The evolution of the international monetary system:

II. THE GOLD STANDARD (1880-1913)

• Even though the world moved off the gold standard more than 75 years
ago, it still resurfaces

occasionally. For example, in the 1996 presidential campaign the gold

standard was mentioned

in occasional speeches by vice-presidential candidate Jack Kemp. However,

there has been

very little recent support for its re-enactment.

• Gold has historically been used as money mostly for its ability to be a good
store of value:

gold did not tarnish or erode easily and was fairly scarce. It was also a useful
medium

of exchange since it was desired by most people and could be transported in

fairly small

quantities. Gradually, the use of gold for money turned into the minting of
coins whose face

value typically was equivalent to the intrinsic value of gold.

• Beginning in the late 19th century, the world moved away from gold coins
to paper money,

with the caveat that the paper was convertible into gold. A holder of a bank
note could, if

she so desired, exchange it for the equivalent weight in gold. By 1880, most
of the major

trading nations had adopted this monetary system.

• The rules of the system could be described as follows:

1. Each country defined the value of its currency in terms of gold - the U.S.
government
announced a $/ounce of gold value (about $20/oz) and the British
government a sterling/ounce of gold value.

2. The $/pound-sterling exchange rate can be calculated as $ per ounce of

gold/poundsterling per ounce of gold. These exchange rates were set by
arbitrage depending on the

transportation costs of gold.3. Central banks are restricted in not being able
to issue more currency than gold reserves.

Arguments in Favor of a Gold Standard

1. Price Stability:

• By tying the money supply to the supply of gold, central banks are unable
to expand

the money supply.

• The only ways in which they can do so are by acquiring more supplies of
gold through

production or by running balance of payments surpluses with other

countries.

2. Facilitates BOP adjustment automatically:

• This was first described by David Hume and is referred to as Hume’s specie
flow mechanism.

• The basic idea is that a country that runs a current account deficit needs to
export

money (gold) to the countries that run a surplus. The surplus of gold reduces
the deficit

country’s money supply and increases the surplus country’s money supply.

• This results in a lowering of the deficit country’s goods’ prices and an

increase in the

surplus country’s goods’ prices helping to restore equilibrium.

Arguments against a Gold Standard

1. The growth of output and the growth of gold supplies needs to be closely
linked. For example,

if the supply of gold increased faster than the supply of goods did there
would be inflationary

pressure. Conversely, if output increased faster than supplies of gold did

there would be

deflationary pressure.

2. Volatility in the supply of gold could cause adverse shocks to the

economy: rapid changes

in the supply of gold would cause rapid changes in the supply of money and
cause wild

fluctuations in prices that could prove quite disruptive: the benefits of

external adjustment

are counteracted by the internal disruption.

3. In practice monetary authorities may not be forced to strictly tie their

hands in limiting the

creation of money, so some of the theoretical advantages may not hold up.
For example, the

Central Bank could issue more currency without having acquired more gold,
and the public

may not become aware of what’s going on.

4. Countries with respectable monetary policy makers cannot use monetary

policy to fight domestic issues like unemployment.

III. THE INTERIM YEARS (1914-1944)

• The onset of the World Wars saw the end of the gold standard as countries,
other than the

U.S., stopped making their currencies convertible and started printing money
to pay for war
related expenses.• After the war, with high rates of inflation and a large
stock of outstanding money, a return to the old gold standard was only
possible through a deep recession inducing monetary

contraction as practiced by the British after WW I.

• The focus shifted from external cooperation to internal reconstruction and

events like the

Great Depression further illustrated the breakdown of the international

monetary system,

bringing such bad policy moves such as a deep monetary contraction in the
face of a recession.

IV. BRETTON WOODS (1945-1971)

• Bretton Woods is a little town in New Hampshire, famous mostly for good
skiing. In July

1944, the International Monetary and Financial Conference organized by the

U.N attempted

to put together an international financial system that eliminated the chaos of

the inter-war

years.

• The terms of the agreement were negotiated by 44 nations, led by the U.S
and Britain. The

British delegation was led by John Maynard Keynes, perhaps the most
famous economist of

the 20th century.

• The main hope of creating a new financial system was to stabilize

exchange rates, provide

capital for reconstruction from the war and foment international cooperation.
What they

settled on constituted the primary features of the Bretton-Woods agreement.

Features of the Bretton-Woods Agreement

• The features of the Bretton Woods system can be described as a “gold-
exchange” standard

rather than a “gold-standard”. The key difference was that the dollar was the
only currency

that was backed by and convertible into gold. (The rate initially was $35 an
ounce of gold)

• Other countries would have an “adjustable peg” vis--vis the dollar:

basically, they were

exchangeable at a fixed rate against the dollar, although the rate could be
readjusted at

certain times under certain conditions. The dollar or the pound (British
pressure added this

clause!) could be used as reserve currencies for intervention in foreign

exchange markets.

• Each country was allowed to have a 1% band around which their currency
was allowed to

fluctuate around the fixed rate. Except on the rare occasions when the par
value was allowed

to be readjusted, countries would have to intervene to ensure that the

currency stayed in the

required band.

• The IMF (the International Monetary Fund) was created with the specific
goal of being the

multilateral body that monitored the implementation of the Bretton Woods

agreement. Its

role was to hold gold reserves and currency reserves that were contributed
by the member

countries and then lend this money out to other nations that had difficulty
meeting their

obligations under the agreement.

• The borrowing was classified into tranches, each with attached conditions
that became progressively stricter. This enabled the IMF to force countries to
adjust excess fiscal deficits,

tighten monetary policy etc, and force them to be more consistent with their
obligations

under the agreement.• Although the adjustable exchange rate system meant
that countries that could no longer sustain the fixed exchange rate vis-a-vis
the dollar would be allowed to devalue their currencies,

they could only do so with the consent of the other countries and the
auspices of the IMF.

• Currencies had to be convertible: central banks had to exchange domestic

currency for dollars

upon request. However, certain countries were also allowed to institute

capital controls on

certain types of transactions. Only current account related transactions were

required to be

fully convertible and countries were allowed to impose restrictions on the

exchange of capital

account related transactions.

• The capital account restrictions placed limitations on the flow of private

capital and often

limited international help to official lending between governments. Countries

that ran large

current account deficits, could not run capital account surpluses and
therefore had to resort

to large scale intervention with the help of other countries and the IMF.

The Asymmetric Position of the Reserve Center Country

• In a world with N currencies there are only N-1 exchange rates against the
reserve currency.

If all the countries in the world are fixing their currencies against the reserve
currency and
acting to keep the rate fixed, then the reserve country has no need to
intervene.

• It acquires an advantage in that it can use monetary policy for its own
domestic policy

purposes while other countries are unable to use monetary policy for
domestic policy purposes.

• Therefore a decrease in the reserve country’s money supply would cause

an appreciation of

the reserve currency and force the other central banks to lose external
reserves. So the reserve

country can affect both the output in its country as well as output in other
countries through

changes in its monetary policy.

The Demise of the Bretton Woods System

• In the early post-war period, the U.S. government had to provide dollar
reserves to all

countries who wanted to intervene in their currency markets. The famous

comment of the

economist Hendrik Houthhakker was “You can’t play poker unless all of you
have chips”. This

was especially true since many countries insisted on setting their currencies
at the pre-war

level vis--vis the dollar.

• The increasing supply of dollars worldwide, made available through

programs like the Marshall

Plan, meant that the credibility of the gold backing of the dollar was in
question. U.S. dollars

held abroad grew rapidly and this represented a claim on U.S. gold stocks
and cast some

doubt on the U.S.’s ability to convert dollars into gold upon request.
• Domestic U.S. policies, such as the growing expenditure associated with
Vietnam resulted

in more printing of dollars to finance expenditure and forced foreign

governments to run up

holdings of dollar reserves. Although they pursue this for a while a few
countries began to

become growingly less keen on holding dollars and more keen on holding
gold.

• In 1971, the U.S. government “closed the gold window” by decree of

President Nixon. The

world moved from a gold standard to a dollar standard: from Bretton Woods
to the Smithsonian Agreement. Growing increase in the amount of dollars
printed further eroded faith

in the system and the dollars role as a reserve currency. By 1973, the world
had moved to

search for a new financial system: one that no longer relied on a worldwide
system of pegged

exchange rates.V. POST BRETTON WOODS: THE QUEST FOR A NEW

INTERNATIONAL MONETARY SYSTEM

• Surprisingly, the collapse of the Bretton-Woods system did not lead to a

widespread rush to

adopt flexible exchange rates. Instead, the post Bretton-Woods era has
mostly been about a

search for individual or small group adaptations of fixed exchange rate or

managed floating

exchange rate arrangements.

The First Oil Price Shock (the early 1970s)

• The search for a replacement system was delayed by the first of the two oil
price shocks in
the 1970’s. The oil price increase was precipitated by the 1973 Arab-Israeli
war, which drove

up the demand for oil and stifled production: the price of oil quadrupled
between 1973 and

1974.

• Increases in the price of oil were coupled with adverse shocks to grain
harvests in the Soviet

Union and the Unites States, falls in output of sugar and cocoa and
disappearance of Peruvian

anchovies (which turn out to apparently very important in cattle feed).

• The high commodity prices had significant contractionary and inflationary

impacts on many

commodity importing countries and drove many of them into recession.

Conversely, the current account balances of oil importing countries rose
dramatically. According to work by Paul

Krugman and Maurice Obstfeld, the collective current account balance of the
industrialized

countries fell from $14 billion to -$21 billion in 12 months.

• Since most developed countries had a flexible exchange rate at this time
they were able to

better withstand the impact of the oil price shock. The depreciation of the
currency also

helped improve their current account balance. Furthermore, because they

had monetary

policy autonomy, they were able to pursue expansionary monetary policy

and ward off some

of the negative impacts of the oil price shock as well.

• Economists generally think of the oil price crisis as a perfect example of

the positive aspects
of a flexible exchange rate system whereby developed countries were able
to use autonomous

monetary policy to manage the severity of the impact of the price shock and
used the flexible

exchange rate to restore balance in the current account without running into
any BOP crises.

• By 1976, the industrial nations were ready to accept flexible exchange

rates, with a caveat

calling for intervention to stop “erratic fluctuations” in exchange rates. At

this point, the

responsibilities of the IMF were also modified to allow countries to pick

whatever exchange

rate system they preferred.

The Second Oil Price Shock (the late 1970’s)

• The expansionary monetary policy pursued by the U.S. had helped it

recover fairly quickly

from the oil price shock but further attempts to boost the economy through
expansionary

monetary policy (with lower interest rates) led to a steep depreciation of the
dollar which

further fueled U.S. inflation because of increases in the price of imports.

• By the late 1970’s (the tail-end of the Carter administration) the U.S.
economy was characterized by a weak dollar and high rates of inflation. The
fall of the Shah of Iran in 1979

led to the second oil crisis: roughly a doubling in the price of oil between
1978 and 1980.

The impact of the second oil crisis was milder, but industrial countries still
continued to run

current account deficits.• In 1979, Paul Volcker was appointed to be the new
Fed chair; he announced that he would
tighten monetary policy to reduce inflation in the U.S. economy. So the
response to the

second oil price shock was very different. Instead of pursuing expansionary
monetary policy,

the U.S. and the other developed countries: pursued contractionary

monetary polices.

The Period of the Rising Dollar (the mid 1980’s) and the Plaza Accord

• As a result, by the early 1980’s the U.S. and most industrial economies
were stuck in a deep

recession (U.S. unemployment rates were as high as 9.5% in 1982.

Developing countries, which

had already borrowed significant amounts of foreign money in the first oil
crisis, continued

to run substantial current account deficits and the debt burdens in these
countries reached

crisis proportions: especially in Latin America.

• The tight monetary policy pursued by Paul Volcker did its job. By the early
1980’s U.S.

inflation had declined rapidly. Furthermore the tight monetary policy had led
to a steep

appreciation of the dollar. The stronger dollar worsened the U.S. current
account deficit and

helped the Europeans improve theirs.

• However, the European nations were unhappy with the fact that prices of
U.S. imports were

adding to inflation faced in their countries. They responded with tighter

interest rates thus

dragging their economies into a recession as well. These types of

competitive interest rate

increases are sometimes referred to as attempts to ”export” inflation.

• The appreciation of the dollar was leading to an unprecedented increase in
the U.S. trade

deficit (coupled of course with the Reagan era tax cuts and investment
increases). The

increase in the trade deficit led to an increase in protectionist pressures in

the U.S.

• This led to a meeting by leaders of the industrial nations to intervene in the

foreign exchange

markets to bring about fall in the value of the dollar devaluation. The
meeting was held at

the Plaza hotel in New York and the agreement reached that day is often
referred to as the

Plaza Accords.

The Period of the Falling Dollar (the late 1980s) and the Louvre Accord

• The U.S. was finally moving from a position of ”benign neglect” towards
the dollar to a

position of active intervention in foreign exchange markets.

• The interventions were successful but as always there were new problems
that emerged: European countries were now unhappy with the appreciation
of their currencies and began to

worry about their current account balances.

• In 1987, members of the G-5 (the U.S., Britain, France, Germany, Japan)
and Canada had

gathered at the Louvre in Paris to establish a new system of exchange rate

cooperation. This

meeting is often referred to as the Louvre Accords.

• The Louvre Accords called for the establishment of target zones (bands
around which currencies were allowed to fluctuate, believed to be around 5%
of the exchange rates prevailing

at the time.)
• The currencies stayed within this range although by now the dollar was
depreciating substantially. This meant that the U.S central bank had to raise
interest rates if they were keen on

maintaining the value of the dollar within the prescribed exchange rate
band.• Thoughts that monetary policy makers would focus so much on the
external sector were

dashed by the stock market collapse in October 1987. Alan Greenspan, the
Fed chair at the

time, took immediate steps to lower interest rates by easing monetary policy
to help prevent

the economy from going into a severe tailspin.

• The lowering of interest rates meant that the dollar depreciated to a far
greater extent than

the target bands established by the Louvre Accords allowed for. Even though
subsequent

attempts to establish a worldwide system of exchange rate bands were

periodically revived

they have never since taken effect.

• However, the European nations had maintained a version of a fixed

exchange rate system

through this period: from 1979 onwards. The European countries basically
agreed on a

system of managed exchange rates amongst themselves while allowing for

their currencies to

float against the dollar. This was known as the European Monetary System or
EMS.

• In more recent times, the significant European development has been the
adaptation of the

Euro and the movement towards European Monetary Union. We will analyze
the transition
from EMS to EMU and discuss the pros and cons of each system in a
subsequent lecture.

• In the rest of the world, the 1990s has been a remarkable mix of prosperity
and turmoil. We

will study the behavior of the international financial system in more detail
during the second

half of the course.

What Does European Monetary System - EMS Mean?

A 1979 arrangement between several European countries which links their currencies in
an attempt to stabilize the exchange rate. This system was succeeded by the European
Monetary Union (EMU), an institution of the European Union (EU), which established
a common currency called the euro.

The European Monetary System originated in an attempt to stabilize inflation and stop
large exchange-rate fluctuations between European countries. Then, in June 1998, the
European Central Bank was established and, in January 1999, a unified currency, the
euro, was born and came to be used by most EU member countries.

There are three stages of monetary cooperation in the European Union.

Stage I

European Monetary System (EMS) was an arrangement established in 1979 under

the Jenkins European Commission where most nations of the European Economic
Community (EEC) linked their currencies to prevent large fluctuations relative to one
another.

After the demise of the Bretton Woods system in 1971, most of the EEC countries
agreed in 1972 to maintain stable exchange rates by preventing exchange rate
fluctuations of more than 2.25% (the European "currency snake"). In March 1979, this
system was replaced by the European Monetary System, and the European Currency
Unit (ECU) was defined.

The basic elements of the arrangement were:

 1. The ECU: A basket of currencies, preventing movements above 2.25%
(6% for Italy) around parity in bilateral exchange rates with other member
countries.
2. An Exchange Rate Mechanism (ERM)
3. An extension of European credit facilities.
4. The European Monetary Cooperation Fund: created in October 1972 and
allocates ECUs to members' central banks in exchange for gold and US dollar
deposits.

Although no currency was designated as an anchor, the Deutsche Mark and

German Bundesbank were unquestionably the centre of the EMS. Because of its
relative strength, and the low-inflation policies of the bank, all other currencies were
forced to follow its lead. This situation led to dissatisfaction in most countries, and was
one of the primary forces behind the drive to a monetary union (ultimately the euro).

Periodic adjustments raised the values of strong currencies and lowered those of
weaker ones, but after 1986 changes in national interest rates were used to keep the
currencies within a narrow range. In the early 1990s the European Monetary System
was strained by the differing economic policies and conditions of its members,
especially the newly reunified Germany, and Britain (which had initially declined to join
and only did so in 1990) permanently withdrew from the system in September
1992. Speculative attacks on the French Franc during the following year led to the so-
called Brussels Compromise in August 1993 which established a new fluctuation band
of +15%.
1992 crisis
For more information see Black Wednesday

 On 13 September 1992 Italy decided to devalue Italian Lira by 3,5% (other

currencies revalu of 3,5%: Lira loses 7%)
 On 16 September 1992 UK withdrew from ERM.
 On 17 September 1992 Italy withdrew from ERM.

Stage II

The European Monetary System was no longer a functional arrangement in May 1998
as the member countries fixed their mutual exchange rates when participating in
the euro. Its successor however, the ERM-II, was launched on 1 January 1999. In ERM-
II the ECU basket was discarded and the new single currency euro has become an
anchor for the other currencies participating in the ERM 2. Participation in the ERM 2 is
voluntary and the fluctuation bands remain the same as in the original ERM, i.e. +15
percent, once again with the possibility of individually setting a narrower band with
respect to the euro. Denmark and Greece became new members.
Stage III

The EMS-2 is sometimes described as "waiting room" for joining the Economic and
Monetary Union of the European Union. In the EMU(stage III) the actual currencies in
the participating member states are replaced by euro banknotes and coins; thus,
entering the Euro Zone.
SOUTH-EAST ASIAN CRISIS

THE ECONOMIC CRISIS OF 1997-99 OVERVIEW

Unfolding of the Crisis (June 1997)

1. Fixed exchange rate system pegged to the USD. When the Dollar rose,

consequently the ASEAN currencies grew too, resulting in lower exports.

2. Decline in Export competitiveness particularly in Electrical goods.

3. The decrease in exports resulted in increased Trade and Current Account

deficit.

4. The crisis first emerged in Thailand when as a crisis of loan repayment.

This

led to fears of loan defaults and foreign short-term creditors withdrew funds

from Thai financial institutions.

5. The withdrawal of ST credit led to pressure on forex reserves and the

value of

Baht. The Bank of Thailand in its attempt to save the Baht lost all its
Reserves

and had to request assistance from the IMF.

6. The contagion then spread to Philippines, Malaysia and Indonesia.

ANALYSIS

Causes of the crisis in 1997

There are 2 main theses as to the causes of the crisis.

1. Weakness of Macro-Economic fundamentals

The basic weaknesses in the Macro-Economic fundamentals itself led to Low

productivity and competitiveness vis-à-vis other regions of the world.

Inadequate supervision of Financial institutions and lack of adequate

disclosure by the

corporate world further worsened the situation. Weak governments lacked

the political

autonomy or will to enact the deflationary policies necessary to reduce

current account

deficits and domestic asset bubbles. They also contributed to the cronyism
and ethical

problem that encouraged over borrowing, over lending, and over investment
in the

private corporate sector as well as in state projects.

2. Overvalued Exchange Rate & Openness of Capital Account

Overvalued exchange rates tied to an appreciating U.S. dollar led to large

current account

deficits and inadequate or declining long-term capital inflows. This resulted

in heavy

dependence on short-term external debt and the depletion of foreign

exchange reserves.

The Opening up of Capital Account led to local financial institutions over

borrowing

more from foreign sources. All this made a currency devaluation inevitable
and attracting
speculators eager to benefit from it. Borrowed Short-Term funds were
invested in the

Stock market and in Real Estate. The overall quality of investments declined
with

reduction investor confidence which was a result of bad news that the export
market had

slowed down. Impact of the crisis

The crisis led to weaker, unstable exchange rates and weakened Financial
Institutions. To

tackle this, the Government imposed higher domestic Interest rates, which
led to a

slowdown in manufacturing and industrial activity. This brought about huge

unemployment and an undesirable social impact – on food, healthcare and

education. To

make matters worse, the financial crisis coincided with the worst drought
conditions in

the ASEAN region. Since ASEAN is the fourth largest trading block in the
world, the

spillover effect was on world trade (mainly ASEAN’s trading partners).

Proposed Solutions

1. Stabilizing the Exchange Rate and Debt Management

The idea here is to stabilize the exchange rate. The firms should not be
allowed to take

any further debt which would imply Debt Standstill. This would stop
withdrawal of

foreign lending in the long run. Loans should be rolled over and re-scheduled
which will

help in servicing loans through export earnings rather than fresh debts.
Collective re-negotiation of debt should be encouraged and the Provision of
Working

Capital will keep the business activities going. Moreover, the bankruptcy laws
need to be

put in place and enforced properly.

2. Dealing with the Social impact

To deal with the Social Impact the availability of food and healthcare at
affordable prices

has to be ensured to prevent the impact to prolong. Private organizations

should play a

more active role in preventing students from dropping out of school, which
will prevent

the negative social impact on human resources.

3. Strengthening the Financial sector

The Assurance needs to come that foreign capital will not leave the country
at the first

signs of trouble. Financial Institutions need to be properly regulated with

greater

disclosure and better transparency Norms. Increase in domestic savings has

to take place

as it is crucial.

4. Adjustment of Industrial Structures

The Govt. can help companies by increasing access to new technologies,

reducing

taxation levels and facilitating finance for investments. One needs to take
advantages of

the integrated ASEAN market for restructuring and look for opportunities
within

ASEAN.
5. International Financial markets

Regulation and control of capital flow should be made to open economies.

There should

be a surveillance system to monitor flow of capital. Prevention of flight of

foreign capital

in key sectors, regulations governing disinvestments should be in place.

There is a lot of

need for specialized Training Institutes in Finance (in the ASEAN region). A
Re-look at

the policies of the IMF towards such economies is highly suggested.

6. Revitalizing the Financial MarketsThe ASEAN mutual monitoring

mechanism established in Feb 1998 provides an

opportunity for ASEAN Finance ministers to exchange views on status of

financial and

exchange markets in their countries. One must now use ASEAN currencies
for trade

among ASEAN countries. Moreover the proposed Asian Bond Market can
effectively

deal with flow of debt capital.

ASEAN: Steps to Handle the Crisis

Four areas where new developments are taking place that are relevant to
long-term

investment decisions.

I. The progressive openness of ASEAN economies

1) ASEAN economies are on the steady path of liberalization, privatization

and

deregulation.
2.
2) ASEAN is moving toward new forms of linkage with other countries and
regions.

Examples are the recently initialed Singapore-New Zealand Agreement on a

Closer

Economic Partnership and the recently announced start of negotiations on a

SingaporeJapan Economic Agreement for a New Age Partnership.

3) The process of expanding co-operation between ASEAN and China, Japan

and the

Republic of Korea - the process known as ASEAN+3 - is rapidly gaining

momentum.

These include the joint monitoring of financial and economic movements in

East Asia

and in the world and a network of currency swap and repurchase

agreements to make

resources available to countries in balance-of-payments difficulties.

II Sound Financial measures

1) ASEAN plans to adopt sound financial practices and standards by 2003.

Capital

markets will be deepened, particularly the bond market, to provide a wide

variety of

instruments with longer maturity and ample liquidity.

2) Common currency is being given serious consideration

3) Capital account liberalization shall be properly sequenced to allow freer

flow of

capitals. At the same time, certain measures can be put in place to reduce
the adverse

impact of sudden shift in capital flows.

III The growing integration of the ASEAN economy

1) Under the ASEAN commitment to AFTA (ASEAN Free Trade Area) more
than 85

per cent of tariff lines in the AFTA scheme already in the minimal-tariff zone
and there is

a proposal to abolish all import duties on trade by 2010.

2) ASEAN countries are streamlining and harmonizing customs procedures.

They are

entering into mutual recognition arrangements.

3) ASEAN is working towards the development of the trans ASEAN highway

system,

open-skies regime, and ASEAN Power Grid, Trans-SEAN Gas Pipeline Network
and

Telecommunications interconnectivity.

IV The expansion and diversification of ASEAN 1) Expansion of ASEAN will

give investors more choices in deciding where to

locate their operations for the increasingly integrated ASEAN market or for
production

for export elsewhere in the world.

2) ASEAN is making a special effort to upgrade the skills of the people of the
newer

members and build their institutional capacity.

Some major initiatives taken

1. The Manila Framework

ASEAN has come up with new initiatives under the so-called Manila
Framework that

includes

(i) ASEAN Surveillance Process: This has been set up to keep an eye on

macroeconomic trends and short-term capital flows. It is something of an

early warning
system to signal possible trouble.

(ii) Peer Review in which the ASEAN countries exchange views with one
another on

economic developments and measures being undertaken to address the

crises and to

jointly formulate policy responses to pending problems.

2. The Chiang Mai Initiative

At the ASEAN Plus Three Finance Ministers Meeting in Chiang Mai in May
2000, one

of the main topics of discussion was how to develop a regional financing

arrangement

that could be utilized to maintain financial stability in the East Asian region.
At that time,

the discussion on the expansion of the ASEAN swap arrangement (ASA) to

include all

ASEAN countries and increase its size to US$1 billion by the ASEAN central
banks was

near its final stage. The ASEAN Plus Three countries decided to combine the
expanded

ASA with a network of bilateral swap arrangements (BSAs) among the

ASEAN Plus

Three countries to establish the first regional financing arrangement called

the "Chiang Mai I”

ForeignExchangeRisks

The identified risks in the foreign exchange market are: (a) rates; (b) credit; (c)
mismatched maturities; (d) country; and (e) business.
• Rate Risk : Rate risk is normally assumed when a dealer quotes a price against
another currency and does not cover it immediately. He is running the risk of the
currency going against him. The rate risk is assumed by corporate treasurer who has
invoiced his exports or imports in foreign currency at a predetermined Indian rupee
rate and does not cover his foreign exchange by entering into a forward contract with a
bank, For example, if an exporter invoices his goods in US dollar US $ l = INR 17.50,
and exports the goods and when he receives the payment if the exchange rate has
moved against him he may receive only INR 17.25 resulting in a loss of 25 paise per
dollar. Although in the present scenario of depreciating rupee this is unlikely to
happen, one can imagine the risk to which an exporter will be exposed to in conditions
of an appreciating rupee.
• Credit Risk: Credit risk is assumed on counter parties with whom an exchange
transaction is concluded. If a spot contract is concluded between a bank and a
customer, the bank is taking a risk on the customer, in the sense that if the bank
delivers the foreign currency, let us say in Tokyo, in an important transaction, because
of the time zone differences, the bank will be able to debit the customer’s account only
after an interval of 4-5 hours and is, therefore, exposed to full amount of the contract
concluded. However, with regard to forward contracts which can be liquidated in the
market, the risk assumed is between 1 0 per cent and 20 per cent of the contracted
amount.
• Risk of Mismatched Maturities: The risk of mismatched maturities arises due to
the mismatch of inflows and outflows of foreign currencies. Technical, if one were to
receive US$ 1 million and also remit US$ 1 million today, one does not carry any
exchange risk except the loss of the spread to the bank, However, in real life,
situations are not so ideal and, therefore, corporate treasurers are exposed to risks of
mismatched maturities ‘ that is, a time lag between receipt and payment of foreign
currency, even if they are both exporters and importers.
• Country Risk : Country risk has assumed serious proportions in view of the
economic and political instability prevailing in many countries, such as in Latin
America, and Africa. It is advisable for a corporate treasurer to check the country risk
aspect before he concludes a deal with problem countries, as he may not receive the
foreign exchange against his goods due to exchange control restrictions. The recent
Middle-East war has ravaged the economies of Iraq and Iran and, therefore, all
transactions with these countries must be carefully handled to ensure that goods or
funds are not blocked.
• Business Risk : Business risk is common to all types of businesses, such as
hearing a wrong rate, communicating the wrong amount, etc; however, in the foreign
exchange business, it can be disastrous as exchange rates move very quickly and
 errors could be difficult to rectify without a loss. The corporate treasurers are,
therefore, advised to communicate all the details in writing with the banks to avoid any
misunderstandings.
Management of Foreign Exchange Risks
Generally, the corporate treasurers fall into one of the three categories:
(a) Those who cover every exposure;
(b) Those who do not cover all; and
(c) Those who cover judiciously.
The first category belongs to corporate which are extremely conservative and, therefore,
cover every exposure immediately by entering into a forward exchange contract with a
bank their contention is that they should best concentrate on the line of their business
rather than dabble in the speculative world of foreign exchange. If the corporate cover
every exposure, obviously they eliminate the foreign exchange risk altogether. The
second category belongs to corporate which believe in the “do nothing” approach and
cover their exposure on a spot basis at whatever rate is offered on the date of
remittance. This category of corporate, therefore, believes in keeping exposures open
and, pays for the risk they assume. Although in some cases they might benefit by
favorable movements of exchange rates, they do not crystallize their liabilities and will
never know their rupee liabilities until the date of remittance. The third category belongs
to corporate which cover their exposure judiciously by talking to corporate dealers of the
respective banks and deciding whether to book exposure or not, depending upon short
– term / long-term trends of currencies, the rate of depreciation of the rupee against
foreign currency, and the level of premier and discounts prevailing in the inter-bank
market.
It is, therefore, obvious that a corporate treasurer may belong to any one of the three
categories and depending upon circumstances, decide his policy on foreign exchange
objective may be stated to curtail losses on account of exchange risk fluctuations to the
extent of I per cent of the cost of goods or projected cost during the period I January to
31 December 1990. Within these broad objectives, the operative staff can be given
authority to book exposure within 1/4 per cent or 1/2 per cent of costs involved so that
they do not have to revert to the senior management every time an exposure decision
needs to be taken. The operating staff could then work in close co-ordination with the
corporate dealers of banks and efficiently cover the exchange risk on an on-going basis.
Suggestions
Here are a few practical suggestions for corporate treasurers to manage their exchange
risk,
(a) Quotes from more than one bank: It is imperative that a corporate treasurer takes
advantage of rates quoted by different banks. The corporate treasurers must take
quotes from at least two banks before concluding business with any one of them.
Exchange rates will not be the same with banks depending upon currency position of
each bank, the nature of operation – whether cover operation or trading operation,
quality of dealers, and currency traded. Although it may not be possible for a corporate
treasurer to take away business from one bank to another due to funded facilities, which
may be made available, it at least improves his bargaining power with the bank, and in
some cases he may be able to get an improved rate quoted to him. Banks normally
quote indicative rates in the morning, which are subject to variation, and a firm rate is
quoted only if a corporate treasurer wishes to do business at that point of time.
(b) Indicate Your Interest: It is very important that a corporate treasurer establishes a
close rapport with the corporate dealer in his bank and absolute confidence should exist
between the two of them. It is desirable that a corporate treasurer confides in the
corporate dealer and discloses his position, which he wishes to cover so that the
corporate dealer can keep this in mind and revert to him whenever an opportunity arises
to cover the position profitably. For instance, a corporate treasurer can inform the dealer
that he wishes to cover his three months export exposure at US$ 5.56. A corporate
dealer will call the client whenever the spot rate appreciates and the premiums are
higher to give the benefit of the desired rate to the customer.
(c) Standing Instruction: If the corporate treasurer is not likely to be available in the
office, for some reason, it is expedient to leave a standing instruction with a corporate
dealer to cover his exposure, let us say, at US$ 5.56 so that the corporate treasurer
does not lose out on an opportunity presented in the market
(d) Stop Loss Order: Stop loss orders are also a kind of standing instruction to stop
loss in a deteriorating market. For instance, if an importer does not want to cover his
exposure at a rate worse than US$ 5.60, he should leave such instructions with a
corporate dealer to stop loss at US $ 5.60, a limit up to which he can sustain loss.
(e) Quick Decision: In a volatile foreign exchange market, quick decisions are of
paramount importance and, therefore, a corporate treasurer should not keep dealers
holding to give decisions. Once a rate is quoted, a dealer is also running the risk and if
the market changes, the rate may not hold well. It is, therefore, important that the senior
management in a company delegate’s authority within certain parameters to the
operating staff so that they are able to quickly respond to the dealers on telephone.
(f) Partial Hedge: When in doubt, partial hedge is the answer. There is no auspicious
day for booking foreign exchange exposure and if one feels that the rate offered is
reasonable, one should at least book a part of the exposure rather than leaving the
entire exposure to be covered on a single day in the future. What matters are the
average rate for a series of transactions rather than a good rate for one transaction?
(g) Forward Period: There are spot rates and forward rates in the foreign exchange
market. Forward rates are quoted at either premium or discount depending upon
whether the currency is at premium or discount and it is, therefore, important that a
corporate treasurer informs the appropriate period to the corporate dealer to enable him
to quote an accurate rate. For example, if an exporter wants to ship his goods after a
period of three months, he should ask for a three-month forward rate rather than the
spot rate.
Choice of Bank
A corporate treasurer cannot efficiently manage his foreign exchange risk unless he is
helped by a bank which has a well equipped dealing room with the necessary
infrastructure facilities and trained dealers who have the support of over-seas dealing
centers. The choice of a bank will also depend upon the individual currency
requirement. Many banks have consultancy services, and publish newsletters, to keep
their clients advised about the happenings in the international markets. The corporate
treasurers should take advantage of such services and keep in close touch with trends
of the currencies, and endeavor to manage their exposure in a professional manner.
In the last few years, many corporate treasurers have come to grief for not appreciating
exchange risks involved in foreign trade, resulting in the escalation of project costs,
working capital, and cash flow problems. Although RBI has not allowed the introduction
of sophisticated products, such as options or swaps in the local market, exchange risk
can be managed more effectively by following the approaches discussed in this paper.

When engaged in international marketing, it is critical that you pay attention to local customs and
culture if you want to successfully expand your business. When in another country, many
businesspeople find they have much more success luring prospects when they respect and adhere
to the cultural customs of the international company with which they conduct business.
International marketing is as much about respecting culture as it is about expanding your
business in the international markets.

Making Cultural Accommodations

Cultural misunderstandings often result in frustration and the loss of business. International
marketing aims to help people communicate clearly and be mindful of their business partner’s
cultural ideals, because they often impact how one business partner or client engages when
conducting business and why they hold the beliefs they do.

For example, one business partner may find it acceptable when making purchases to pay the
highest price possible because they are raised in an environment that teaches that you get what
you pay for. The other business client may have been raised in a culture that teaches to pay the
cheapest price for the best quality product. When it comes to doing business, the two may be at
the opposite ends of the spectrum.

If these cultural differences are not known at the time of negotiations, this could lead to conflict
or other problems. International marketing shows business people how important it is to research
another client’s cultural customs before engaging in business so these types of conflicts or
potential sore spots can be eradicated or minimized.

Local Representatives

Because it is impossible to learn everything about another culture before doing business, many
companies find it sensible to hire a local business representative, one that can help a company in
the native country. This person can escort visiting business professionals and apprise them of any
cultural considerations specific to various events or meetings. This person can also act as a
business liaison. This practice is common in international marketing and benefits all parties
involved.

Local representatives may be permanent employees that work for the company abroad. If this is
the case, a manager or hiring representative will have to fly to the host country to hire this
individual. It is best that this person lives in the host country rather than that of the home
company to ensure he or she is up-to-date in cultural practices.

A syndicated loan is one that is provided by a group of lenders and is structured,

arranged, and administered by one or several commercial banks or investment
banks known as arrangers.

The syndicated loan market is the dominant way for corporations in the U.S. and
Europe to tap banks and other institutional financial capital providers for loans. The U.S.
market originated with the large leveraged buyout loans of the mid-1980s,[1] and
Europe's market blossomed with the launch of the euro in 1999.

At the most basic level, arrangers serve the investment-banking role of raising investor
funding for an issuer in need of capital. The issuer pays the arranger a fee for this
service, and this fee increases with the complexity and risk factors of the loan. As a
result, the most profitable loans are those to leveraged borrowers—issuers whose credit
ratings are speculative grade and who are paying spreads (premiums or margins
above LIBOR in the U.S., Euribor in Europe or another base rate) sufficient to attract the
interest of non-bank term loan investors. Though, this threshold moves up and down
depending on market conditions.

In the U.S., corporate borrowers and private equity sponsors fairly even-handedly drive
debt issuance. Europe, however, has far less corporate activity and its issuance is
dominated by private equity sponsors, who, in turn, determine many of the standards
and practices of loan syndication.[2]
Types of Syndications

Globally, there are three types of underwriting for syndications: an underwritten deal,
best-efforts syndication, and a club deal. The European leveraged syndicated loan
market almost exclusively consists of underwritten deals, whereas the U.S. market
contains mostly best-efforts.
[edit]Underwritten deal
An underwritten deal is one for which the arrangers guarantee the entire commitment,
then syndicate the loan. If the arrangers cannot fully subscribe the loan, they are forced
to absorb the difference, which they may later try to sell to investors. This is easy, of
course, if market conditions, or the credit’s fundamentals, improve. If not, the arranger
may be forced to sell at a discount and, potentially, even take a loss on the paper. Or
the arranger may just be left above its desired hold level of the credit.

Arrangers underwrite loans for several reasons. First, offering an underwritten loan can
be a competitive tool to win mandates. Second, underwritten loans usually require more
lucrative fees because the agent is on the hook if potential lenders balk. Of course, with
flex-language now common, underwriting a deal does not carry the same risk it once did
when the pricing was set in stone prior to syndication.
[edit]Best-efforts syndication
A best-efforts syndication is one for which the arranger group commits to underwrite
less than the entire amount of the loan, leaving the credit to the vicissitudes of the
market. If the loan is undersubscribed, the credit may not close—or may need major
surgery to clear the market. Traditionally, best-efforts syndications were used for risky
borrowers or for complex transactions. Since the late 1990s, however, the rapid
acceptance of market-flex language has made best-efforts loans the rule even for
investment-grade transactions.
[edit]Club deal
A club deal is a smaller loan—usually $25–100 million, but as high as $150 million—that
is premarketed to a group of relationship lenders. The arranger is generally a first
among equals, and each lender gets a full cut, or nearly a full cut, of the fees.
[edit]The Syndication Process

Leveraged transactions fund a number of purposes. They provide support for general
corporate purposes, including capital expenditures, working capital, and expansion.
They refinance the existing capital structure or support a full recapitalization including,
not infrequently, the payment of a dividend to the equity holders. They provide funding
to corporations undergoing restructurings, including bankruptcy, in the form of super
senior loans also known as debtor in possession (DIP) loans. Their primary purpose,
however, is to fund M&A activity, specifically leveraged buyouts, where the buyer uses
the debt markets to acquire the acquisition target’s equity.

In the U.S., the core of leveraged lending comes from buyouts resulting from corporate
activity, while, in Europe, private equity funds drive buyouts. In the U.S., all private
equity related activities, including refinancings and recapitalizations, are called
sponsored transactions; in Europe, they are referred to as LBOs.

A buyout transaction originates well before lenders see the transaction’s terms. In a
buyout, the company is first put up for auction. With sponsored transactions, a company
that is for the first time up for sale to private equity sponsors is a primary LBO; a
secondary LBO is one that is going from one sponsor to another sponsor, and a tertiary
is one that is going for the second time from sponsor to sponsor. A public-to-private
transaction (P2P) occurs when a company is going from the public domain to a private
equity sponsor.

As prospective acquirers are evaluating target companies, they are also lining up debt
financing. A staple financing package may be on offer as part of the sale process. By
the time the auction winner is announced, that acquirer usually has funds linked up via a
financing package funded by its designated arranger, or, in Europe, mandated lead
arranger (MLA).

Before awarding a mandate, an issuer might solicit bids from arrangers. The banks will
outline their syndication strategy and qualifications, as well as their view on the way the
loan will price in market. Once the mandate is awarded, the syndication process starts.

In Europe, where mezzanine capital funding is a market standard, issuers may choose
to pursue a dual track approach to syndication whereby the MLAs handle the senior
debt and a specialist mezzanine fund oversees placement of the subordinated
mezzanine position.

The arranger will prepare an information memo (IM) describing the terms of the
transactions. The IM typically will include an executive summary, investment
considerations, a list of terms and conditions, an industry overview, and a financial
model. Because loans are unregistered securities, this will be a confidential offering
made only to qualified banks and accredited investors. If the issuer is speculative grade
and seeking capital from nonbank investors, the arranger will often prepare a “public”
version of the IM. This version will be stripped of all confidential material such as
management financial projections so that it can be viewed by accounts that operate on
the public side of the wall or that want to preserve their ability to buy bonds or stock or
other public securities of the particular issuer (see the Public Versus Private section
below). Naturally, investors that view materially nonpublic information of a company are
disqualified from buying the company’s public securities for some period of time. As the
IM (or “bank book,” in traditional market lingo) is being prepared, the syndicate desk will
solicit informal feedback from potential investors on what their appetite for the deal will
be and at what price they are willing to invest. Once this intelligence has been gathered,
the agent will formally market the deal to potential investors.

The executive summary will include a description of the issuer, an overview of the
transaction and rationale, sources and uses, and key statistics on the financials.
Investment considerations will be, basically, management’s sales “pitch” for the deal.

The list of terms and conditions will be a preliminary term sheet describing the pricing,
structure, collateral, covenants, and other terms of the credit (covenants are usually
negotiated in detail after the arranger receives investor feedback).

The industry overview will be a description of the company’s industry and competitive
position relative to its industry peers.

The financial model will be a detailed model of the issuer’s historical, pro forma, and
projected financials including management’s high, low, and base case for the issuer.

Most new acquisition-related loans are kicked off at a bank meeting at which potential
lenders hear management and the sponsor group (if there is one) describe what the
terms of the loan are and what transaction it backs. Management will provide its vision
for the transaction and, most importantly, tell why and how the lenders will be repaid on
or ahead of schedule. In addition, investors will be briefed regarding the multiple exit
strategies, including second ways out via asset sales. (If it is a small deal or
a refinancing instead of a formal meeting, there may be a series of calls or one-on-one
meetings with potential investors.)

In Europe, the syndication process has multiple steps reflecting the complexities of
selling down through regional banks and investors. The roles of each of the players in
each of the phases are based on their relationships in the market and access to paper.
On the arrangers’ side, the players are determined by how well they can access capital
in the market and bring in lenders. On the lenders’ side, it is about getting access to as
many deals as possible.

There are three primary phases of syndication in Europe. During the underwriting
phase, the sponsor or corporate borrowers designate the MLA (or the group of MLAs)
and the deal is initially underwritten. During the sub-underwriting phases, other
arrangers are brought into the deal. In general syndication, the transaction is opened up
to the institutional investor market, along with other banks that are interested in
participating.
In the U.S. and in Europe, once the loan is closed, the final terms are then documented
in detailed credit and security agreements. Subsequently, liens are perfected and
collateral is attached.

Loans, by their nature, are flexible documents that can be revised and amended from
time to time after they have closed. These amendments require different levels of
approval. Amendments can range from something as simple as a covenant waiver to
something as complex as a change in the collateral package or allowing the issuer to
stretch out its payments or make an acquisition.
[edit]Loan Market Participants

There are three primary-investor constituencies: banks, finance companies, and

institutional investors; in Europe, only the banks and institutional investors are active.

In Europe, the banking segment is almost exclusively made up of commercial banks,

while in the U.S. it is much more diverse and can involve a commercial bank, a savings
and loan institution, or a securities firm that usually provides investment-grade loans.
These are typically large revolving credits that back commercial paper or are used for
general corporate purposes or, in some cases, acquisitions.

For leveraged loans, U.S. banks typically provide unfunded revolving credits, letters of
credit (LOCs), and—although they are becoming increasingly less common—amortizing
term loans, under a syndicated loan agreement. European banks fund and hold all
tranches within the credit structure.

Finance companies have consistently represented less than 10% of the leveraged loan
market, and tend to play in smaller deals—$25–200 million. These investors often seek
asset-based loans that carry wide spreads and that often feature time-intensive
collateral monitoring.

Institutional investors in the loan market are principally structured vehicles known
as collateralized loan obligations (CLO) and loan participation mutual funds (known as
“prime funds” because they were originally pitched to investors as a money-market-like
fund that would approximate the prime rate) also play a large role. Although U.S. prime
funds do make allocations to the European loan market, there is no European version of
prime funds because European regulatory bodies, such as the Financial Services
Authority (FSA) in the U.K., have not approved loans for retail investors.

In addition, hedge funds, high-yield bond funds, pension funds, insurance companies,
and other proprietary investors do participate opportunistically in loans. Typically,
however, they invest principally in wide-margin loans (referred to by some players as
“high-octane” loans), with spreads of 500 bps or higher over the base rate.

CLOs are special-purpose vehicles set up to hold and manage pools of leveraged
loans. The special-purpose vehicle is financed with several tranches of debt (typically a
‘AAA’ rated tranche, a ‘AA’ tranche, a ‘BBB’ tranche, and a mezzanine tranche) that
have rights to the collateral and payment stream in descending order. In addition, there
is an equity tranche, but the equity tranche is usually not rated. CLOs are created
as arbitrage vehicles that generate equity returns through leverage, by issuing debt 10
to 11 times their equity contribution. There are also market-value CLOs that are less
leveraged—typically three to five times—and allow managers more flexibility than more
tightly structured arbitrage deals. CLOs are usually rated by two of the three major
ratings agencies and impose a series of covenant tests on collateral managers,
including minimum rating, industry diversification, and maximum default basket.

In the U.S., CLOs had become the dominant form of institutional investment in the
leveraged loan market by 2007, taking a commanding 60% of primary activity by
institutional investors. But when the structured finance market cratered in late 2007,
CLO issuance tumbled and by mid-2008, the CLO share had fallen to 40%.

In Europe, over the past few years, other vehicles such as credit funds have begun to
appear on the market. Credit funds are open-ended pools of debt investments. Unlike
CLOs, however, they are not subject to ratings oversight or restrictions regarding
industry or ratings diversification. They are generally lightly levered (two or three times),
allow managers significant freedom in picking and choosing investments, and are
subject to being marked to market.

In addition, in Europe, mezzanine funds play a significant role in the loan market.
Mezzanine funds are also investment pools, which traditionally focused on the
mezzanine market only. However, when second lien entered the market, it eroded the
mezzanine market; consequently, mezzanine funds expanded their investment universe
and began to commit to second lien as well as payment-in-kind (PIK) portions of
transaction. As with credit funds, these pools are not subject to ratings oversight or
diversification requirements, and allow managers significant freedom in picking and
choosing investments. Mezzanine funds are, however, riskier than credit funds in that
they carry both debt and equity characteristics.

Retail investors can access the loan market through prime funds. Prime funds were first
introduced in the late 1980s. Most of the original prime funds were continuously offered
funds with quarterly tender periods. Managers then rolled true closed-end, exchange-
traded funds in the early 1990s. It was not until the early 2000s that fund complexes
introduced open-ended funds that were redeemable each day. While quarterly
redemption funds and closed-end funds remained the standard because the secondary
loan market does not offer the rich liquidity that is supportive of open-end funds, the
open-end funds had sufficiently raised their profile that by mid-2008 they accounted for
15-20% of the loan assets held by mutual funds.

As the ranks of institutional investors have grown over the years, the loan markets have
changed to support their growth. Institutional term loans have become commonplace in
a credit structure. Secondary trading is a routine activity and mark-to-market pricing as
well asleveraged loan indexes have become portfolio management standards.[4]
[edit]Credit Facilities

Syndicated loans facilities (Credit Facilities) are basically financial assistance programs
that are designed to help financial institutions and other institutional investors to draw
notional amount as per the requirement.

There are four main types of syndicated loan facilities: a revolving credit; a term loan; an
LOC; and an acquisition or equipment line (a delayed-draw term loan).[5]

A revolving credit line allows borrowers to draw down, repay and reborrow as often as
necessary. The facility acts much like a corporate credit card, except that borrowers are
charged an annual commitment fee on unused amounts, which drives up the overall
cost of borrowing (the facility fee). In the U.S., many revolvers to speculative-grade
issuers are asset-based and thus tied to borrowing-base lending formulas that limit
borrowers to a certain percentage of collateral, most often receivables and inventory. In
Europe, revolvers are primarily designated to fund working capital or capital
expenditures (capex).

A term loan is simply an installment loan, such as a loan one would use to buy a car.
The borrower may draw on the loan during a short commitment period and repay it
based on either a scheduled series of repayments or a one-time lump-sum payment at
maturity (bullet payment). There are two principal types of term loans: an amortizing
term loan and an institutional term loan.

An amortizing term loan (A-term loan or TLA) is a term loan with a progressive
repayment schedule that typically runs six years or less. These loans are normally
syndicated to banks along with revolving credits as part of a larger syndication. In the
U.S., A-term loans have become increasingly rare over the years as issuers bypassed
the bank market and tapped institutional investors for all or most of their funded loans.

An institutional term loan (B-term, C-term or D-term loan) is a term-loan facility with a
portion carved out for nonbank, institutional investors. These loans became more
common as the institutional loan investor base grew in the U.S. and Europe. These
loans are priced higher than amortizing term loans because they have longer maturities
and bullet repayment schedules. This institutional category also includes second-
lien loans and covenant-lite loans.

What Does Euro Deposit Mean?

The equivalent of a money market rate on cash deposits made in the euro currency.
Euro deposit rates will usually be quoted as "money market euro deposit rates" and are
typically only offered to U.S. investors with minimum investments of greater than 10,000
euros. Euro deposits pay a floating interest rate (like a money market account) and offer
the chance for capital appreciation if the euro appreciates against the investor's home
currency (presumably the dollar). Euro deposit rates are based on the euro interbank
offer rate, which is set by the European Central Bank.

investopedia explains Euro Deposit

There has been increased investor demand for cash equivalents in currencies outside
of the U.S. dollar. If the dollar decreases in value compared to other currencies, there is
little recourse for the investor's loss of global purchasing power, but by holding a euro-
denominated asset, the investor can diversify some of his currency risk and possibly
reduce overall portfolio risk in the process.

There are two distinct types of euro deposit. The older of the two refers to a deposit of
foreign currency into a bank account outside the currency's home country; the deposit of
U.S. dollars into a bank account in London is one example. Since the 1999 introduction
of the euro currency, a euro deposit may also refer to a deposit of euros into a bank,
typically in a European Monetary System (EMS) member country, but not necessarily
so; a growing number of banks around the world offer deposit accounts in a range of
currencies, the euro prominent among them. Both types are usually made for fixed
terms, though this can range from one day — typically made only by corporations, large
investment firms, and other banks — to one year or more. Interest rates on both types
of euro deposits may be fixed for the term of the deposit, or floating, meaning the rate
will be reset periodically over the deposit's term.
Euro deposits
Surplus Euro funds can be safely and profitably invested, at a higher interest rate than
the one on sight deposits. You can also choose special-purpose deposits.
Who are they intended for?
All domestic legal entities and sole proprietors who want to manage cash flows
economically.
Main advantages
• stimulating interest rate,
• the possibility of making a deposit in a lump sum or in instalments over a certain
period,
• flexible maturity tailored to your needs.
Basic information
• maturity: from 3 days to 5 years,
• minimum deposited amount: EUR 250 (except for special-purpose deposits).

Versions of Euro deposits

• overnight deposits for municipalities,
• overnight deposits,
• non-special-purpose and special-purpose deposits up to 30 days,
• non-special-purpose and special-purpose deposits for more than 3 days with
notice period,
• non-special-purpose and special-purpose deposits for more than 30 days,
• special-purpose deposits.
Conditions, required documents
Funds may be deposited by any legal entity and sole proprietors, whether a customer of
the Bank or not. For concluding the agreement you need documentation providing
evidence of the status of a legal entity, your company identification number and tax
number.
Conclusion
All term deposits can be made in the Branches for companies and sole proprietors,
Business centres for corporate banking II, Treasury Department in the Branch for
trading with clients and organizational units of NLB. If you are NLB's customer, you can
arrange a term deposit with your customer relations officer.

What Does International Bond Mean?

Bonds that are issued in a country by a non-domestic entity. International bonds include
Eurobonds, foreign bonds and global bonds. An international bond is a type of long-
term debt security that is generally issued to an investor in a country by a non-domestic
entity. An international bond essentially works like a loan, with the investor being
the lender and the issuing entity being the borrower. International bonds can provide
bondholders with the ability to earn fixed interest payments for a set period of time. Most
international bonds have a face value, interest rate, and maturity date. Entities that
issue these types of bonds often do so in order to help finance property and equipment
purchases or to help fund current operations.

In general, the process of purchasing an international bond works like a regular bond
purchase. Typically, an investor purchases the international bond from an issuing
company, bank, or government for a set face value. The investor then earns interest
payments at periodic intervals until the bond reaches its maturity date. Once the bond
matures, the initial principal is paid back to the investor in full.

The international bond market includes global bonds, foreign bonds, Eurobonds, and
Brady bonds. Global bonds are offered in several countries simultaneously and can be
issued in the same currency as the country of issuance. Global bonds are typically
issued by international companies that possess high credit ratings. Foreign bonds are
issued by foreign entities and are denominated in the currency of the domestic market.
Examples of foreign bonds include Samurai bonds in Japan, Yankee bonds in the
United States, and Bulldog bonds in the United Kingdom.

A Eurobond is a type of international bond that is issued using currency that differs from
the domestic market country’s currency. Eurobonds are named according to the
currency in which they are denominated in. For example, a Euroyen bond is
denominated in Japanese yen.

Brady bonds are designed to help emerging market countries manage their international
debt. Brady bonds are issued by an emerging market country and denominated in U.S.
dollars. Brady bonds are generally backed by U.S. Treasury zero-coupon bonds.

International bond funds can provide investors with a way to diversify their investment
portfolios. An international bond fund is a type of fund that invests a percentage of its
assets, often 40% or greater, in international bonds. These funds generally hold
investment-grade bonds from countries that are politically stable and considered
developed countries. Investors that choose to place their money in an international fund
can realize income from the bond interest as well as from currency fluctuations

Euro bonds:

Investopedia explains Eurobond

Usually, a eurobond is issued by an international syndicate and categorized according
to the currency in which it is denominated. A eurodollar bond that is denominated in
U.S. dollars and issued in Japan by an Australian company would be an example of a
eurobond. The Australian company in this example could issue the eurodollar bond in
any country other than the U.S.

Eurobonds are attractive financing tools as they give issuers the flexibility to choose the
country in which to offer their bond according to the country's regulatory constraints.
They may also denominate their eurobond in their preferred currency. Eurobonds are
attractive to investors as they have small par values and high liquidity.

Features:

Conventional foreign bonds are much simpler than Eurobonds; generally, foreign bonds
are simply issued by a company in one country for purchase in another. Usually a
foreign bond is denominated in the currency of the intended market. For example, if a
Dutch company wished to raise funds through debt to investors in the United States, it
would issue foreign bonds (dollar-denominated) in the United States. By contrast,
Eurobonds usually are denominated in a currency other than the issuer's, but they are
intended for the broader international markets. An example would be a French
company issuing a dollar-denominated Eurobond that might be purchased in the United
Kingdom, Germany, Canada, and the United States.

Like many bonds, Eurobonds are usually fixed-rate, interest-bearing notes, although
many are also offered with floating rates and other variations. Most pay an annual
coupon and have maturities of three to seven years. They are also usually unsecured,
meaning that if the issuer were to go bankrupt, Eurobond holders would normally not
have the first claim to the defunct issuer's assets.

However, these generalizations should not obscure the fact that the terms of many
Eurobond issues are uniquely tailored to the issuers' and investors' needs, and can vary
in terms and form substantially. A large number of Eurobond transactions involve
elaborate swap deals in which two or more parties may exchange payments on parallel
or opposing debt issues to take advantage of arbitrage conditions or complementary
financial advantages (e.g., cheaper access to capital in a particular currency or funds at a
lower interest rate) that the various parties can offer one another.

Market composition:

The Eurobond market consists of several layers of participants. First there is the issuer,
or borrower, that needs to raise funds by selling bonds. The borrower, which could be a
bank, a business, an international organization, or a government, approaches a bank
and asks for help in issuing its bonds. This bank is known as the lead manager and may
ask other banks to join it to form a managing group that will negotiate the terms of the
bonds and manage issuing the bonds. The managing group will then sell the bonds to an
underwriter or directly to a selling group. The three levels—managers, underwriters, and
sellers—are known collectively as the syndicate. The underwriter will actually purchase
the bonds at a minimum price and assume the risk that it may not be possible to sell
them on the market at a higher price. The underwriter (or the managing group if there is
no underwriter) sells the bonds to a selling group that then places bonds with investors.
The syndicate companies and their investor clients are considered the primary market
for Eurobonds; once they are resold to general investors, the bonds enter the secondary
market. Participants in the market are organized under the International Primary
Market Association (IPMA) of London and the Zurich-based International Security
Market Association (ISMA).

After the bonds are issued, a bank acting as a principal paying agent has the
responsibility of collecting interest and principal from the borrower and disbursing the
interest to the investors. Often the paying agent will also act as fiscal agent, that is, on
the behalf of the borrower. If, however, a paying agent acts as a trustee, on behalf of the
investors, then there will also be a separate bank acting as fiscal agent on behalf of the
borrowers appointed.

In the secondary market, Eurobonds are traded over-the-counter. Major markets for
Eurobonds exist in London, Frankfurt, Zurich, and Amsterdam.

AMERICAN DEPOSITARY RECEIPTS AND GLOBAL DEPOSITORY

RECEIPTS :
AMERICAN DEPOSITARY RECEIPTS AND GLOBAL DEPOSITORY RECEIPTS
PRESENTED BY KIRTI GARG

ABOUT ADR… :
ABOUT ADR… ADRs first introduced in 1927. ADR is a security issued by a
company outside the U.S. which physically remains in the country of issue
,but usually in the custody of a bank, is traded on U.S. stock exchanges. For
the American public ADRs simplify investing. So when Americans purchase
Infy (the Infosys Technologies ADR) stocks listed on Nasdaq, they do so
directly in dollars, without converting them from rupees. ADR’s basically
used by Non Resident Indians (NRIs) and non-Indians for making investments
in India

American Depository Receipt :

American Depository Receipt Thus, ADR is a negotiable U.S. certificate
representing ownership of shares in an non-US corporation. ADR’s are
quoted and traded in U.S. Dollars in the US securities market. Also, the
dividends are paid to investor in US dollars. ADRs were specifically designed
to facilitate the purchase, holding and sale of non-US securities by US
investor, and to provide a corporate finance vehicle for non-US companies.
Domestic Stock Exchange SHARES U.S. AMERICA CERTIFICATE

Specimen Of ADR … :
Specimen Of ADR …

Global Depositor y reciepts :

Global Depositor y reciepts These are similar to the ADR but are usually
listed on exchanges outside the U.S., such as Luxembourg or London If the
depository receipt is traded in a country other than USA, it is called a Global
Depository Receipt, or a GDR. Thus GDR is a negotiable certificate held in the
bank of one country representing a specific number of shares of a stock
traded on an exchange of another country. To raise money in more than one
market, some corporations use global depositary receipts (GDRs) to sell their
stock on markets in countries other than the one where they have their
headquarters. The GDRs are issued in the currency of the country where the
stock is trading.

PROCESS OF ADR/GDR :
PROCESS OF ADR/GDR The company deposits a large number of its shares
with a bank located in the country where it wants to list indirectly. The bank
issues receipts against these shares, each receipt having a fixed number of
shares as an underlying (Usually 2 or 4). These receipts are then sold to the
people of this foreign country (and anyone who is allowed to buy shares in
that country). These receipts are listed on the stock exchanges. They behave
exactly like regular stocks – their prices fluctuate depending on their demand
and supply, and depending on the fundamentals of the underlying company.
These receipts, which are traded like ordinary stocks, are called Depository
Receipts. Each receipt amounts to a claim on the predefined number of
shares of that company. The issuing bank acts as a depository for these
shares – that is, it stores the shares on behalf of the receipt holders.

Process for ADR/GDR… :

Process for ADR/GDR… Releases Equity Shares Issue ADRs/GDRs Gives
Instructions to Issue ADRs/ GDRs Requests for buying ADR/GDR Requests the
bank to release of equity Shares
Some Major ADRs issued by Indian Companies :
Some Major ADRs issued by Indian Companies Among the Indian ADRs listed
on the US markets, are Infy (the Infosys Technologies ADR), WIT (the Wipro
ADR), Rdy(the Dr Reddy’s Lab ADR), and Say (the Satyam Computer ADS)

Some Major GDRs issued by Indian Companies :

Some Major GDRs issued by Indian Companies Dr. Reddys HDFC Bank
Hindalco ICICI Bank Infosys Technologies ITC L&T MTNL Ranbaxy
Laboratories State Bank of India VSNL WIPRO
Factors Influencing Foreign
Investment Decisions

Now that you understand the basic

economic reasons why companies
choose to invest in foreign markets,
and what forms that investment may
take, it is important to understand the
other factors that influence where and
why companies decide to invest
overseas. These other factors relate
not only to the overall economic
outlook for a country, but also to
economic policy decisions taken by foreign governments—aspects that can be very
political and controversial.

The policy frameworks relating to FDI and FPI are relatively similar, although there are a
few differences.

Direct investors tend to look at a number of factors relating to how they will be able to
operate in a foreign country:

• the rules and regulations pertaining to the entry and operations of foreign
investors
• standards of treatment of foreign affiliates, compared to "nationals" of the host
country
• the functioning and efficiency of local markets
• trade policy and privatization policy
• business facilitation measures, such as investment promotion, incentives,
improvements in amenities and other measures to reduce the cost of doing
business. For example, some countries set up special export processing zones,
which may be free of customs or duties, or offer special tax breaks for new
investors
• restrictions, if any, on bringing home ("re-patriating") earnings or profits in the
form of dividends, royalties, interest or other payments

The determinants of FPI are somewhat more complex, however. Because portfolio
investment earnings are more likely to be tied to the broader macroeconomic indicators
of a country, such as overall market capitalization of an economy, they can be more
sensitive to factors such as:

• high national economic growth rates

• exchange rate stability
• general macroeconomic stability
• levels of foreign exchange reserves held by the central bank
• general health of the foreign banking system
 • liquidity of the stock and bond market
• interest rates

In addition to these general economic indicators, portfolio investors also look at the
economic policy environment as well, and especially at factors such as:

• the ease of repatriating dividends and capital

• taxes on capital gains
• regulation of the stock and bond markets
• the quality of domestic accounting and disclosure systems
• the speed and reliability of dispute settlement systems
• the degree of protection of investor's right

Definitions and types of FDI

Foreign direct investment (FDI) is also called "direct foreign investment (DFI)", "direct
investment", or "foreign investment." It is an activity where foreigners come to your country to
set up and/or run a factory, hotel, farms, or other business enterprises. More precisely, here are
some definitions of FDI (my italic):

Definition #1: "Direct investment refers to investment that is made to acquire a lasting
interest in an enterprise operating in an economy other than that of the investor, the investor's
purpose being to have an effective voice in the management of the enterprise." [IMF Balance of
Payments Manual, 4th ed, 1977, p.136]

Definition #2: "The balance-of-payments accounts define direct investment as that part of
capital flows that represents a direct financial flow from a parent company to an overseas firm
that it controls." [E.M. Graham and P.R. Krugman, "The Surge in FDI in the 1980s"]

Definition #3: "Direct investment is intended to comprise investments involving a certain degree
of control (by the investor) over the use of the funds invested, whereas portfolio investment lacks
such control." [Rivera-Batiz & Rivera-Batiz, p.220)

It is clear from the above that FDI intends to "control" or, more mildly, "participate in" the
management of a business enterprise. Thus, my definition is:

Definition #4: FDI is an international financial flow with the intention of controlling or
participating in the management of an enterprise in a foreign country. [K Ohno]

FDI is contrasted to "portfolio investment" where there is no intention or interest to control an

enterprise. The purpose of portfolio investment is to get a good financial return as in the case of
investing in stocks, bonds, gold, art objects, etc.

Operationally, there are three types of FDI:

(1) Equity acquisition--buying shares of an existing or a newly created
enterprise
(2) Profit re-investment--FDI firms re-investing their profits for further
expansion
(3) Loans from a parent company

In additional terminology, if foreigners come to build an entirely new factory (rather than buying
an existing one), it is called greenfield-type FDI.

In addition to 100% foreign-owned firms, there are also "joint venture" (JV) firms where
foreigners and domestic partners set up a company together. The ratio of ownership
(shareholding) varies from company to company. In some countries there are restrictions on how
much foreigners are permitted to own (say, up to 49%). Ownership restriction may be imposed
on only certain "sensitive" sectors. In other countries, there is no such restriction and 100%
foreign ownership is acceptable.

Difficulty in measurement

While the theoretical definition of FDI is clear, in reality there are serious measurement
problems. For example,

(1) Whether a foreign investor has an intention to control or participate in

the management is not directly observable. In the Japanese and US balance-
of-payments statistics, investment is considered FDI if the foreign share is
10% or more; otherwise, it is classified as portfolio investment. Clearly, this
rule is a bit arbitrary.

(2) While a loan from the parent company is counted as FDI, a bank loan guaranteed by the
parent company is not. Again, this is an arbitrary distinction since the two loans would have
virtually the same economic effect.

(3) Whether the value of foreign investment is recorded at book value or at market value makes a
difference. The latter changes due to inflation/deflation and capital gain/loss.

(4) Statistics for commitment (approval or promise to invest) is easier to collect, but
actual implementation is more difficult to know.

General features

Here are some general features of global FDI flows:

(1) FDI is less volatile than portfolio investment or bank loans. In the 1997-98
Asian crisis, capital inflows in the form of short-term bank loans suddenly
reversed, but FDI did not leave the affected countries. In fact, FDI in the form
of mergers and acquisitions (M&A) rose sharply after the crisis, as foreigners
bought up local firms at low cost (i.e., at greatly depreciated exchange
rates).

(2) Generally speaking, FDI among developed countries is much greater than FDI from
developed to developing countries. FDI among developing countries is very small. The only
notable exception to this rule is China's huge absorption of FDI in recent years.

(3) Total FDI data includes mergers & acquisitions (M&A), setting up branch offices, service
FDI, energy and mineral extraction, and so on. Greenfield-type manufacturing FDI, most desired
by developing countries, is only a small part of FDI flows.

(4) Over time, popular destinations of FDI shift. From the viewpoint of Japan as a source
country, the most popular FDI destination in the 1970s was NIEs (Hong Kong, Singapore,
Korea, Taiwan). In the late 1980s it was ASEAN4 (especially Thailand and Malaysia). Since the
1990s to present, China has emerged as the most popular FDI destination in the entire developing
world.

(5) As far as Japanese companies are concerned, the main motive for investing in East Asia is the
pursuit of low cost and the building of regional production networks. However, the main motive
for investing in EU and NAFTA (US-Canada-Mexico) is market access. This includes producing
within a free trade area (FTA) or customs union so that tariff exemption and other benefits are
enjoyed.

Multinational capital budgeting

Capital budgeting
capital budgetingis the planning process used to determine whether afirm's long
term investmentssuch as new machinery, replacement machinery, new plants, new
products, and researchdevelopment projects are worth pursuing. It is budgetfor
major capital, or investment, expenditures.
Manyformal methods are used in capital budgeting, including the techniques such as
y
Accounting rate ofreturn
y
Net present value
y
Profitability index
y
Internal rate of return
y
Modified internal rate of return
y
Equivalent annuity
These methods use the incremental cashflowsfrom each potential investment, orpr
ojectTechniques based on accounting earnings and accounting rules are sometimes
used - thougheconomists consider this to be improper - such as the accounting rate
of return, and "return oninvestment." Simplified and hybrid methods are used as
well, such as payback period anddiscounted
payback period.
Multinational capital budgeting
Multinational corporations (MNCs) evaluate international projects by using
multinational capitalbudgeting, which compares the benefits and costs of these
projects. Multinational capital budgetinginvolves determining the projects net
present value by estimating the present value of the projects
future cash flows and subtracting the initial outlay required for the projects.
Some special
circumstances of international projects that affect thefuture cashflow or the
discount rate used to
discount cashflow make multinational capital budgeting more complex.
Why Multinational capital budgeting
Many international projects are irreversible and cannot be easily sold to other
corporations at a reasonable price
Proper use of multinational capital budgeting can identify the international
projects worthy of implementation.
It affects the profitability of afirm.
It effect over a long time spans and inevitably affects the companysfuture cost
structure.
Capital investment decision once made, are not easily reversible without much
financial loss of f irm
It involves cost and the majority of the firms have scarce capital sources.

10
Subsidiary versus Parent Perspective
Multinational capital budgeting can be conducted from two perspective:

• Parents perspective
 • Subsidiary perspective
Thefeasibility of the capital budgeting analysis can vary with the perspective
because the net after-tax cash inflows to the subsidiary can differ
substantiallyfrom those to the parent. Such differencescan be due to
severalfactors, some of which are pointed here:

• Tax differentials

• Restricted remittances

• Excessive remittances

• Exchange rate movement

he parent perspective isappropriate in attempting to determine whether a project

will enhancethefirms value.Any project that create a positive net present
valuefor the parent should enhanceshareholder wealth.
One exception to the rule of using a parents perspective occurs when theforeign
subsidiary is notwholly owned by the parent and theforeign project is
partiallyfinanced with retained earnings ofthe parent and of theforeign subsidiary.
In this case the goal is to make decisions in the interests ofboth groups
of shareholders and not to transfer wealthfrom one entity to another.
throughout our report wefocused deeply on parents perspective.
Input for multinational capital budgeting
1. Initial investment:
Funds initially invested in a project may include not only whatever is necessary to
start theproject but also additionalfunds, such as working capital to support the
project over time.Because cash inflows will not always be sufficient to cover
upcoming cash outflows, workingcapital is needed t
Price and consumer demand:
The estimated price and demand schedules during each of the year.
3. Costs:
The variable costs(for material, labor,etc per unit have been estimated and
consolidated.
4. Tax laws:
Bangladesh government imposes a 20% tax rate on income, in addition it will impose
a 10%
withholding tax on anyfunds remitted by the subsidiary.
5. Remitted funds:
The subsidiary company sends back all the net cashflows to the parent at the end
of the year.
6. Exchange rates:
The spot exchange rate of usdollar is 69.15 . subsidiary uses this exchange rate as
its best

forecast of that will be exist in future.

7.Salvage (liquidation value):
Government will pay some amount of dollarfor the sale of subsidiary to the parent.
8.Required rate of return:
Subsidiary requires a 17% return on this project.

12
Factors to consider in multinational capital budgeting
y
Exchange rate fluctuation
The exchange rate typically change over time.
y
Inflation
In this country inflation is increasing over time. It si considered in multinational
capital
budgeting.
y
Financing arrangement
Manyforeign projects are partiallyfinanced byforeign subsidiaries.
Thisforeignfinancing
influences thefeasibility of a project.
y
Blocked funds
The host country may blockfund that the subsidiary attempts to send to the
parent.
y
Uncertain salvage value
When the salvage value is uncertain, the MNC may incorporate various possible
outcomesfor
the salvage value and estimate the NP based on each possible outcome.
y
Impact of project on prevailing cash flow
The new project has no impact on prevailing cashflows.
y
Host government incentives
Foreign project proposed by MNCs may have afavorable impact on economic
conditions in the
host country and are therefore encouraged by the host government.
y
Real option
A real option is an option on specified real asset such as machinery or a facility.
Some capital
budgeting projects contain real options in that they may allow opportunities to
obtain or
eliminate real assets.