Interbank deals refer to purchase and sale of foreign exchange between the banks. In other words it refers to the foreign exchange dealings of a bank in the interbank market. The main features of interbank deals are given in this section. 1. Cover Deals Purchase and sale of foreign currency in the market undertaken to acquire or dispose of foreign exchange required or acquired as a consequence of the dealings with its customers is known as the ‘cover deal’. The purpose of cover deal is to insure the bank against any fluctuation in the exchange rates. Since the foreign currency is a peculiar commodity with wide fluctuations in price, the bank would like to sell immediately whatever it purchases and whenever it sells it goes to the market and makes an immediate purchase to meet its commitment. In other words, the bank would like to keep its stock of foreign Continue reading
International Finance
International finance is the branch of economics that studies the dynamics of foreign exchange,foreign direct investment and how these affect international trade. Also studies the international projects, international investment and the international capital flow .International Finance can be broadly defined, as the study of the financial decisions taken by a multinational corporation in the area of international business i.e. global corporate finance. International finance draws much of its background from the preliminary studies in the topics of corporate finance such as capital budgeting, portfolio theory and cost of capital but now viewed in the international dimension.
Trends in International Trade and Cross Border Financial Flows
When a firm operates only in the domestic market, both for procuring inputs as well as selling its output, it needs to deal only in the domestic currency. As companies try to increase their international presence, either by undertaking international trade or by establishing operations in foreign countries, they start dealing with people and firms in various nations. Since different countries have different domestic currencies, the question arises as to which currency should the trade be settled in. The settlement currency may either be the domestic currency of one of the parties to the trade, or may be an internationally accepted currency. This gives rise to the problem of dealing with a number of currencies. The mechanism by which the exchange rate between these currencies (i.e., the value of one currency in terms of another) is determined, along with the level and the variability of the exchange rates can have Continue reading
Advantages of Fixed Exchange Rate System
A nation’s choice as to which currency regime to follow reflects national priorities about all factors of the economy, including inflation, unemployment, interest rate levels, trade balances, and economic growth. The choice between fixed and flexible exchange rates may change over time as priorities change. Read More: Fixed Exchange Rate System Flexible Exchange Rate System At the risk of over-generalizing, the following points partly explain why countries pursue certain exchange rate regimes. They are based on the premise that, other things being equal, countries would prefer fixed exchanges rates. Fixed exchange rates provide stability in international prices for the conduct of trade. Stable prices aid in the growth of international trade lessens risks for all businesses. Fixed exchange rate system reduces the possibility of competitive depreciation of currencies, as it happened during the 1930s. Also, deviation from the fixed rates is easily adjustable. Fixed exchange rate provides stability in the Continue reading
Role of FEDAI in Foreign Exchange
Authorized Dealers in Foreign Exchange (Ads) have formed an association called Foreign Exchange Dealers Association of India (FEDAI) in order to lay down certain terms and conditions for transactions in Foreign Exchange Business. Ad has to given an undertaking to Reserve Bank of India to abide by the exchange control and other terms and conditions introduced by the association for transactions in foreign exchange business. Accordingly FEDAI has evolved various rules for various transactions in order to protect the interest of the exporters, importers general public and also the authorized in dealers. FEDAI which is a company registered under Section 25 of the companies Act, 1956 has subscribed to the 1. Uniform customs and practice for documentary credits (UCPDC) 2. Uniform rules for collections(URC) 3. Uniform rules for bank to bank reimbursement. Various rules of FEDAI Rules No 1. of FEDAI deals with hours of business of banks which is Continue reading
Interest Rate Swaps
The basic structure of an interest rate swap consists of the exchange between two counter-parties of fixed rate interest or floating rate interest in the same currency calculated by reference to a mutually agreed notional principal amount. This principal amount, which would normally equate to the underlying assets or liabilities being “swapped” by the counter-parties, is applicable solely for the calculation of the interest to be exchanged under the swap. At no time it is physically passed between the counter-parties. The counter-parties are able to convert an underlying fixed rate asset/ liability and vice-versa, through this straight forward swap structure. The majority of the interest rate swap transactions are driven by the cost savings to be obtained by each of the counter-parties. These cost savings are substantial and result from differentials in the credit standing of the counter-parties and other structural considerations. Generally investors in fixed rate instruments are more Continue reading
Purchasing Power Parity (PPP) Theory of Exchange Rate
Purchasing Power Parity Theory (PPP) holds that the exchange rate between two currencies is determined by the relative purchasing power as reflected in the price levels expressed in domestic currencies in the two countries concerned. Changes in the exchange rate are explained by relative changes in the purchasing power of the currencies caused by inflation in the respective countries. The concept of Purchasing power parity theory (PPP) is traced to David Ricardo, but the credit for stating the law in an orderly manner is given to the Swedish economist Gustav Cassel who proposed it in 1918 as a basis for resumption for normal trade relations at the end of First World War. The Purchasing Power Parity Theory is stated in two versions : The stronger absolute version of Purchasing Power Parity, and The diluted relative version of Purchasing Power Parity. Absolute Version of Purchasing Power Parity The absolute version of Continue reading