Swap contracts can be arranged across currencies. Such contracts are known as currency swaps and can help manage both interest rate and exchange rate risk. Many financial institutions count the arranging of swaps, both domestic and foreign currency, as an important line of business. This method is virtually cheaper than covering by way of forward options. Technically, a currency swap is an exchange of debt service obligations denominated in one currency for the service in an agreed upon principal amount of debt denominated in another currency. By swapping their future cash flow obligations, the counterparties are able to replace cash flows denominated in one currency with cash flows in a more desired currency. A ‘swap deal’ is a transaction in which the bank buys and sells the specified foreign currency simultaneously for different maturities. Thus a swap deal may involve: simultaneous purchase of spot and sale of forward or vice 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.
Some terms and concepts related to foreign exchange market
1 & 2. Exposure and Risk: Exposure is a measure of the sensitivity of the value of a financial item (asset, liability or cash flow) to changes in the relevant risk factor while risk is a measure of variability of the value of the item attributable to the risk factor. Let us understand this distinction clearly. April 1993 to about July 1995 the exchange rate between rupee and US dollar was almost rock steady. Consider a firm whose business involved both exports to and imports from the US. During this period the firm would have readily agreed that its operating cash flows were very sensitive to the rupee-dollar exchange rate, i.e.; it had significant exposure to this exchange rate; at the same time it would have said that it didn’t perceive significant risk on this account because given the stability of the rupee-dollar fluctuations would have been perceived to be Continue reading
Reasons for Divergences Between De facto and De jure Exchange Rate Policies
The first reason for the divergences between de facto and de jure exchange rate policies is that, de facto exchange rate stability is just an incidental side effect of a monetary policy strategy in which the exchange rate is only one of the many variables that the central bank monitors and reacts to. This is as; whatever decision of the authorities of the country that is being made in turn will have an effect on the pricing of its goods and services, economic wellbeing of the country and also its exchange rate. The second reason to it is that, the central bank thinks that the economy will occasionally be affected by idiosyncratic shocks that will require significant exchange rate adjustments. This means that the central bank does not want the exchange rate to be tied by a previous commitment that might make the adjustments more difficult to be carried out. Continue reading
Global Scenario of Exchange Rate Arrangements
Firms engaged in international business must have an idea about the exchange rate arrangement prevailing in different countries as this will facilitate their financial decisions. In this context, it can be said that over a couple of decades, the choice of the member countries has been found shifting from one form of exchange rate arrangement to the other, but, on the whole, preference for the floating rate regime is quite evident. At present as many as 35 of a total of 187 countries have an independent float, while the other 51 countries have managed floating system. The other 7 countries have a crawling peg, while 53 countries have pegs of different kinds. The EMU and other 20 countries of Africa and the Caribbean region come under some kind of economic and monetary integration scheme in which they have a common currency. Lastly, nine countries do not have their own currency Continue reading
The Current Account Component in Balance of Payments (BoP)
The Current Account Component The Current Account records a nation’s total exports of goods, services and transfers, and its total imports of them. The current account is subdivided into two components (1) balance of trade (BoT), and (2) balance of invisibles (BOIs). Structure of Current Account in India’s BOP Statement A. CURRENT ACCOUNT I. Merchandise (BOT): Trade Balance (A-B) A. Exports, f.o.b. B. Imports, c.i.f. II. Invisibles (BOI): (a + b + c) a. Services i. Travel ii. Transportation iii. Insurance iv. Govt. not elsewhere classified v. Miscellaneous b. Transfers i. Official ii. Private c. Income i. Investment Income ii. Compensation to employees Total Current Account = I + II 1. Balance of Trade (BoT) Balance of payments refers the difference between merchandise exports and merchandise imports of a country. BOT is also known as “general merchandise”, which covers transactions of movable goods with changes of ownership between residents and Continue reading
The Capital Account component in Balance of Payments (BoP)
Capital account records public and private investment, and lending activities. It is the net change in foreign ownership of domestic assets. If foreign ownership of domestic assets has increased more quickly than domestic ownership of foreign assets in a given year, then the domestic country has a capital account surplus. On the other hand, if domestic ownership of foreign assets has increased more quickly than foreign ownership of domestic assets in a given year, then the domestic country has a capital account deficit. It is known as “financial account”. IMF manual lists out a large number of items under the capital account. But India, and many other countries, has merged the accounting classification to fit into its own institutional structure and analytical needs. Until the end of the 1980s, key sectors listed out under the capital account were: (i) private capital, (ii) banking capital, and (iii) official capital. Private capital Continue reading