International Finance

International finance is the branch of economics that studies the dynamics of foreign exchange,foreign direct investment and how these affect international trade. Also studies the international projects, international investment and the international capital flow .International Finance can be broadly defined, as the study of the financial decisions taken by a multinational corporation in the area of international business i.e. global corporate finance. International finance draws much of its background from the preliminary studies in the topics of corporate finance such as capital budgeting, portfolio theory and cost of capital but now viewed in the international dimension.

How options are used to cover foreign exchange risks?

Currency options provide corporate treasurer another tool for hedging foreign exchange risks arising out of firms operations. Unlike forward contract, options allow the hedger to gain from favorable exchange rate movements, while been unprotected from unfavorable movements. However forward contracts are costless while options involve up front premium cost. Examples are:

a) Hedging a Foreign Currency with calls.

In late February an American importer anticipates a yen payment of JYP 100 million to a Japanese supplier sometime late in May. The current USD/JYP spot is 0.007739 (which implies a JYP/USD rate of 129.22.). A June yen call option on the PHLX, with strike price of $0.0078 per yen is available for a premium of 0.0108 cents per yen or $0.000108 per yen.… Read the rest

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Tools to manage foreign exchange risk involved due to fluctuations in exchange rates and interest rates

A firm may be able to reduce or eliminate currency exposure by means of internal and external hedging strategies.

Internal Hedging Strategies

1. Invoicing

A firm may be able to shift the entire risk to another party by invoicing its exports in its home currency and insisting that its imports too be invoiced in its home currency, but in the presence of well functioning forwards markets this will not yield any added benefit compared to a forward hedge. At times, it may diminish the firm’s competitive advantage if it refuses to invoice its cross-border sales in the buyer’s currency.

In the following cases invoicing is used as a means of hedging:

  1. Trade between developed countries in manufactured products is generally invoiced in the exporter’s currency.
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Management of Foreign Exchange Risks

What gives rise to foreign exchange transactions? Basically, there are four important factors which give rise to foreign exchange deals or transactions: (a) trade (exports/imports); (b) transfer (remittances); (c) investment (say, FCNR transactions); and (d) speculation. If one were to ask what is the proportion of speculation to the first three in the global foreign exchange market, one would be shocked to know that speculation accounts for nearly 96 per cent of the foreign exchange turnover of about US$ 700 billion per day in the international foreign exchange market. As we are aware, banks have established huge dealing rooms, and foreign exchange dealers are consistently buying and selling foreign currencies to make profits for their own institutions.… Read the rest

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Role of different parties involved in launching of Global Depositary Receipt (GDR)

GDRs (Global Depositary Receipts) are a type of straight equity shares, which are issued in the offshore market. These are essentially those instruments, which possess a certain number of underlying shares in the custody of depository bank. It is negotiable instrument, which are publicly traded local currency share.

It is in the form of depository or certificate issued by the overseas depository bank outside India and issued to the non- resident investors against the issue of the ordinary shares or foreign currency convertible bonds of the issuing company. In case of typical Global Depositary Receipt, it is denominated in US $ and the underlying shares are denominated in local currency of the issuer.… Read the rest

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The major risks in foreign exchange dealings

Forex Risk Management

The following are the major risks in foreign exchange dealings

  • Open Position Risk
  • Cash Balance Risk
  • Maturity Mismatches Risk
  • Credit Risk
  • Country Risk
  • Overtrading Risk
  • Fraud Risk, and
  • Operational Risks

Open Position Risk

The open position risk or the position risk refers to the risk of change in exchange rates affecting the overbought or oversold position in foreign currency held by a bank. Hence, this can also be called the rate risk. The risk can be avoided by keeping the position in foreign exchange square. The open position in a foreign currency becomes inevitable for the following reasons:

  • The dealing room may not obtain reports of all purchases of foreign currencies made by branches on the same day.
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The main features of interbank deals

Interbank deals refer to purchase and sale of foreign exchange between the banks. In other words it refers to the foreign exchange dealings of a bank in the interbank market. The main features of interbank deals are given in this section.

Cover Deals

Purchase and sale of foreign currency in the market undertaken to acquire or dispose of foreign exchange required or acquired as a consequence of the dealings with its customers is known as the ‘cover deal’. The purpose of cover deal is to insure the bank against my fluctuation in the exchange rates.

Since the foreign currency is a peculiar commodity with wide fluctuations in price, the bank would like to sell immediately whatever it purchases and whenever it sells it goes to the market and makes an immediate purchase to meet its commitment.… Read the rest

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