is committed to selling amounts of that currency
exceeding its commitments to purchase it.

2. Foreign Exchange Brokers:

Foreign exchange brokers also operate in the international currency market. They act as agents who facilitate
trading between dealers. Unlike the banks, brokers serve merely as matchmakers and do not put their own
money at risk.They actively and constantly monitor exchange rates offered by the major international banks
through computerized systems such as Reuters and are able to find quickly an opposite party for a client without
revealing the identity of either party until a transaction has been agreed upon. This is why inter-bank traders use
a broker primarily to disseminate as quickly as possible a currency quote to many other dealers.

3. Central banks:
Another important player in the foreign market is Central bank of the various countries. Central banks
frequently intervene in the market to maintain the exchange rates of their currencies within a desired range and
to smooth fluctuations within that range. The level of the bank’s intervention will depend upon the exchange
rate regime flowed by the given country’s Central bank.

4. MNCs:
MNCs are the major non-bank participants in the forward market as they exchange cash flows associated with
their multinational operations. MNCs often contract to either pay or receive fixed amounts in foreign currencies
at future dates, so they are exposed to foreign currency risk. This is why they often hedge these future cash
flows through the inter-bank forward exchange market.

5. Individuals and Small Businesses:

Individuals and small businesses also use foreign exchange market to facilitate execution of commercial or
investment transactions. The foreign needs of these players are usually small and account for only a fraction of
all foreign exchange transactions. Even then they are very important participants in the market. Some of these
participants use the market to hedge foreign exchange risk.

Segments of Foreign Exchange Market:

There are two segments of foreign exchange market, viz., Spot Market and Forward Market.
1. Spot Market:
In spot market currencies are exchanged immediately on the spot. This market is used when a firm wants to
change one currency for another on the spot. The procedure is very simple. A banker can either handle the
transaction for the firm or may have it handled by another bank.

Within minutes the firm knows exactly how many units of one currency are to be received or paid for a certain
number of units of another currency.

For instance, a US firm wants to buy 4000 books from a British Publisher. The Publisher wants four thousand
British Pounds for the books so that the American firm needs to change some of its dollars into pounds to pay
for the books. If the British Pound is being exchanged, say, for US $ 1.70, then £ 4,000 equals $ 6800.

The US firm simply pays $ 6800 to its bank and the bank exchanges the dollars for 4000 £ to pay the British
Publisher.

In the Spot market risks are always involved in any particular currency. Regardless of what currency a firm
holds or expects to hold, the exchange rate may change and the firm may end up with a currency that declines in
values if it is unlucky or not careful.

There are also risks that what the firm owes or will owe may be stated in a currency that becomes more valuable
and, as such possibly harder to obtain and use to pay the obligation.

2. Forward Market:
Forward market has come into existence to avoid uncertainties. In Forward market, a forward contract about
which currencies are to be traded, when the exchange is to occur, how much of each currency is involved, and
which side of the contract each party is entered into between the firms.

With this contract, a firm eliminates one uncertainty, the exchange rate risk of not knowing what it will receive
or pay in future. However, it may be noted that any possible gains in exchange rate changes are also estimated
and the contract may cost more than it turns out to be worth.

For example, suppose that the ninety-day forward price of the British pound is 2.000 (US$ 2.00 per £) or quoted
£ 0.5000 per US $, and that the current spot price is US $ 1.650. If a firm enters into a forward contract at the
forward exchange rate, it indicates a preference for this forward rate to the unknown rate that will be quoted
ninety days from now in the spot market.

However, if the spot price of the pound increases by 100 per cent during the next 90 days, the pound would be
US $ 3.3000 and the £ 5,00,000 could be converted into US $ 1,650,000 The forward market, therefore, can
remove the uncertainty of not knowing how much the firm will receive or pay. But it creates one uncertainty-
whether the firm might have been better off by waiting.

Functions of Foreign Exchange Market:

Foreign exchange market plays a very significant role in business development of a country because of
the fact that it performs several useful functions, as set out below:
1. Foreign exchange market transfers purchasing power across different countries, which results in enhancing
the feasibility of international trade and overseas investment.

2. It acts as a central focus whereby prices are set for different currencies.

3. With the help of foreign exchange market investors can hedge or minimize the risk of loss due to adverse
exchange rate changes.
4. Foreign exchange market allows traders to identify risk free opportunities and arbitrage these away.

5. It facilitates investment function of banks and corporate traders who are willing to expose their firms to
currency risks.

Q2B Write Note ON:

1) CROSS RATE
 cross rate is the currency exchange rate between two currencies when neither are the official currencies of the
country in which the exchange rate quote is given. Foreign exchange traders often use the term to refer to
currency quotes that do not involve the U.S. dollar, regardless of what country the quote is provided in.

An exchange rate between the euro and the Japanese yen is considered to be a cross rate in the market sense
because it does not include the U.S. dollar. In the pure sense of the definition, it is considered a cross rate if it is
referenced by a speaker or writer who is not in Japan or one of the countries that uses the euro. While the pure
definition of a cross rate requires it be referenced in a place where neither currency is used, the term is primarily
used to reference a trade or quote that does not include the U.S. dollar.

KEY TAKEAWAYS

 A cross rate is technically any rate between two currencies that are not the domestic currency in the
country where the quote is published.
 In practice, a cross rate is usually a currency pair that doesn't involve the U.S. dollar.

2) Spot & Forward Rate

There are two types of foreign exchange rates, namely the spot rate and forward rates ruling in the foreign
exchange market. The spot rate of exchange refers to the rate or price in terms of home currency payable for
spot delivery of a specified type of foreign exchange. The forward rate of exchange refers to the price at
which a transaction will be consummated at some specified time in future.

In modern times the system of forward rate of foreign exchange has assumed great importance in affecting
the international capital movements and foreign exchange banks play an important role in this respect by
matching the purchases and sales of forward exchange on the part of would be importers and would be
exporters respectively. The system of forward foreign exchange rate has actually been developed to minimize
risks resulting from the possibility of fluctuations over time in the spot exchange rate to the importers and
exporters. An example would illustrate this point.

The forward foreign exchange rate market gives him this assurance. His band will sell him “three months
forward” pound-sterling at Rs. 18 per pound sterling by charging a slight premium. That means that the bank
undertakes to sell the named quantity of the pound—sterling at and exchange rate of Rs. 18 per pound—sterling
in three months time, whatever the rate of exchange in the exchange market may be when that time comes.
Similarly, persons who expect to receive sums in foreign currency at future dates are able to sell “forward
exchange” to the banks in order to be sure in advance exactly how much they will receive in terms of home
currency. The basic importance of forward rate of exchange flows from the fact that actual rate of exchange is
liable to fluctuate from time to time and this renders the purchase and sale of goods abroad risky. Forward
exchange rate enables the exporters and importers of goods to know the prices of their goods which they are
about to export or import.

Q3A. Define concept of Deregulation and its characteristic. State Causes of deregulations.
Deregulation is the reduction or elimination of government power in a particular industry, usually enacted to
create more competition within the industry. Over the years the struggle between proponents of regulation and
proponents of no government intervention have shifted market conditions. Finance has historically been one of
the most heavily scrutinized industries in the United States.

Characteristics of Deregulations.

1) The business are left to themselves to determine their operational process and strategic
imperatives
2) They can launch product and set prices according to demand and supply
3) Deregulation is an emerging market economy it also means state is at last giving few play to
market
4) This is the reason why various business welcomes deregulation with open arm
5) Deregulation also means that business can focus on their core competencies without having to
submit themselves to constant scrutiny

Factors Affecting Deregulation

1) Asset bubble are far more likely to build and burst creating crisis and recession
2) Industries with initial infrastructure cost need government support to get stated examples includes
electricity and cable industry
3) Customers are more exposed to fraud and excessive risk taking by companies
4) Social concerns are lost

Q3B Securitization

Securitization is the procedure where an issuer designs a marketable financial instrument by merging or

pooling various financial assets into one group. The issuer then sells this group of repackaged assets to
investors. Securitization offers opportunities for investors and frees up capital for originators, both of which
promote liquidity in the marketplace.

In theory, any financial asset can be securitized—that is, turned into a tradeable, fungible item of monetary
value. In essence, this is what all securities are.
However, securitization most often occurs with loans and other assets that generate receivables such as different
types of consumer or commercial debt. It can involve the pooling of contractual debts such as auto loans
and credit card debt obligations.

In securitization, the company holding the assets—known as the originator—gathers the data on the assets it
would like to remove from its associated balance sheets. For example, if it were a bank, it might be doing this
with a variety of mortgages and personal loans it doesn't want to service anymore. This gathered group of assets
is now considered a reference portfolio. The originator then sells the portfolio to an issuer who will create
tradable securities. Created securities represent a stake in the assets in the portfolio. Investors will buy the
created securities for a specified rate of return.

Often the reference portfolio—the new, securitized financial instrument—is divided into different sections,
called tranches. The tranches consist of the individual assets grouped by various factors, such as the type of
loans, their maturity date, their interest rates, and the amount of remaining principal. As a result, each tranche
carries different degrees of risk and offer different yields. Higher levels of risk correlate to higher interest rates
the less-qualified borrowers of the underlying loans are charged, and the higher the risk, the higher the potential
rate of return.

Mortgage-backed security (MBS) is a perfect example of securitization. After combining mortgages into one
large portfolio, the issuer can divide the pool into smaller pieces based on each mortgage's inherent risk of
default. These smaller portions then sell to investors, each packaged as a type of bond.

By buying into the security, investors effectively take the position of the lender. Securitization allows the
original lender or creditor to remove the associated assets from its balance sheets. With less liability on their
balance sheets, they can underwrite additional loans. Investors profit as they earn a rate of return based on the
associated principal and interest payments being made on the underlying loans and obligations by the debtors or
borrowers.

Q4A Define Floating Rate Note. Explain its Types.

 floating-rate note (FRN) is a debt instrument with a variable interest rate. The interest rate for an FRN is tied to
a benchmark rate. Benchmarks include the U.S. Treasury note rate, the Federal Reserve funds rate—known as
the Fed funds rate—the London Interbank Offered Rate (LIBOR), or the prime rate.

Types of Floating Rate Note:

Plain Floating Rate Note

This is the simplest type of floater. If you invest in this kind of FRN, all you have to remember is that the
interest rate applicable to your investment increases proportionately to the rise in the interest rate used in the
money market or capital market index. In essence, you gain money as the index rate increases.
Capped Note
This type of FRN minimizes the seller's risk because it puts a limit on the coupon rate. This means that even if
the interest rate in the index surges, the investor’s gain will be limited only to the maximum interest rate set by
the note's seller.
Floored Note
Unlike the capped floater, this type of note protects the buyer. If you invest in a floored FRN, you will get a
guaranteed minimum coupon rate. Thus, even if the interest rate drops, you can still get a good return on your
investment.
Collared Floater
This type of security combines the characteristics of floored and capped notes. Collared FRNs offer both
minimum and maximum coupon rates to limit return to the investor and risk to the seller via a specified range of
interest rates.
Perpetual FRN
The main feature of this type of floater is the absence of a definite maturity date. As a result, investors receive
interest income constantly and in perpetuity. More often than not, perpetual FRNs are considered capital
investments.
Reverse Floating Rate Note
This type of floater, which is also known as an inverse FRN, offers the same structure as a plain or regular
floating rate note except for how the applicable coupon rate is computed. In essence, the coupon rate for this
type of debt security is inversely proportional to the reference rate movement. Investors in reverse floaters
usually receive huge profits from declining rates.
Flip-flop Note
This type of FRN offers investors a type of security that has a fixed rate and a floating rate. If the floating
interest rate falls below the fixed coupon rate, you can opt to receive profit using the specified fixed rate.
However, if the interest rate surpasses the fixed coupon rate, you can choose the prevailing floating rate to earn
higher income.

Q4B What are strategies used for international cash management?

Managing an international business is easy feat handling geographically distressed terms, catering to an
international client base large scale operation the list goes on but all aspects of international business, the many
ment of cash flow is real challenge.
1) Have a Foreign currently account for your business.
2) We a budgeting tool.
3) Avoid redundancy omission and errors
4) Leverage the currency option
5) Chose the transfer online