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BHUSNUR MATH

Professor (Finance)

M D I , Gurgaon

Capital Markets

Equity Markets

Debt Markets

Govt Bonds

Corporate Bonds

Credit Markets

Money Markets

2

Foreign Exchange

Foreign Currency

Receivables from a Non-resident

Travelers Cheques

Cheques, Demand Drafts drawn by an

overseas bank on a bank in India

Wire Transfer

Bills-of-Exchange Bills of Exchange

3

Exchange Rate

(rupees)

Determined by market supply & demand

forces floating currency

market forces but the RBI intervenes in

the market when it so desires.

BHUSNUR MATH - Forex markets

Supply of Forex

Inward Investment FDI, FII

Current

Account

Capital

Account

Remittances & Travel

Overseas Investment

Current

Account

Capital

Account

ECBs, FDI/FII, Flow from Maturing Investments abroad

Recipient / Beneficiary

Bank / Authorized Dealers: Gives Rupees and takes

Bank sells

$ (makes profit)

Other Banks

in need of $

Inter-Bank Market

R B I (Intervention)

if it is buying

Investments abroad, Flow from Maturing FDI/FII

Client / Customer

Bank Buys/Aquires

$ (makes profit)

Other Banks

Inter-Bank Market

R B I (Intervention)

if it is selling

Sells Cy / TCs, Remits, Makes payment to O/S Seller

Bank

Inter Bank

Forex Market

Intervention

RBI

Other Banks

Customers

Forex Markets

If RBI Buys

Increases Demand

If RBI Sells

Increases Supply

10

Import, Export, Trade deficit

Remittances

Capital Flows- ECBs, FDI, FII

Interest rate in India

Interest rate in US

Indian Policies, economy prospects

BHUSNUR MATH - Forex markets

11

Settlement locations

Spot Transactions

Value second working day

Cash - Value same day

Tom Value next working day

Forwards

Value spot + the calendar month(s)

Swaps

Combination of a Buy & a Sell -spot &

forward or forward and a forward

AUD, EUR, CHF

Currency bought or sold /

no of units of quoted currency

Not a fraction

USD/CHF 1.4550/ 1.4555 ;

USD/JPY 159.00/80 AND 160.98/05

1.4550/55

Forward Rates

effective one year from today

rate keep it so that we can deliver these

dollars at t=1yr

borrow

We need to at least recover our cost of

buying and holding

We need $

Borrow Rs

Buy $

1

(1 r$ )

1

(1 r$ )

1

Sp *(

)

1 r$

@ rRe

Deposit these $

After one year

1

(1 r$ )

Re Loan Payment:

[(

1

* s p ] * (1 rRe )

(1 r$ )

Forward Premium

To break even :

Forward Rate=

1 rRe

S

*

p

r

$

% Forward Premium =

=

1 rRe

1

r

$

rRe r$

1 r$

1 rRe

S

*

p

r

$

Interbank Transactions

With other banks

Deal lots 1 mln of base currency

For cover operations

Own account trading

Merchant Transactions

To facilitate remittances & Trade

Mostly as per customers requirements

Clean and Doc

An Interbank Deal

Tom from Bank A Dollar Swiss pl

Forty forty-five

Mine

OK. Bank B sells Bank A USD 10 Mln against

CHF at 1.5545 value 18 April 2012, UBS

Geneva for CHF

Citi Ny for my Dollars, Thanks Bye

Rate Quotations

Inter Bank

Arbitrage

fractions, work like math fractions

Merchant Rates

Base Rate Acquiring or Disposal Rate

Extra margin/charges for docs as handling

charges

TT Buying and TT Selling; Bills Buying and

Bills Selling

Usance Bills rates

inter-bank (wholesale) market acquiring rate

the inter-bank market disposal rate

The Margin over the acquiring or disposal rate would

include

a) Transaction costs ie., overheads , brokerage etc

b) And profit

And one is able to operate freely in both

the Forex Market (buy/sell the currency)

opportunities

will have to fall in line with the theoretical rate.

(1 ni A ) Fn ( B / A)

(1 niB ) S ( B / A)

Fn ( B / A) (1 ni A )

S ( B / A) (1 niB )

Fn ( B / A) S ( B / A) (ni A niB )

S ( B / A)

(1 niB )

(ni A niB )

Forward Differential (%)

Interest Rate Differential

niB

Equilibrium relationship

International Business

and Trade Finance

Overseas Trade

Export

Import

High-seas trade

Barter trade

No local market

Better price

Components off-shoring

Incentives -tax and duty

Cheaper credit

Payment risk

Regulatory risk

Political risk

Raw material

Components

Value addition

Ways of settling

Cross-Border Transactions

risk)

Advance Payment

Bills for collection

Bills discounting

Use of LCs

INCO Terms

Counter- Trade

Delivery risk

payment

Quality risk

Price risk

Regulatory risk

Advance Payment

Bill Discounting

Factors / Forfaiting

Commercial Documents

Invoice

Bill-of-Exchange, Draft

Consignment Sale

Counter Trade

High-seas sale

Documents

Advice

SBI

Delhi

Documents

Account Credited

Seller

Intimation

SBI

Coimbatore

Documents

against

Payment

Buyer

Documents

SBI

Delhi

Documents

taken and

A/c

Seller

Credited

Intimation

SBI

Coimbatore

Docs

against

Acceptance

Buyer

Documents

SBI

Delhi

Documents

taken and

A/c

Seller

Credited

Intimation

SBI

Coimbatore

Documents

against

Payment

Buyer

Documents

Documents

taken and

A/c

Seller

Credited

Intimation

SBI

Coimbatore

Doc against

Acceptance

Buyer

Payment

SBI

Delhi

ADVICE

SBI

INDIA

SBI

NEW YORK

PAY INR

EXPORTER

INDIA

RECEIVE

USD

SELLS GOODS

IMPORTER

ITALY

ADVICE

SBI

INDIA

SBI

NEW YORK

Pays Rupees

IMPORTER

INDIA

OWES MONEY

PAY USD

SUPPLIER

JAPAN

Contract

IMPORTER

OPENING

BANK

GOODS

DOCS

SHIPPING

COMPANY

OPEN CREDIT

DOCUMENTS

PAYMENT

GOODS

DOCS

ADVISING/

NEGOTIATING

BANK

EXPORTER

DOCUMENTS

PAYMENT

Name of issuing bank, confirmation??

Irrevocable??

Amount of credit

Place and time of expiry

documents.

Terms of payment sight, usance

Part-shipment/ trans-shipment

Exporter:

Exposure to Bank

the applicant (importer)

Importer

Can negotiate for better price

Factoring

A Financial Intermediary

trader, at a discount, and

Takes responsibility for collection of

payments.

Factoring Services

Help in getting information and credit

line on customers (credit protection)

relationship with Buyer & Seller.

percentage of value of Debts purchased)

(0.50% to 1.50%)

Types of Factoring

Recourse Factoring

Non-recourse Factoring

Maturity Factoring

Cross-border Factoring

Forfaiting

which means surrender of fights.

export receivables of an exporter (Client) is

purchased by a Financial Intermediary (Forfaiter)

without recourse to him.

much as it deals with receivables relating to

deferred payment exports, while Factoring deals

with short term receivables.

FACTORING

FORFAITING

Individual Sale

Transaction

Service of Sale

Transaction

Individual Sale

Transaction

3. Recourse

With Recourse

Without

Recourse

4. Sales

Administration

Not Done

With or

Without

Recourse

Done

Not Done

5. Term

Short Term

Short Term

Medium Term

6. Charge

Creation

Hypothecation

Assignment

Assignment

1. Scrutiny

2. Extent of

Finance

BILLS

DISCOUNTED

Upto 100%

guaranteed by a bank as good as the

Banks word

Exposure to the Bank so high creditrating

a firm that is guaranteed by a

commercial bank

Trade Finance

L/Cs

B As

Suppliers Credit

Buyers credit

Buyer's credit

from overseas lenders for payment of his

imports on due date

guarantee issued by the importers bank

Suppliers Credit

exporter extends credit to a foreign

importer to finance his purchase.

Importer pays a portion of the contract

value in cash and issues a Promissory

note or accepts a draft

LC with Usance Terms

Deferred payment

Basics of Derivatives

BHUSNUR MATH

Basics of Derivatives

51

Derivatives

derived from / dependent on value of

another (underlying) commodity /

contract

BHUSNUR MATH

Basics of Derivatives

52

Types of Derivatives

Futures & Forwards

Options

Swaps

BHUSNUR MATH

Basics of Derivatives

53

Forward Contract

quantity of some thing at a price agreed

today and delivered and paid for paid for

on a future date

Futures are standardized forward

contracts traded on an exchange

BHUSNUR MATH

Basics of Derivatives

54

Forwards Characteristics

An agreement / contract

Price fixed on day 0

Cancellation

for the same maturity

On due date at opposite spot rate

BHUSNUR MATH

Basics of Derivatives

55

Standardized quantity

1 mln US Dollars

BHUSNUR

Deliver

Specs

MATH

Basics of Derivatives

56

Quality

Quality

Mode of delivery

spot

Procedures in case of default

BHUSNUR MATH

Basics of Derivatives

57

Futures Pay-Off

Long

Short

BHUSNUR MATH

So

Basics of Derivatives

So

58

Options

option to buy (sell) a certain quantity

of the underlying at a price agreed upon

today (Strike Price - X) to be settled on

an agreed future date

Types of Options

Put and Call

BHUSNUR MATH

Basics of Derivatives

59

Options - characteristics

Choice to exercise

a premium

Premium upfront outlay

Kind of an insurance

same maturity

MATH

Basics of Derivatives

BHUSNUR

Counterparty

writes

the option - writer 60

OTC Over-the-Counter

Customized

Opaque market

Availability / Liquidity

Regulated

StandardizedBasics

Contract

Specs

of Derivatives

BHUSNUR MATH

61

Call Holder

BHUSNUR MATH

Call Writer

So

Basics of Derivatives

So

62

Put Holder

Put Writer

So

X

BHUSNUR MATH

Basics of Derivatives

So

63

Use of Derivatives

Hedging

Both down-side & upside cut out

Trading - Speculation

BHUSNUR MATH

Basics of Derivatives

64

Derivatives - Hedging

Producer

Sell Forward

Buy Put

Consumer

Buy Call

BHUSNUR MATH

Write a Put

Basics of Derivatives

65

Swaps

agreement, on a future date.

BHUSNUR MATH

Basics of Derivatives

66

L+ 0.5

BHUSNUR MATH

6%

L+ 0.5

Basics of Derivatives

6%

67

IRS - Characteristics

Fixed-to-Floating

Floating-to- fixed

Notional Principal

Interest receivable and payable are setoff and net paid / received

Default / Counter-party risk

BHUSNUR MATH

Basics of Derivatives

68

IRS - Warehousing

available Banks become counter-party

and warehouse swaps till they find a

counter-party.

L+ 0.5

BHUSNUR MATH

6+ 0.5%

L+ 0.5

Basics of Derivatives

Bank

69

Currency Swaps

Need

currency into a liability in another

currency

BHUSNUR MATH

Basics of Derivatives

70

t= 0

$ 1.3 mln

BHUSNUR MATH

$ 1.3 mln

Euro 1 mln

Basics of Derivatives

Bank

71

t= 6m

$0.039 mln

BHUSNUR MATH

$ 0.039 mln

Basics of Derivatives

Bank

72

t= 10 yrs

$1.3 mln

BHUSNUR MATH

Euro 1 mln

$1.3 mln

Basics of Derivatives

Bank

73

agreed level, the bank will make good the

difference

Floors: If the interest rate goes below an

agreed level, the bank will make good the

difference

agreed level or below and agreed level, the

bank will make good the difference

BHUSNUR MATH

Basics of Derivatives

74

at interest rate agreed upon today

A contract to make good the loss which would

be incurred by the buyer of FRA for a certain

term, on a notional sum of money, if spot

interest rates for that term, on the fixed future

date is lower than an agreed rate,

would make if the rate is higher

BHUSNUR MATH

Basics of Derivatives

75

FRA An example

for a notional sum of Euro 1 mln

Effective date 2m from now

Interest rate term: 3m

On t=2m, if 3m rate is

<6% B pays A

>6% A pays B

BHUSNUR MATH

Basics of Derivatives

76

asset / liability creation on a future date

If funds are to be invested on a future

date -- Buy FRA

date -- Sell

BHUSNUR MATH

Basics of Derivatives

77

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