IF- CRR- International bond market

The two segments of the international bond market are: foreign bonds and Eurobonds. A foreign bond issue is one offered by a foreign borrower to investors in a national capital market and denominated in that nation’s currency. A Eurobond issue is one denominated in a particular currency, but sold to investors in national capital markets other than the country which issues the denominating currency. Eurobonds make up over 80 percent of the international bond market. The two major reasons for this stem from the fact that the U.S. dollar is the currency most frequently sought in international bond financing. First, Eurodollar bonds can be brought to market more quickly than Yankee bonds because they are not offered to U.S. investors and thus do not have to meet the strict SEC registration requirements. Second, Eurobonds are typically bearer bonds that provide anonymity to the owner and thus allow a means for evading taxes on the interest received. Because of this feature, investors are generally willing to accept a lower yield on Eurodollar bonds in comparison to registered Yankee bonds of comparable terms, where ownership is recorded. For borrowers the lower yield means a lower cost of debt service. 

The major types of international bond instruments and their distinguishing characteristics are as  follows:

 1.Straight fixed-rate bond issues have a designated maturity date at which the principal of the bond issue is promised to be repaid. During the life of the bond, fixed coupon payments that are some percentage rate of the face value are paid as interest to the bondholders. This is the major international bond type. Straight fixed-rate Eurobonds are typically bearer bonds and pay coupon interest annually

2. Floating-rate notes (FRNs) are typically medium-term bonds with their coupon payments indexed to some reference rate. Common reference rates are either three-month or six-month U.S. dollar LIBOR. Coupon payments on FRNs are usually quarterly or semi-annual, and in a accord with the reference rate. A convertible bond issue allows the investor to exchange the bond for a pre-determined number of equity shares of the issuer. The floor value of a convertible bond is its straight fixed-rate bond value. Convertibles usually sell at a premium above the larger of their straight debt value and their conversion value. Additionally, investors are usually willing to accept a lower coupon rate of interest than the comparable straight fixed coupon bond rate because they find the call feature attractive. Bonds with equity warrants can be viewed as a straight fixed-rate bond with the addition of a call option (or warrant) feature. The warrant entitles the bondholder to purchase a certain number of equity shares in the issuer at a pre-stated price over a pre-determined period of time. 

3. Zero coupon bonds are sold at a discount from face value and do not pay any coupon interest over their life. At maturity the investor receives the full face value. Another form of zero coupon bonds are stripped bonds. A stripped bond is a zero coupon bond that results from stripping the coupons and principal from a coupon bond. The result is a series of zero coupon bonds represented by the individual coupon and principal payments. 

4. A dual-currency bond is a straight fixed-rate bond which is issued in one currency and pays coupon interest in that same currency. At maturity, the principal is repaid in a second currency. Coupon interest is frequently at a higher rate than comparable straight fixed-rate bonds. The amount of the dollar principal repayment at maturity is set at inception; frequently, the amount allows for some appreciation in the exchange rate of the stronger currency. From the investor’s perspective, a dual currency bond includes a long-term forward contract. 

5. Composite currency bonds are denominated in a currency basket, such as SDRs or ECUs, instead of a single currency. They are frequently called currency cocktail bonds. They are typically straight fixed-rate bonds. The currency composite is a portfolio of currencies: when some currencies are depreciating others may be appreciating, thus yielding lower variability overall

IF- CRR

• Balance of visible trade is also known as balance of merchandise trade, and it covers all transactions related to movable goods where the ownership of goods changes from residents to non-residents (exports) and from non-residents to residents (imports). The valuation should be on F.O.B basis so that international freight and insurance are treated as distinct services and not merged with the value of goods themselves. Exports valued on F.O.B basis are the credit entries. Data for these items are obtained from the various forms that the exporters have fill and submit to the designated authorities. Imports valued at C.I.F are the debit entries. Valuation at C.I.F. though inappropriate, is a forced choice due to data inadequacies. The difference between the total of debits and credits appears in the “Net” column. This is the ‘Balance of Visible Trade.’ In visible trade if the receipts from exports of goods happen to be equal to the payments for the imports of goods, we describe the situation as one of zero “goods balance.’ Otherwise there would be either a positive or negative goods balance, depending on whether we have receipts exceeding payments (positive) or payments exceeding receipts (negative).
• Transactions above the line in BOP. : Economists have often found it useful to distinguish between autonomous and accommodating capital flows in the BOP. Transactions are said to Autonomous if their value is determined independently of the BOP. Accommodating capital flows on the other hand are determined by the net consequences of the autonomous items. An autonomous transaction is one undertaken for its own sake in response to the given configuration of prices, exchange rates, interest rates etc, usually in order to realise a profit or reduced costs. It does not take into account the situation elsewhere in the BOP. An accommodating transaction on the other hand is undertaken with the motive of settling the imbalance arising out of other transactions. An alternative nomenclature is that capital flows are ‘above the line’ (autonomous) or ‘below the line’ (accommodating). Obviously the sum of the accommodating and autonomous items must be zero, since all entries in the BOP account must come under one of the two headings. Whether the BOP is in surplus or deficit depends on the balance of the autonomous items. The BOP is said to be in surplus if autonomous receipts are greater than the autonomous payments and in deficit if vice – a – versa. Essentially the distinction between both the capital flow lies in the motives underlying a transaction, which are almost impossible to determine. We cannot attach the labels to particular groups of items in the BOP accounts without giving the matter some thought. For example a short term capital movement could be a reaction to difference in interest rates between two countries. If those interest rates are largely determined by influences other than the BOP, then such a transaction should be labelled as autonomous. Other short term capital movements may occur as a part of the financing of a transaction that is itself autonomous (say, the export of some good), and as such should be classified as accommodating. There is nevertheless a great temptation to assign the labels ‘autonomous’ and ‘accommodating’ to groups of item in the BOP. i.e. to assume, that the great majority of trade in goods and of long term capital movements are autonomous, and that most short term capital movements are accommodating, so that we shall not go far wrong by assigning those labels to the various components of the BOP accounts. Whether that is a reasonable approximation to the truth may depend in part on the policy regime that is in operation. For example what is an autonomous item under a system of fixed exchange rates and limited capital mobility may not be autonomous when the exchange rates are floating and capital may move freely between countries. 

• The overall BOP is determined by computing the cumulative balance of payments including the current account, capital account, and the statistical discrepancies. The overall BOP is significant because it indicates a country’s international payment gap that must be financed by the government’s official reserve transactions. Overall balance is the total sum of current account, capital account and errors and omissions. Reserve account is not considered while computing overall balance. Basic balance refers to total of current account and capital account and when errors and omission is added we get overall balance. Except Foreign exchange reserve account, rest all is considered in overall balance.
•    Yankee bonds: These are dollar denominated bonds issued by foreign borrowers. It is the largest and most active market in the world but potential borrowers must meet very stringent disclosure, dual rating and other listing requirements, options like call and put can be incorporated and there are no restrictions on size of the issue, maturity and so forth.  Yankee bonds can be offered under rule 144a of Sec. These issues are exempt from elaborate registration and disclosure requirements but rating, while not mandatory is helpful. Finally low rated or unrated borrowers can make private placements. Higher yields have to be offered and the secondary market is very limited.
• American depository receipt is a negotiable certificate that represents a company's publicly traded equity or debt. They are created when a broker purchases the company's shares on the home stock market and delivers those to the depository's local custodian bank, which then instructs the depository bank, to issue Depository Receipts. Depository receipts could be traded freely just like any other security, either by exchange or in the over-the-counter market and could be used to raise capital.
• Arbitrage may be defined as an operation that consists in deriving a profit without risk from a differential existing between different quoted rates. It may result from 2 currencies, also known as, geographical arbitrage or from 3 currencies, also known as, triangular currencies.  Arbitrage may be defined as an operation that consists in deriving a profit without risk from a differential existing between different quoted rates. It may result from 2 currencies, also known as, geographical arbitrage or from 3 currencies, also known as, triangular currencies. Arbitraging is the process of buying and selling the same security (currency) in different markets to benefit or gain from the price differential. In the international parlance, arbitraging means taking advantage of the price differentials in the quoted prices of the currencies in different markets. The process of arbitrage will normalise the prices.  For example, if a stock is quoted on two different equity markets, there is the possibility of arbitrage if the quoted price (adjusted for institutional idiosyncrasies) in one market differs from the quoted price in the other. 
• Triangular arbitrage is the process of trading out of the U.S. dollar into a second currency, then trading it for a third currency, which is in turn traded for U.S. dollars. The purpose is to earn an arbitrage profit via trading from the second to the third currency when the direct exchange between the two is not in alignment with the cross exchange rate. Most, but not all, currency transactions go through the dollar. Certain banks specialize in making a direct market between non-dollar currencies, pricing at a narrower bid-ask spread than the cross-rate spread. Nevertheless, the implied cross-rate bid-ask quotations impose a discipline on the non-dollar market makers. If their direct quotes are not consistent with the cross exchange rates, a triangular arbitrage profit is possible.
• A crawling peg rate is a hybrid of fixed and flexible exchange rate systems. Under this system, while the value of a currency is fixed in terms of a reference currency, this peg keeps on changing itself in accordance with the underlying economic fundamentals, thus letting the market forces play a role in the determination of the change in exchange rate. There are several bases which could be used to determine the direction of change in the exchange rate for example – the actual exchange rate ruling the market, t there is gradual modifications with permissable variations around the parity restricted to a narrow band. The change in parity per unit period is subject to a ceiling with an additional short term constraint, e.g. parity change in a month cannot be more than 1/12^th of the yearly ceiling. Parity changes are carried out , based on a set of indicators. They may be discretionary, automatic or presumptive. The indicators are : current account deficits, changes in reserves, relative inflation rates and moving average of past spot rates. Countries such as Portugal and Brazil have in the part adopted variants of Crawling Peg.
• Adjustable Peg system was established which fixed the exchange rates, with the provision of changing them if the necessity rose. Under the new system, all the members of the newly set up IMF were to fix the par value of their currency either in terms of gold, or in terms of US dollar. The par value of the US dollar was fixed at $ 35 per ounce. All these values were fixed with the approval of the IMF, and were reflected in the change economic and financial scenario in the countries engaged in international trade. The member countries agreed to maintain the exchange rates for their currency within a band of one percent on either sides of the fixed par value. The extreme points were to be referred to as upper and lower support point, due to which requirement that the countries do not allow the exchange rate to go beyond these points. The monetary authorities were to stand ready to buy or sell the US dollar and thereby support the exchange rates. For this purpose, a country which would freely buy and sell gold at the aforementioned par value for the settlement of international transactions was deemed to be maintaining its exchange rate within the one percent band.
• Transaction exposure is the sensitivity of realized domestic currency values of the firm’s contractual cash flows denominated in foreign currencies to unexpected changes in exchange rates. Unlike economic exposure, transaction exposure is well-defined and short-term. Some typical situations, which give rise to transactions exposure, are: (a)   A currency has to be converted in order to make or receive payment for goods and services; (b)          A currency has to be converted to repay a loan or make an interest payment; or (c)        A currency has to be converted to make a dividend payment, royalty payment, etc.  Note that in each case, the foreign value of the item is fixed; the uncertainty pertains to the home currency value. The important points to be noted are (1) transaction exposures usually have short time horizons and (2) operating cash flows are affected.
•     Translation Exposure. (April 2003):Also called Balance Sheet Exposure, it is the exposure on assets and liabilities appearing in the balance sheet but which is not going to be liquidated in the foreseeable future. Translation risk is the related measure of variability.The key difference is the transaction and the translation exposure is that the former has impact on cash flows while the later has no direct effect on cash flows. (This is true only if there are no tax effects arising out of translation gains and losses.)            Translation exposure typically arises when a parent multinational company is required to consolidate a foreign subsidiary’s statements from its functional currency into the parent’s home currency.
• The authorities are intervened more or less intensely in the foreign exchange market in which there are no officially declared parties, but there is official intervention that has come to be known as managed or dirty float. A dirty float system is not considered as true floating rate system don’t allow for intervention.  Floating rate system may be independent or managed. Theoretically speaking, the system of managed floating involves intervention by the monetary authorities of the country for the purpose of exchange rate stabilization. The process of intervention interferes with market forces and so it is known as “dirty” floating as against independent floating which is known as “clean” floating. However, in practice, intervention is global phenomenon. Keeping this fact in mind, the IMF is of the view that while the purpose of intervention in case of independent floating system is to moderate the rate of change, and to prevent undue fluctuation, in exchange rate; the purpose in managed floating system is to establish a level for the exchange rate
• Currency options provide a more flexible means to cover transactions exposure. A contracted foreign currency outflow can be hedged by purchasing a call option (or selling a put option) on the currency while an inflow can be hedged by buying a put option. (Or writing a call option. This is a “covered call” strategy).  A fixed-to-floating currency swap is a combination of a fixed-to-fixed currency swaps and a fixed-to-floating interest rate swap. Here, one payment stream is at a fixed rate in currency X while the other is at a floating rate in currency Y.
•     Samurai Bond. (April 2003): They are publicly issued yen denominated bonds. They are issued by non-Japanese entities. The Japanese Ministry of Finance lays down the eligibility guidelines for potential foreign borrowers. These specify the minimum rating, size of issue, maturity and so forth. Floatation costs tend to be high. Pricing is done with respect to Long-term Prime Rate. Foreign bonds are referred to as traditional international bonds because they existed long before eurobonds. Yankee bonds are foreign bonds issued in the United States. Foreign bonds issued in U.K. re called Bulldog bonds. Those issued in Japan are called Samurai bonds.
• International Capital Markets have come into existence to cater to the need of international financing by economies in the form of short, medium or long-term securities or credits. These markets also called Euro markets, are the markets on which Euro currencies, Euro bonds, Euro shares and Euro bills are traded/exchanged. Over the years, there has been a phenomenal growth both in volume and types of financial instruments transacted in these markets. Euro currency deposits are the deposits made in a bank, situated outside the territory of the origin of currency. For example, Euro dollar is a deposit made in US dollars in a bank located outside the USA; likewise, Euro banks are the banks in which Euro currencies are deposited. They have term deposits in Euro currencies and offer credits in a currency other than that of the country in which they are located. A distinctive feature of the financial strategy of multinational companies is the wide range of external services of funds that they use on an ongoing basis. British Telecommunication offers stock in London, New York and Tokyo, while Swiss Bank Corporation-, aided by Italian, Belgian, Canadian and German banks- helps corporations sell Swiss franc bonds in Europe and then swap the proceeds back into US dollars.
• While opening up of the domestic markets began only around the end of seventies, a truly international financial market had already been born in the mid-fifties and gradually grown in size and scope during sixties and seventies. This refers to the well-known ‘Eurocurrencies Market’. It is the largest offshore market.  Prior to 1980, Eurocurrencies market was the only truly international financial market of any significance. It is mainly an inter-bank market trading in time deposits and various debt instruments. What matters is the location of the bank neither the ownership of the bank nor ownership of the deposit. The prefix "Euro" is now outdated since such deposits and loans are regularly traded outside Europe.  Over the years, these markets have evolved a variety of instruments other than time deposits and short-term loans, e.g. certificates of deposit (CDs), euro commercial paper (ECP), medium- to long- term floating rate loans, eurobonds, floating rate notes and euro medium-term notes (EMTNs). Euro market transactions are the financial transactions denominated with currency outside the country of its origin. Euro banks are other banks which take deposits and make loans in a currency or currencies other than that of the country in which they are located. Euro markets consist of Euro banks that offer wholesale deposits and loans in favourable jurisdiction and in a variety of currencies other than that of the country in which the banks are situated. These Euro banks are entirely free of market regulatory controls. Euro market operations basically have been medium to long-term lending with floating interest rates. Euro currency is the currency of Euro land and transaction in the Euro currency are known as Euro currency market
• At the end of each trading session, all outstanding contracts are appraised at the settlement price of that trading session. This is known as marking to market. This would mean that some participants would make a loss while others would stand to gain. The exchange adjusts this by debiting the margin accounts of those members who made a loss and crediting the accounts of those members who have gained.
• Global Depositary Receipts mean any instrument in the form of a depositary receipt or certificate (by whatever name it is called) created by the Overseas Depositary Bank outside India and issued to non-resident investors against the issue of ordinary shares or Foreign Currency Convertible Bonds of issuing company.”      They are negotiable certificates that usually represent a company’s publicly traded equities and can be denominated in any freely convertible foreign currency. They are listed on a European stock exchange, often Luxembourg or London. Each DR represents a multiple number or fraction of underlying shares or alternatively the shares correspond to a fixed ratio, for example, 1 GDR = 10 Shares.
•  A spread can be defined as an option trading strategy, in which a trader offsets the purchase of one trading unit against another. It can also be referred to as the gap or difference between the bid and ask of a financial instrument. Interbank market deals are conducted mainly over the telephone. If the price quoted is acceptable, then the deal between traders will move further in terms of amount bought/sold, price, identity of the party etc. in their respective banks’ computerised record systems. On the day of settlement, banks will settle the transaction with both the sides.
• When the exchange of currencies takes place on the second working day after the date of the deal, it is called spot rate.  A spot foreign exchange transaction is the exchange of one currency for another, at the spot (or today’s) exchange rate. Although the exchange rate is agreed at the time of the transaction, market convention dictates that the exchange of funds (settlement) will occur two business days later (the spot date).A forward transaction is identical to a spot transaction, except that the settlement date (and the exchange of currencies) is more than two business days ahead. The forward transaction allows each party to lock in a known forward exchange rate today, with the outright exchange of currency amounts occurring at a future date. If the exchange of currencies takes place after a certain period from the date of the deal (more than 2 working days), it is called a forward rate. A trader may quote a forward transaction for any future date. It is a binding contract between a customer and dealer for the purchase or sale of a specific quantity of a stated foreign currency at the rate of exchange fixed at the time of making the contract.
  
  
• The foreign exchange market is an informal arrangement of the larger commercial banks and a number of FOREX brokers. The banks and brokers are linked together by telephone, Telex and satellite communication network called the SWIFT (Society For World Wide International Financial Telecommunications). This counter based communication system, based in the Brussels, Belgium links banks and brokers in just about every financial centers.
• The bid rate denotes the number of units of a currency a bank is willing to pay when it buys another currency.   The offer rate denotes the number of units of a currency a bank will want to be paid when it sells a currency.
• The 'spot' and 'forward' contracts are the most basics tools of Foreign exchange Management. These are contracts between end users (exporters, importers etc.) and financial institutions that specify the terms of an exchange of two currencies. In any foreign exchange contract the following have to be agreed upon:  1) The currencies to be bought and sold - in every contract there are two currencies. One that is bought and the one that is sold.  2) The amount of currency to be bought or sold
  3) The date at which the contract matures  4) The rate at which the exchange of currencies will occur. In determining the rate of exchange in six months time there are two components:  1) The current spot rate  2) The forward rate adjustment The spot rate is simply the current market rate as determined by supply and demand.  The forward rate adjustment is a slightly more complicated calculation that involves the interest rates of the currencies involved.
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IMTP- CRR - Few of Viduropadesha for modern managers!

The messages given by Vidura to Dhrutharaashtra is known as  Viduropadesha, which is the part of Mahabharatha, the great  epic of Bharath. Few of viduropadesha is listed as under

1. A scholar/ manager  should have  spiritual knowledge, devotion towards work, patience , endurance, moral  strength.

2. He should use the moral strength for protecting dharmic values; devotion towards work should be used for   earning money  and controlling luxurious expectations  and  the spiritual knowledge should be used for detachment. 

3.  The scholar should  follow dharma and never practice  adharma.

4. He should have faith in god  and concentration towards work. 

5. He should not  get  angry nor get excited / nor show  the ego /nor be childish. He should not be a spent thrift  and should not think ‘I am great and respectable’.

6. Should take other’s advise/ opinion  before undertaking /doing a work.

7. He should not disclose everything about a work before it is completed. 

8.  Heat, cold, fear, happiness, unhappiness, luxury, poverty, etc., should not  affect him positively or negatively. 

9. He should not  focus too much on the negatives or positives.

10. He should  focus mainly on the work (Karma) / mission only. 

11.  A scholar/manager  should use his wisdom  for dharmic mission  and also  for prosperity in a dharmic way.

12.  He should get away/ relieved from a luxurious / extravaganza  in his life.

13. Expect what he deserves  and whole heartedly work  to achieve the goal (expectations). 

14.  Never ignore anything nor consider as silly;  take  seriously the work. 

15. Try to listen as much as possible from all sources 

16. Try to learn quickly and  systematically

17. Never start any work without a deep understanding about  the  work.

18.  Never interfere with others work without his consent.

19. Never talk in between without the consent of the speaker.

20. Never expect  which you will not get; never feel sad on what you lost for ever and keep stability during crisis.

21. A manager should use powerful and attractive words during discussions 

22. He should be in a position to convince others  easily. 

23. His words should reflect his wisdom and  should be capable for interpreting the rules positively. 

24. He should become a model for others  in words and deeds. 

25.   His knowledge + experience + wisdom + action should  work complementary to each other 

26.  His qualification, method of action and attitudes should  also compliment each other. 

27. He should never become crazy for money but should earn  that through hard work. 

28. Never give up any mission undertaken without completing it, however difficult may that be. 

29. Never interfere  with other’s work if it does not come under your purview . Treat the friends  with the same dignity they show to you  and  never be over polite  to those who do not respect / love you  and never  give up any good friends 

30. Do not show affection / love to those  who do not reciprocate and never  try to  fight with strong and powerful people.

32. Never try  to impress  by showing that an enemy is your friend 

33.  Never ill treat your  good friends    and never do bad  against them / others.

34. Never try to project yourself, never doubt others (for everything).

35. Do the work undertaken within specific time limit 

36.  Respect the  parents and forefathers, keep faith in the divine power  and also try to make good friends.

37. Never enter into a house without invitation, never try to  answer to a question without asking   and never try to put trust on those who are not trustworthy.

38. Criticizing others for doing something and  doing the same thing by self is foolishness.

39. Knowing well that  self is  incapable of doing something and then getting  angry on others  is foolishness. 

40. Without knowing our own limitations  and without  doing  any work / strain, trying to  grab wealth of others  is foolish. 

41. Never advise those who do not deserve/ seek  your guidance.

41. Expect nothing from a  miser and from a useless fellow.

42. Try to follow the footsteps of highly educated, hardworking man who makes money  in a dharmic way.

43. Share the food and money with others for making friendship. 

44. Remember that many people  do heinous work and others suffer.

45. Many a times  those who create problems  escape from the punishment.

46. The arrow  shot from a bow may or may not kill but the  intellectual power shot  from an intelligent man  can even uproot a nation.

47.  A poison and an arrow may kill only to whom it was given/shot,  the advise of  a manager can destroy the whole  system, including the manager himself.

48. Never eat tasty food alone, never  analyze a serious matter alone, never go for a long tour alone, never walk away  from a group of  people  sleeping together.

49. For Ship is needed for crossing  the ocean similarly truth is needed for solving the problems.

50. Only one criticism / blame  may have to be  faced  by  a manager having good patience. That is   ‘the manager is a coward’’ he will not have to face any other blame because  patience  is  a great  quality  which attracts  many

IMTP- CRR Indian ethos and Qualifications needed for manager

1)       (Six qualifications needed for manager) Uddhyamam saahasam dhairyam bhuddhi sakti paraakramam shadethey yathra varthanthey daivam thathra prakaasayeth:  where the  six qualifications of entrepreneurship, facing any challenges, courage, wisdom, power, capacity to thrash out the  obstacles  exist,  the  blessings of the divine power  will automatically be there. (Dharma sastra)

2)        (Ten qualifications for a manager) Ahimsa sathyam astheyam brahmachryam aparigraham soucham santhosham sthapa swaadhyaaya eeswara pranidhaanam: Non violence, understanding the  truth/fact/essence, non stealing,  knowing the ultimate purpose of life, self reliance, cleanliness, pleasant happy vision, mission oriented   work,  acquiring  the knowledge on the subject of work, faith in divinity. (Yama and niyama from  Patanjali’s yoga saastra)

3)   

IF- Unit IV CRR

}  While there is no formal definition of Capital Account Convertibility, the committee under the chairmanship of S.S. Tarapore has recommended a pragmatic working definition of CAC. Accordingly CAC refers to the freedom to convert local financial assets into foreign financial assets and vice – a – versa at market determined rates of exchange. It is associated with changes of ownership in foreign / domestic financial assets and liabilities and embodies the creation and liquidation of claims on, or by, the rest of the world. CAC is coexistent with restrictions other than on external payments. It also does not preclude the imposition of monetary / fiscal measures relating to foreign exchange transactions, which are of prudential nature. Following are the prerequisites for CAC:

}  Maintenance of domestic economic stability.

}  Adequate foreign exchange reserves.

}  Restrictions on inessential imports as long as the foreign exchange position is not very comfortable.

}  Comfortable current account position.

}  An appropriate industrial policy and a conducive investment climate.

}  An outward oriented development strategy and sufficient incentives for export growth.

•        RBI has issued Authorised Dealers (AD) licences to banks, all India financial institutions and a few co-operative banks to undertake foreign exchange transactions in India

•        It has also issued Money Changer licences to a large number of established firms, companies, hotels, shops, etc.

•        Money changers help facilitate encashment of foreign currencies of foreign tourists

•        Entities authorised to buy and sell foreign currency notes, coins and travellers’ cheques are called full fledged money changers

•        Those authorised only to buy are called restricted money changers

•        FEDAI (Foreign Exchange Dealers’ Association of India) is a non-profit making body formed in 1958 with the approval of RBI

•        Its members are authorised dealers and it prescribes guidelines and rules of the game for market operations, merchant rates, quotations, delivery dates, holidays, interest on defaults, etc.

FEDAI also advises RBI on market related issues and supplements RBI on strengthening the market

Exposure refers to foreign currency assets, liabilities, income and expenditure whose values will change in terms of home currency in response to exchange rate fluctuations.

Risk is the likely or probable loss from such forex exposure due to adverse exchange rate fluctuations.

Foreign Exchange Exposures can be defined as the “sensitivity of changes in the real domestic currency value of assets and liabilities or operating incomes to unanticipated changes in exchange rates”. Any company exporting or importing goods has a foreign exchange exposure. However, a company doing business in the domestic marketplace will also have a considerable foreign exchange exposure if any of its competitors are based in a foreign country.

Types of Exposures: -Foreign exchange exposures can be classified into transaction, translation, and operating exposures.

•           Transaction Exposure involves different transactions where items are traded in foreign currency, i.e., there are contractual future cash flows of the foreign currency. For example, a company may sign a contract to supply machine parts to a foreign company at a specified sell price. The company will be susceptible to fluctuations in foreign exchange markets till it receives payment and converts it into domestic currency. The company’s exposures can be calculated by deducting the potential future inflows from future outflows. There are various methods that can be employed to minimise transactional exposure risks, namely,

o          Forward contracts.

o          Price adjustment clauses.

o          Currency options

o          Borrowing and lending in foreign currency.

o          Invoicing in domestic currency, etc.

•           Translation exposure is the possibility of change in the net worth of the company due to fluctuations in home valuation of assets and liabilities denominated in foreign currency. Translation exposure occurs when an MNC’s overseas subsidiary’s earnings are translated into domestic currency prior to consolidation with the parent company’s financial statements. This can reflect in the company’s consolidated profit and loss account. Companies can adopt any of the following strategies to manage their translation exposure,

o          Adjusting the flow of funds

o          Entering into forward contracts

o          Netting of exposures.              

•        Transaction exposure is the sensitivity of realized domestic currency values of the firm’s contractual cash flows denominated in foreign currencies to unexpected changes in exchange rates. Unlike economic exposure, transaction exposure is well-defined and short-term. Some typical situations, which give rise to transactions exposure, are: (a)   A currency has to be converted in order to make or receive payment for goods and services; (b)          A currency has to be converted to repay a loan or make an interest payment; or (c)        A currency has to be converted to make a dividend payment, royalty payment, etc.  Note that in each case, the foreign value of the item is fixed; the uncertainty pertains to the home currency value. The important points to be noted are (1) transaction exposures usually have short time horizons and (2) operating cash flows are affected.

•         This is a measure of the sensitivity of the home currency value of the assets and liabilities, which are denominated, in the foreign currency, to unanticipated changes in the exchange rates, when the assets or liabilities are liquidated. The foreign currency values of these items are contractually fixed, i.e.; do not vary with exchange rate. It is also known as contractual exposure.

•        Some typical situations, which give rise to transactions exposure, are:

•        (a)        A currency has to be converted in order to make or receive payment for goods and services;

•        (b)        A currency has to be converted to repay a loan or make an interest payment; or

•        (c)        A currency has to be converted to make a dividend payment, royalty payment, etc.

Transaction exposure

• Contract specific                              

• Cash flow loss can be easily computed

• Co’s do have policies to cope up with it

• Duration is same as time period of contract

Economic exposure

• General relates to entire investment.

• V difficult to compute opportunity losses.

• Do not have any policies to cope up.

• Relatively longer duration

1)      Transaction risk : When Bank quote their rates to customers the transaction risk gets transferred from customer to bank. This is because the bank normally cover mechant transaction through an opposite transactions in the interbank market. The idea is to ensure that the anticipated Profit in each transaction is locked through the cover transaction. Any adverse rate movement between quoting to the customer and covering the transaction is accepted as normal business risk. Bank do not hedge transaction risk. 

2)      Sometimes the bank dealer may deliberately leave a transaction uncovered in anticipation of a favorable rate movement, effectively a normal business transaction get converted in to a speculation transaction popularly known as “taking a position”. If the position is created through an uncovered purchase its known as over-bought or long position, where as if position created through sale transaction known as oversold or short position. The maximum accumulation dealer can make in terms of such uncovered transactions is called “Day light Limit”. It indicates the level up to which the bank is willing to accept the exposure on behalf of dealer. If the dealer is wrong in his views the bank stipulate a stop-loss limit at which a compulsory covering of transaction to be initiated. The stop-loss signifies the loss in terms of domestic currency which the bank is willing to accept on inaccurate decision.In case if the dealer is correct in his views he takes profits in stages and achieve a near square position at the end of trading day. The Gross outstanding in all currencies at the end of the day are controlled through an “overnight limit”. The activity of freezing the possible loss on speculations through stop-loss are well-known as position risk.

3)      Credit risk: Bank continuously contract each other for forward maturities in each such case both counterparties are exposed to counterpart risk. That is the counterparty not fulfilling contractual obligation if such an event occur any day prior to settlement the other party would enter in to replacement contract to square these exposure. If this replacement contract is at the adverse rate compare to original contract rate the bank suffers a replacement contract also described as pre settlement risk.

4)      On settlement day if there is a counterparty failure after the bank has fulfilled its obligation than the principle amount would be lost in addition to which the bank may have to bear a replacement cost-plus minimum one day interest effectively the problem less on settlement today is more than 100% of contract value termed as settlement risk. These risk became a matter of risk management  example Herstelle case of 1978. In india bank control exposure to foreign counterparties through a global limit which monitor the exposure to counterparty at universal level.With in this global limit the concentration of the contract on a particular future date are monitored to prevent excessive settlement risk.

5)      Mismatched maturity risk: Bank continuously quote forward rate to their customers each such forward contract is required to covered for expected forward maturity. In active market its difficult to find counterparties for broker delivery maturities , the forward exchange rate represents two components : Spot rate and forward margin. Since exchange rates are more volatile than interest rates banks normally cover the transaction for nearest available maturity. This enables the bank to eliminate exchange risk but results in :

a) Liquidity mismatch between inflow and outflow

b) Under and over recovery of forward margin.

To simultaneously adjust both effect these bank required to undertake Swap transaction. A delay in getting the necessary swap may result in a loss on forward margin due to a shift in interest rates . Such losses are described as mismatch maturity risk

Hedging

In international parlance, hedging means a transaction undertaken specifically to offset some exposure arising out of the firm’s usual operations.

In the stock market parlance, hedging is the process of buying one security and selling another in order to produce a riskless security. Hedging involves two investments that are perfectly correlated. For example if the returns of X and Y are perfectly correlated, then to hedge, you have to buy X and sell Y or vice versa to make the net position riskless. Hedging is a mechanism to reduce price risk inherent in open positions.

INTERNAL HEDGING STRATEGIES /TECHNIQUES

• a) Natural hedge

• b) Invoicing in own currency

• C) Split currency invoicing

• D) Netting

• D) Leading and lagging

• e) Price adjustments

• f) Risk sharing agreements

• g) Review of market – product combination

EXTERNAL HEDGING STRATEGIES /TECHNIQUES

• a) Currency forward contracts

• b) Currency future contracts

• c) Currency options

• e) Money market hedge

Currency invoicing: A firm may be able to shift the entire exchange risk to the other party by invoicing its exports in its home currency and insisting that its imports too be invoiced in its home currency.

Netting and Offsetting: A firm with receivables and payables in different currencies can net out its exposure in each currency by matching its receivables with payables. For example, a firm with exports to and imports from France need not cover each transaction separately, it can use a receivable to settle all or part of a payable and take a hedge only for the net Francs payable or receivable.

Sometimes, a currency might have a receivable in one currency say, DM and a payable not in the same currency but a closely related currency such as Swiss francs; the exposure arising from the same can be offset. To explain further, for example, a loss on a payable due to an appreciation of the Swiss Franc vis-à-vis the firm’s home currency will be closely matched by the gain on the receivable due to the appreciation of DM.

Leading and Lagging: This is another way of managing exposures by shifting the timing of the exposures by leading and lagging payables and receivables. The rule of thumb is lead i.e. advance payables and lag i.e. postpone receivables in strong currencies and conversely in weak currencies.

Lead and lags in combination with netting form an important cash management strategy for multinationals with extensive intra-company payments.

The term 'Derivatives' indicates it derives its value from some underlying i.e. it has no independent value. Underlying can be securities, stock market index, commodities, bullion, currency or anything else. From Currency Derivatives market point of view, underlying would be the Currency Exchange rate, in the Indian context it is USD/INR. Derivatives are unique product, which helps in hedging the portfolio against the future risk. At the same time, derivatives are used constructively for arbitrage and speculation too. Currency Derivatives are very efficient risk management instruments and you can derive the below benefits:

  (i) Hedging: You can protect your foreign exchange exposure in business and hedge potential losses by taking appropriate positions in the same. For e.g. If you are an importer, and have USD payments to make at a future date, you can hedge your foreign exchange exposure by buying USD/INR and fixing your pay out rate today. You would hedge if you were of the view that USD/INR was going to depreciate. Similarly it would give hedging opportunities to Exporters to hedge their future receivables, Borrowers to hedge foreign currency loans for interest and principal payments, Resident Indians, who can hedge their offshore investments.

  (ii) Speculation: You can speculate on the short term movement of the markets by using Currency Futures. For e.g. If you expect oil prices to rise and impact India's import bill, you would buy USD/INR in expectation that the INR would depreciate. Alternatively if you believed that strong exports from the IT sector, combined with strong FII flows will translate to INR appreciation you would sell USD/INR.

  (iii) Arbitrage: You can make profits by taking advantage of the exchange rates of the currency in different markets and different exchanges.

  (iv)Leverage: You can trade in the currency derivatives by just paying a fixed % value called the margin amount instead of the full traded value. Currently the margin amount charged is 4-5%.

The NDF markets have generally evolved for currencies with foreign exchange convertibility restrictions, particularly in the emerging Asian economies, viz., Taiwan, Korea, Indonesia, India, China, Philippines, etc., With controls imposed by local financial regulators and consequently the non-existence of a natural forward market for non-domestic players, private companies and investors investing in these economies look for alternative avenues to hedge their exposure to such currencies. NDF market is an offshore market to trade and hedge in currencies of countries wherein there is no full convertibility (both capital account and Current Account). Few of the NDF market traded currencies are Indian Rupee, Chinese Yuan, Philippine Peso, Taiwan Dollar, and Korean Won. NDFs are distinct from deliverable forwards as the NDF s trade outside the countries of the corresponding currencies. NDF is a Non-Deliverable Forward contract which is settled in cash and only in US Dollars. The difference between the Spot rate and the outright NDF rate is arrived on an agreed notional amount and settled between the two counterparties. Trading in the NDF market generally takes place in offshore centres.

In this market, no exchange takes place of the two currencies’ principal sums; the only cash flow is the movement of the difference between the NDF rate and the prevailing spot market rate and this amount is settled on the settlement date in a convertible currency, generally in US dollars, in an offshore financial centre. The other currency, usually an emerging market currency with capital controls, is non-deliverable. In this particular respect, of course, NDFs are similar to commodities futures market where commodities, like wheat or corn, are traded in organized futures markets and positions are later settled in dollars, wheat or corn being nondeliverable. The NDF prices are generally determined by the perceived probability of changes in foreign exchange regime, speculative positioning, conditions in local onshore interest rate markets, the relationship between the offshore and onshore currency forward markets and central bank policies.

NDFs are primarily over-the-counter, rather than exchangetraded products, thus making it difficult to gauge the volume of  contracts traded, who trades the contracts, and where they are traded. At the international level, New York tends to dominate trading in Latin American NDFs, Singapore (and to a lesser extent Hong Kong) dominate trading in non- Japan Asian NDFs, while London spans these markets. The INR NDF is largely concentrated in Singapore and Hong Kong, with small volumes being traded in the Middle East (Dubai and Bahrain) as well.

Bank for International Settlements (BIS), a bank created in the 1930s to manage and monitor the repatriation from the war in Europe would have hardly thought that it would go on to provide guidelines for the risks that bankers face the world over. BIS is, today, one of the most formidable institutions in economics and financial sector. In June 2004, the BIS finalised Basel II, after five years of industry and regulatory consultation. The objective behind this regulation is to align regulatory capital measures with the inherent risk profile of a bank considering credit, market, operational and other risks. Basel I recommendation was the first among the  series of reforms suggested. The greatest drawback of the Basel I proposal was that it prescribed a onefits- all solution for all circumstances and focused on single risk to measure credit and market risk capital adequacy ratio. It does not cover the main risk element ‘Operational Risk’. BIS defines operational risk as, “the risk of loss resulting from inadequate or failed internal processes, people and system or from external events.” In short, operational risk identifies:

a. Why loss has happened, and

b. A breakdown of the causes into: Ø People Ø Process Ø System, and Ø External events

Even though India has one of the strongest  banking systems compared to many peer group countries, our credit, market and operational risk measurement and management system is lagging behind the banks of many developed countries. Basel II implementation will certainly improve the working efficiency and competitiveness of Indian banks. Basel II provides a more comprehensive and

flexible approach for measuring and managing risk. It adds a new dimension called operational risk and encourages the bank’s internal risk management methodologies.

The key difference of the new accord is the introduction of operational risk. This is not a new practice. However, the growing number of operational loss events worldwide has forced the management of the banks to look into this aspect more critically to prevent any frauds, reduce errors by implementing controls as a part of operating process. Evolving banking practices suggest that the risk other than credit and market risks can be substantial. The importance of operational risk has increased due to the following changes in operation and introduction of sophisticated methods and technology.

a. Highly automated technology, if uncontrolled can cause system failure. The loss may be much more as compared to manual system.

b. Emergence of E-banking and E-commerce has potential for internal, external fraud and system securities issues. This needs sound internal controls and back up systems.

c. Large-scale acquisitions, mergers and consolidations test the viability of integrated

Basel committee has identified the following types of operational risks:

•        People Risk – connected with placement, competency, work environment and motivation

•        Process Risk – connected with errors in processing, complexity of process, documentation and contract, violation of controls, money laundering, frauds, model and methodology errors

•        Regulatory risk – connected with failing to comply with laws

•        Technology risk – connected with system and technology failure

•        Event Risk – unanticipated changes in external environment.

•        Reputation Risk

Steps for Implementing Risk Management Broadly the following steps are followed to implement the risk management system.

Ø Study the existing process organisationwide and identify the risk that matters.

Ø Classify the risk according to criticality

Ø Set up systems and controls for monitoring and reporting to management

The European Central Bank (ECB) is the institution of the European Union (EU) that administers the monetary policy of the 17 EU Eurozone member states. It is thus one of the world's most important central banks. The bank was established by the Treaty of Amsterdam in 1998, and is headquartered in Frankfurt, Germany. The current President of the ECB is Mario Draghi, former governor of the Bank of Italy.    The European Central Bank (ECB) is the principal institution in the European Union whose purpose is to manage monetary policy for all the member states of the Eurozone. In simple terms, it is the Central Bank responsible for the management of the Euro. As such it is one of the most significant central banks in the world and any decision made concerning the Euro can ripple through to all the worlds currency markets. It was created in1998 and is headquartered in Frankfurt, Germany.

The primary objective of the European Central Bank is to maintain price stability within the Eurozone, which is the same as keeping inflation low. The Governing Council defined price stability as inflation (Harmonised Index of Consumer Prices) of around 2%. Unlike, for example, the United States Federal Reserve Bank, the ECB has only one primary objective with other objectives subordinate to it.

Three bodies function under the ECB:

·         The Governing Council: is made up of six members of the Executive Board of the ECB and the governors of each of the national banks of the countries in the Eurozone. Its primary role is providing directions for the ECB and it has the final word regarding policy implementations.

·         The Executive Board: is in charge of setting up policies and is made up of the President and the Vice-President of the ECB and four other member of the Governing Council. All the members are appointed for a non-renewable 8-year term through a common concession by the Heads of State of the Eurozone countries.

·         The General Council: consists of the President and Vice-President of the ECB and all the governors of the member state’s central banks. Its main role is to act as a forum for all the member states of the European Union (EU) to air their financial concerns. It is a temporary body, which will be dissolved once all the EU countries adopts the principals of the European Monetary Union (EMU) and officially joins the ESCB.

General Functions of the ECB: the ECB is the matriarch of all the banks which are part of the ESCB. Thus, its roles are geared towards regulating most of the major financial obligations of the National Central Banks under its wing.

·         Issuance of bank notes and coins: the authorization regarding the issuing of bank notes lies solely with the ECB. The member states can issue coins however; the ECB has the final say on the amount.

·         Account opening: any credit institution, public bodies and other financial market participants have to get authorization to open an account with the ECB and the national central banks exclusively from the ECB.

·         International relations: only the ECB will engage in negotiations and transactions with central banks and credit institutions of third party countries as well as other international organizations.

·         Open market operations:when the ECB or the national central banks have to deal in the financial markets tasks such as borrowing and lending money will lie with the ECB.

·         Other functions of the ECB include:

-          Transacting in credit operations with credit institutions and other interested parties;

-          Maintaining price stability within the Eurozone

-          Constructing rules for the efficient clearing of payment systems

-          Setting the requirements on credit organizations founded in Member States to hold minimum reserves in accounts with the ECB or the national central banks of the state in question.