CHAPTER 1 NATURE AND SCOPE OF INTERNATIONAL FINANCE
1
Course Overview: T"eor& o0 Trade
'NC
3o%d Standard
'onetar& Union
Understanding E!"ange Rate Regi#es E!"ange Rate Regi#es
Curren!& Crisis
Fied vs$ F%oating
'a!ro(E!ono#i! Deter#inants
Laws -inding S*ot Rates
'ar)et T&*es T&*es
Finan!ia% 'ar)et Stru!ture Instru#ents
P%a&ers + Organi,ation -onds
Forward s
E!"ange Rate -e"avior PPP. CIPC Fis"er E/n$
I#*%i!ations 0or 0uture rates
F Derivatives and Use in Hedging Futures. O*tions. Swa*s
Strengt"s + 2ea)nesses
F Ris) T&*es and Hedging Li#itations A%ternative Hedging Te!"ni/ues Netting. Counter(tr C ounter(trade. ade. Trans0er Pri!ing4
Transa!tion Ris) O*erating Ris) Trans%ation Tr ans%ation Ris) Ris )
Li#itations
Other FX Management Issues
2
Course Overview: T"eor& o0 Trade
'NC
3o%d Standard
'onetar& Union
Understanding E!"ange Rate Regi#es E!"ange Rate Regi#es
Curren!& Crisis
Fied vs$ F%oating
'a!ro(E!ono#i! Deter#inants
Laws -inding S*ot Rates
'ar)et T&*es T&*es
Finan!ia% 'ar)et Stru!ture Instru#ents
P%a&ers + Organi,ation -onds
Forward s
E!"ange Rate -e"avior PPP. CIPC Fis"er E/n$
I#*%i!ations 0or 0uture rates
F Derivatives and Use in Hedging Futures. O*tions. Swa*s
Strengt"s + 2ea)nesses
F Ris) T&*es and Hedging Li#itations A%ternative Hedging Te!"ni/ues Netting. Counter(tr C ounter(trade. ade. Trans0er Pri!ing4
Transa!tion Ris) O*erating Ris) Trans%ation Tr ans%ation Ris) Ris )
Li#itations
Other FX Management Issues
2
Introduction: 1. Inte Intern rnat atio ional nal Fina Finance nce a. Corporate Corporate Finance Finance for for managem management ent of internatio international nal investm investments ents b. More than just corporate finance with exchange rates: Currenc !is"# uncertainty uncertainty surrounding future exchange rates • !is" from non-financial factors such as nationalization$ failure to • enforce patent & copyright laws$ foreign legal risks Capital %arriers and &ifferential 'axes • Financial hedges (&erivatives) to reduce currenc ris" • *ricing structures to reduce taxes or circumvent capital controls • 2or%d(wide a%ternatives for raising+emploing capital •
2. Multin Multinati ational onal Corpor Corporati ations ons (M,C (M,C)) a. Firm that has producti production on and sales in more more than than one countr. countr. b. *ermits efficient distribution distribution of manufacturing and has access to a broader customer base. c. Is able able to shift shift both both production production and and sales activitie activitiess in response response to to mar"et mar"et shifts. d. More than than -$ -$ M,C/s M,C/s world world wide producing producing 20 of of global global output output e. % countr countr of origin: origin: 3$ 4apan$ France$ France$ 5erman 5erman$$ and 6 have have the largest M,C/s. f. 7ver 188/ 188/ss F&I b grew grew at 9 times times the the growth growth rate of of internati international onal trade trade g. xamples: xamples: 5$ xxon$ xxon$ 3hell$ 3hell$ Ford$ 'o 'oota$ ota$ &aimle &aimler;Ch r;Chrsl rsler$ er$ etc. etc.
9. Mar" Mar"et et Im Impe perf rfect ectio ions ns a. M,C/s M,C/s exist exist to ta"e ta"e advantage advantage of mar"et mar"et imperfect imperfections: ions: Minimi
?' >?' (reduces taxes on exports)
b. ?dditional !is"s: Future Foreign xchange rate uncertaint • *olitical (e.g. nationali
9
A. WHY COUNTRIES TRADE : 'heor of Comparative ?dvantage#countries should speciali
Without Trad
Ri0%es
Co#*uter s
e
9$
0$ 566.666
766.666
---$-- 888.889
0$ 20$ 766.666
Austr a%ia Singa*ore Tota%:
With Trade
Austra%ia Singa*ore Tota%:
0. vents+'rends leading to 5lobali
A
• •
Increases production efficienc b as much 2 (more) *rovides fore"! !ves$'e!$ oppor$#!$es
0
Gistor of the International Monetar 3stem: 1. %imetallism+5old 3tandard a. 7riginall coinage in silver and gold b. -i#eta%%is# 0e%% out o0 0avor and 3o%d Standard !reated (where notes were acked y a certain ratio of gold ) c. !uspended y most nations in "#"$ (HH I) d. !estored in 182B$ but dro**ed & #ost e!ono#ies in 1;71(78 because of inabilit to control gold outflows during financial crises.
2. &rawbac"s of 5old 3tandard a. Fixed amount of gold#Currenc does not grow with econom b. @eads to deflation in growing economies c. xchange rates fixed: i. *rices of goods must adjust to compensate for trade imbalances ii. *roblem is that prices are stic". 3tic" prices in a deflationar econom result in lower demand levels and thus$ #!e'plo('e!$ 6 K M3 L *rices L
6 has a trade deficit with France
5old 'ransferred
France French M3
%ecause of rising prices in France$ trade imbalance disappears.
*rices
9. %retton Hoods (18AA)#the last 5old 3tandard: a. !einstituted 5old 3tandard b. *egged the 3 dollar at 90+o<. gold# %! would hold worlds gold c. 7ther ce!$rl )!*s $o +old US dollr s reserve c#rre!c( in lieu of gold d. xchange rates fixed against 3 dollar e. Pro%e# # 0ied a#ount o0 go%d when growing economies reJuire increasing currenc reserves i. Increasing !eserves devl#es $+e US dollr against gold ii. %ecause of fixed exchange rates$ the 'ollar ecomes over-valued in terms of the other currencies (Fran"$ &eutschmar"$ *ound) f. In late -/s and earl /s$ 3 government loosened monetar polic to pa for >ietnam conflict i. Foreign !entra% an)s 0or!ed to *ur!"ase excess US do%%ars to maintain fixed rate parities ii. Expor$ed !fl$o! to other nations t"roug" 0ied e!"ange rates g. ?ttempted to salvage sstem b revaluing dollar to 9B+o<. (3mithsonian) h. 3stem collapsed to floating rates (189)
-
A. Flexib Flexible le xchang xchangee !ates !ates (*rese (*resent nt 3ste 3stem) m) a. Floa Floati ting ng rate ratess tha thatt are are supply(demand ased b. Central ban"s may intervene to calm transient disturbances (e.g. 8+11) c. )old officially aandon as reserve asset #currenc now represents a claim on the econom d. &rawbac"s: i. 5rea 5reate terr exc excha hange nge rate rate vol$l$( ii. U!cer$!$( surrounding the future exchange rate#interferes with financial planning e. @o @ouv uvre re ?cc ?ccor ord d (18B (18B) ) i. Coordinatio Coordination n among 5; 5; countries countries to coordi coordinate nate monetar monetar polici policies es to achieve greater exchange rate stabilit ii. @ouvre @ouvre ?ccor ?ccord d is is de;f de;fact acto o a '!"ed,flo$ rr!"e'e!$ 0. xchan xchange ge !ate !ate ?rran ?rrangem gement ents: s: a. &oll &ollar ari< i
+o Freedom to conduct conduct Monetary *olicy
,omplete Freedom to conduct Monetary *olicy
-. and and the the uro uropean pean Mon Moneta etar r 3s 3stem tem a. 7riginall 7riginall - nations nations$$ now 2 (Croat (Croatia$ ia$ Macedonia Macedonia$$ 'ur"e 'ur"e are are candidates) candidates) b. *urpose: facilitate trade and labor flows$ and economic development c. Creates Creates a Common Common Mar"et Mar"et exceedi exceeding ng the population population of the the 3 d. ffe ffect ctiv ivel el crea create tess a U!$ed S$$es ! E#rope with: ; ase ase of cros cross; s;bor borde derr tra trans nsact actio ions ns ; ?bil ?bilit it of of lab labor or to mo move ve wher wheree nee neede ded d . Intr Introdu oduct ctio ion n of the the ! !7 7 a. Common Common currenc currenc binding binding 10 10 nations nations (,ot (,ot all members members use the the !7$ notabl 6$ 3weden$ and &enmar") b. Facilitates Cross;border 'ransactions 'ransactions and Investment b eliminating exchange rate ris" c. Consis Consisten tentt Monetar Monetar and and Fiscal Fiscal *olic *olic for memb members ers d. Compete Compete as a !eserve !eserve Currenc#cre Currenc#creates ates currenc currenc stabili stabilit t e. Countries Countries wishing wishing to to adopt the the uro must must meet meet Nconvergen Nconvergence ce criteriaO: criteriaO: i. &efi &efici cits ts and *ubl *ublic ic &eb &ebtt ii. *rice *rice 3tabil 3tabilit it (Infla (Inflatio tion) n) iii. 6eep individu individual al currencies currencies within within prescribed prescribed exchange exchange rate rate bands bands f. uropea uropean n Centra Centrall %an" %an" sole solel l resp respons onsibl iblee for of monetary policy$ ,ational Central %an"s in each countr behave li"e regional F&/s
?ppreciation of the uro:
*acific FD *lot P 28 b *rof. Herner ?ntweiler$ niversit of %ritish Columbia$ >ancouver %C$ Canada
B. %ene %enefi fits ts of of Monet Monetar ar nio nion n a. Facilitate Facilitate Cross;borde Cross;borderr 'rans 'ransacti actions ons and and Investm Investment ent i. liminate liminate exchange exchange rate rate ris" ris" and need for for forecas forecasting ting ii. *ermit *ermit %usiness %usiness &ecisi &ecisions ons to be be made solel solel on on economic economic grounds grounds iii. iii. Increa Increase se *rice *rice Compet Competiti ition on iv. iv. limin liminate ate costs costs of curre currenc nc exchan exchange ge b. %enefits of a Major !eserve Currenc i. 3tab 3table le excha exchang ngee val value ue ii. Major Major hold holding ingss in in Centr Central al %an" %an"ss iii. iii. 3impli 3implif f exchange exchange with with 3 and other other countr countries ies iv. iv. Facilit Facilitate ate Capital Capital Mar"et Mar"et &evelop &evelopmen mentt for all memers
8. &rawbac"s a. @imitatio @imitations ns on Fiscal Fiscal *olic *olic for member member nations nations (deficit (deficit spendin spending) g) b. ,o abilit to use Monetar *olic c. xample: xample: France France has 1 unemploment unemploment$$ it cannot cannot use stimul stimulative ative fiscal fiscal or monetar polic d. Free Free flow flow of labo laborr ma ma not corr correct ect prob problem lem
B
%alance of *aments#,et &emand for a Currenc: 1. %alance %alance of *ament *amentss a. ,et &iff &ifference erence between between the 3uppl and &emand &emand for a Currenc Currenc b. %7* Q for a floating floating rate regime (wh) !ates adjust so that !upply .uals 'emand • 'he currenc in &emand ?ppreciates vs. the other currenc • c. nder nder Fixed Fixed !ates !ates a &efici &eficitt or 3urplu 3urpluss can persi persist st through borrowing or 'eficits must e financed through • /he central ank will hemorrhage currenc • d. %7* Q Current Current ?cco ?ccount unt R Capita Capitall ?cco ?ccount unt 11. Current Current ?ccount ?ccount a. xport xportss S Impo Import rtss (,et (,et xpo xports rts or ,D) ,D) b. !eflects imbalances in 'rade 'rade c. For instance instance if if the 3 imports imports 2 milli million on in goods$ goods$ and exports exports 1- million$ it has a trade deficit of A million (a negative n egative balance) 12. Capital Capital ?ccount ?ccount a. Capita Capitall Inflo Inflows ws S Capita Capitall 7utfl 7utflows ows b. Capital Inflows are investment from foreign foreign entities sed to purchase factories0 real property0 • property0 and other productive productive resources Composed of 'irect and and *ortfolio Investment • c. ? posi positi tive ve bal balan ance ce:: More capital is entering the the countr than leaving • • -ore"! !ves$ors re p#rc+s!" 'ore of o#r prod#c$ve reso#rces than we are purchasing of theirs 19. Implicati Implications ons of a 'rade 'rade &eficit &eficit a. x xpo port rtss T Im Impo port rtss < Current ?ccount T b. 3ince %7* Q $ then Capital ?ccount ?ccount U c. 'hus: i. He are selling selling our product productive ive resources resources to to pa for consumpt consumption ion of foreign goods ii. 3ellin 3elling g our futu future re to cons consume ume in in the prese present nt d. /his will eventually lead to a currency depreciation #currentl occurring e. &eviation &eviation from from this rule is when we are are selling selling over;v over;valued alued asset assets#e.g. s#e.g. 4apanese purchase of real;estate in 18B/s
8
%udget &eficits and Implications for Currenc >alue (xchange !ates): 1A. xcessive 5overnment 3pending a. 5overnments finance spending via two means#taxes and debt b. 'eficit !pending means that !pending exceeds /ax 1evenues$ or we must issue debt to finance spending c. ,ote#it does not matter what the spending is forV e.g. 3ocial *rograms$ Medicare$ ducation$ Infrastructure$ Militar$ Har$ Catastrophic vents d. 'o attract purchasers for our debt$ we must increase 'reasur rates#this can result in an immediate appreciation of the currenc e. Gowever$ over the long;run$ higher interest rates mean higher inflation# o#r c#rre!c( devl#es f. Moreover$ to continue deficit spending$ &e &ll +ve $o co!$!#e rs!" !$eres$ r$es W currenc will continue to depreciate 5raphic Model: *rices
?& Q CR5RIR,D
?3 Q f(I(r)$ @)
C#Consumption 5#5overnment I#Capital investment ,D#,et xports @#Cost of labor
!eal 5&*
If 5overnment Increases 3pending: 5 *rices
?&
?3
5 means ?& shifts out 5&* and *rices *rices means inflation$ therefore currenc ultimatel depreciates
!eal 5&*
Crowding out of Investment:
1
Interest !ates (r) ?s 5overnment borrows more mone$ interest rates rise and capital investment falls
*rices ?&
Capital Investment (I)
?3 %ecause of declining investment$ and increasing wages$ ?3 shifts bac"ward.
!eal 5&*
Crowding out of ,et xports: *rices
?&
?3 ,D and Investment Falls as *rices !ise$ thus ?& also gets shoved bac"ward. 'he result is higher prices than we started with (inflation)$ higher wage rates$ and less investment (economic growth)
!eal 5&*
10. Hhat if foreign investors cease buing our debt a. 'reasur rates s"roc"et W Interest rates s" roc"et b. Capital Investment collapses c. 'he currenc plummets d. ,ote: there is a inding relationship between the current spot$ a countr/s ris";free rate ('reasur rate for the .3.)$ and expected future spot (also "nown as the forward)
conomic 3hoc"s: 1-. conomic 3hoc"s a. Can ma"e a countr richer or poorer b. Improve or reduce productivit c. ,egative 3hoc"s such as the destruction of a major oil field$ will reduce a countr/s exports$ its productivit$ and reduce its productive capacit d. Gence$ demand for its currenc will fall$ and $+e c#rre!c( &ll deprec$e
11
*rices
?&
?3 ffect of a negative suppl shoc"$ reduces productive capacit and results in higher prices.
!eal 5&*
&epreciation: 1. Hhat causes a currenc to &epreciate a. Persistent Trade De0i!its will cause a depreciation b. Foreign -orrowing to finance 5overnment &eficit 3pending c. 'a=or Negative E!ono#i! S"o!)s redu!ing *rodu!tive !a*a!it& #e.g. 8+11$ Gurricane 6atrina
1B. Mexico 4anuar 1880 a. Facts A &evaluation against 3 dollar • @oss of 9 %illion in Foreign !eserves • • Financial %ail;out *ac"age • Cr&l!" .!d ( Pe" ) arrangement#essentiall fixed exchange rates b. Mexico losing reserves$ wh • *olitical assassinations and *erceived *olitical Instabilit • Huge ear%& in0%u of foreign investment f!!c!" co!s#'p$o! c. &e;regulation of %an"s S Xero reserve reJuirement+as Credit *olicies xcessive incentives to lend • @ending increasing lower credit borrowers (high defaults) • d. 3hort term management of government debt %egan issuing bonds in &enominated in 3 dollars (dangerous) • @owered interest rates$ but resulted in s"roc"eting debt when • *eso devalued e. 'he result for the Mexican econom was a massive recession 18. ?sian crisis 188;8B a. 'hailand#Indonesia#6orea#Malasia#*hilippines 'hai %aht devalues 2$ 4ul 188 (A b &ecember) • 7ther currencies follow$ !upiah devalues b B • b. Hhat was the cause of the crisis
12
• • • • • •
Gigh levels of foreign currenc debt b firms and governments xcessive government spending xcessive investment beond economicall justified levels @ac" of a Credit Culture at ban"s *olitical lending decisions -xed exc+!"e r$es
c. &evaluation meant financial disaster >alue of foreign denominated debt s" roc"ets • Flight of investment capital • • 3"roc"eting unemploment 2. 7ther Financial Crises# Co##on Co#*onents (T+e ." Pc$#re ) a. -xed r$e arrangements have been a feature in most crisis b. Excessve "over!'e!$ spe!d!" #blossoming government debt c. /r"e A'o#!$s of -ore"! C#rre!c( De)$ #exacerbates crises d2 IMF typically provides a ailout package e. %raariable !ate$ and ,egative ?morti
19
•
• •
'he !esult: %urgeoning Federal &eficits$ exhausting access to world credit &eprives the 3 of Credit to recapitali
d. xcessive Consumerism and as Credit 3trengthening of %an"ruptc @aws combined elimination of • sur @aws has resulted in increased credit card issuance • @i"ewise$ the 3 consumer has become increasing predisposed to living on credit !esult is a negative savings rate$ again reducing the countr/s • potential credit reserve • ?nd$ exacerbates the real;estate crises because of insufficient household savings to ma"e mortgage paments if laid off
e. 'he 3toc" Mar"et#'he Horld/s ,ewest Casino • 3toc" Mar"et trades increasingl characteri
f. &ecline of 3 Manufacturing %ase 3 has ceded much of its manufacturing base to China$ India$ • and several developing countries !esult of economic speciali
1A
g. Contagion to Foreign Mar"ets#wh did it spread 6+urope had its own real;estate crises • Foreign institutions held large Juantities of 3 CM7/s • 'he 3 is the chief export mar"et for ?sia and man developing • nations
CG?*'! 2 F7!I5, DCG?,5 M?!6'
FOREI3N ECHAN3E 'AR>ET AN O?ER?IE2:
In toda/s world no econom is self sufficient$ so there is need for exchange of goods and services amongst the different countries. 3o in this global village$ unli"e in the ancient age the exchange of goods and services is no longer carried out on barter basis. ver sovereign countr in the world has a currenc that is legal tender in its territor and this currenc does not act as mone outside its boundaries. 3o whenever a countr bus or sells goods and services from or to another countr$ the residents of two countries have to exchange currencies. 3o we can imagine that if all countries have the same currenc then there is no need for foreign exchange. 'he Foreign 'rading Mar"et is regarded as the biggest financial mar"et. It is this mar"et that is responsible for the trading of currencies. >er large amounts of currenc are traded b large organi
10
the biggest institutions as was the case in previous ears. ,owadas$ smaller enterprises also ta"e advantage of the foreign exchange mar"et. In fact there are man people who use this mar"et because it has the potential to ield good profits. 'his has become apparent to thousands of individuals who are ta"ing part in the buing and selling of currencies. %ut it is alwas a good idea to have as much bac"ground information as possible in order to ma"e informed decisions. verbod wants to be successful. 'he foreign exchange mar"et one that is uniJue. 'his is a mar"et that has an enormous diversit of traders situated around the globe. 'he foreign exchange mar"et is uniJue because of following: •
trading volume results in mar"et liJuidit
•
geographical dispersion
•
continuous operation: 2A hours a da except wee"ends$ i.e. trading from 2:10 'C on 3unda until 22: 'C Frida
•
the variet of factors that affect exchange rate
•
the low margins of relative profit compared with other mar"ets of fixed income
•
the use of leverage to enhance profit margins with respect to account si
,& F7! F7!I5, DCG?,5: @et us consider a case: Hhere Indian compan exports cotton fabrics to 3? and invoices the goods in 3 dollar. 'he ?merican importer will pa the amount in 3 dollar$ as the same is his home currenc.
xports Cotton Fabrics xporter
Importer
1-
3?
Indian
Co.
3
Gowever the Indian exporter reJuires rupees means his home currenc for procuring raw materials and for pament to the labor charges etc. 'hus he would need exchanging 3 dollar for rupee. If the Indian exporters invoice their goods in rupees$ then importer in 3? will get his dollar converted in rupee and pa the exporter.
xports
convert 3?
!s.
Indian Co.
x orter is aid in !s.
From the above example we can infer that in case goods are bought or sold outside the countr$ exchange of currenc is necessar. 3ometimes it also happens that the transactions between two countries will be settled in the currenc of third countr. In that case both the countries that are transacting will reJuire converting their respective currencies in the currenc of third countr. For that also the foreign exchange is reJuired. 7>!;'G;C7,'! '!?&I,5:
1
Foreign exchange mar"et there is no for mar"et place called the foreign exchange mar"et. It is mechanism through which one countr/s currenc can be exchange i.e. bought or sold for the currenc of another countr. 'he foreign exchange mar"et does not have an geographic location. Foreign exchange mar"et is described as an 7'C (over the counter) mar"et as there is no phsical place where the participants meet to execute the deals$ as we see in the case of stoc" exchange. 'he largest foreign exchange mar"et is in @ondon$ followed b the ,ew Eor"$ 'o"o$ Xurich and Fran"furt. 'he mar"et is situated throughout the different time
1B
7'C *!7&C' *!MI''& I, I,&I? 7'C &!I>?'I>3
I,'!3' !?' &!I>?'I>3
F7!H?!& !?' ?5!M,'
I,'!3' !?' 3H?*3
F7!I5, C!!,CE &!I>?'I>3
F7!I5, DCG?,5 F7!H?!&3
C!733 C!!,CE F7!H?!&3
F7!I5, C!!,CE !* 3H?*3
C!733 C!!,CE 7*'I7,3
F7!I5, C!!,CE !* 7*'I7,3
2"& Ho%d Fore Reserves@
'echnicall$ it is possible to consider three motives i2e20 transaction$ speculative and precautionar motives for holding reserves. International trade gives rise to currenc flows$ which are assumed to be handled b private ban"s driven b the transaction motive. 3imilarl$ speculative motive is left to individual or corporate. Central ban" reserves$ however$ are characteri
18
From a polic perspective$ it is clear that the countr benefits through economies of scale b pooling the transaction reserves$ while sub serving the precautionar motive of "eeping official reserves as a Zwar chest/. Furthermore$ forex reserves are instruments to maintain or manage the exchange rate$ while enabling orderl absorption of international mone and capital flows. In brief$ official reserves are held for precautionar and transaction motives "eeping in view the aggregate of national interests$ to achieve balance between demand for and suppl of foreign currencies$ for intervention$ and to preserve confidence in the countr/s abilit to carr out external transactions.
!eserve assets could be defined with respect to assets of monetar authorit as the custodian$ or of sovereign 5overnment as the principal. For the monetar authorit$ the motives for holding reserves ma not deviate from the monetar polic objectives$ while for 5overnmentV the objectives of holding reserves ma go beond that of the monetar authorities. In other words$ the final expression of the objective of holding reserve assets would be influenced b the reconciliation of objectives of the monetar authorit as the custodian and the 5overnment as principal. 'here are cases$ however$ when reserves are used as a convenient mechanism for 5overnment purchases of goods and services$ servicing foreign currenc debt of 5overnment$ insurance against emergencies$ and in respect of a few$ as a source of income.
F?C'7!3 ?FFC'I,5 F7!I5, DCG?,5 M?!6' !?' ?lthough exchange rates are affected b man factors$ in the end$ currenc prices are a result of suppl and demand forces. 3uppl and demand for an given currenc$ and thus its value$ are not influenced b an single element$ but rather b several. 'hese elements generall fall into three categories: economic factors$ political conditions and mar"et pscholog.
2
II. 1. conomic factors 5overnment budget deficits or surpluses: 'he mar"et usuall reacts negativel to widening government budget deficits$ and positivel to narrowing budget deficits. 'he impact is reflected in the value of a countr[s currenc. •
%alance of trade levels and trends: 'he trade flow between countries illustrates the demand for goods and services$ which in turn indicates demand for a countr[s currenc to conduct trade. 3urpluses and deficits in trade of goods and services reflect the competitiveness of a nation[s econom. For example$ trade deficits ma have a negative impact on a nation[s currenc.
•
Inflation levels and trends: 'picall$ a currenc will lose value if there is a high level of inflation in the countr or if inflation levels are perceived to be rising. 'his is because inflation erodes purchasing power$ thus demand$ for that particular currenc.
•
conomic growth and health: !eports such as gross domestic product (5&*)$ emploment levels$ retail sales$ capacit utili
2. *olitical conditions: ?ll exchange rates are susceptible to political instabilit and anticipations about the new government. For example$ political or financial instabilit in !ussia is also a flag for the !upee to 3 !upee exchange because of the substantial amount of 5erman investments directed to !ussia.
21
9. Mar"et pscholog and trader perceptions 'he
influence
the
foreign
exchange
mar"et
in
a
variet
of
was
Flights to Jualit: nsettling international events can lead to a \flight to Jualit$\ with investors see"ing a \safe haven\. 'here will be a greater demand$ thus a higher price$ for currencies perceived as stronger over their relativel wea"er counterparts. Gow to predict mar"et movements 'here are two tpes of analsis which are generall used to "eep a trac" of the xchange mar"ets.'heseare: ]Fundamental ?nalsis Fundamental analsis includes a detailed stud of the basic and primar elements which have and can potentiall manipulate the financial sstem of a certain thing. 'his tpe of techniJue is often used to stud and forecast the various trends li"e price action and mar"et trends. 'hese predictions are done mainl through evaluating the following indicators: 1. ?ctivit Indicators relating to 5&*$ *roduction$ 3ales$ Income$ 3pending$ Gousing. 2. Inflation Indicators comprising of C*I$ H*I etc. 9. xternal 3ector Indicators which include 'rade %alance$ Current account balance. ] 'echnical ?nalsis 'echnical analsis is a method of evaluating currencies b anal
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1. Candlestic" Charts 2. Moving ?verages (3imple and xponential) 9. %ollinger %ands A. !elative 3trength Indicator 0. 7scillators Hhat is a hedge Gedge is an investment position ta"en in order to protect oneself from the ris" of an unfavorable price move in a currenc. Hh one must hedge his Foreign currenc !is" 1. 'o mitigate xchange rate ris": •
Fluctuations in the exchange rate of currencies give rise to exchange rate ris".
•
?s the time gap between finali
2. 'o avail the following benefits: 1. It brings certaint in business; ou would "now the precise exchange rate at which our receivables+ paables will be converted. 2. Gelps in estimating receipts and paments;once ou are aware of one side on the *+@ ou can plan the other. 9. %usiness is immune to an further movement in currenc mar"ets$ thus relieving itself of the exercise of trac"ing currenc mar"ets. Gedging *roducts
29
1) Forwards: It is a foreign currenc contract to bu or sell a foreign currenc at a fixed rate for deliver on a specified future date or period. Forwards contract is used as a foreign currenc hedge when a person+business has an obligation to either ma"e or ta"e a foreign currenc pament at some point in the future. If the date of the foreign currenc pament and the last trading date of the foreign currenc Forwards contract are matched up$ the investor has in effect \loc"ed in\ the exchange rate pament amount. ?dvantages: 1. Gelps in hedging the exchange rate ris". 2. %rings the certaint of converting foreign exchange at a fixed rate. 9. *rovides for earl or part settlement. &isadvantages: 1. Creates an obligation to settle the contract and does not allow the buer to ma"e use of better mar"et rates$ if available. 1) Hhat is maturit date 'he date on which the forward contract expires. 2) Hhat is a stri"e price 'his is also called Nxercise *riceO. 'his is the rate boo"ed b an exporter or importer on the date of the contract. For xample: 7n 91 March$ 2B$ an exporter bus and Forward contract$ maturit date for 9 3eptember 2B 3&+I,! rate on 91 March$ 2B Q 98.0
2A
Forward rate boo"ed b the exporterQ A.Q 3tri"e price +3tri"e !ate 2 7ptions: It is a financial Foreign currenc contract giving the buer the right$ but not the obligation$ to purchase or sell a specific foreign currenc contract (the underling) at a specific price (the stri"e price) on or before a specific date (the expiration date). 'he amount paid for the contract is called \premium.\ In other words$ bu paing a premium the buer can sta protected from unfavorable mar"et movements and at the same time ma"e use of better mar"et rates when available.
?dvantages: 1. nli"e a forwards contract$ it does not create an obligation to settle$ the buer can ma"e use of better mar"et rates when available. 2. *rovides protection against lossV however the option to ma"e use of favorable mar"et rate exists. 9. *rovides the flexibilit of choosing the stri"e price and maturit period$ accordingl the option price can be arrived to suit the buers/ needs.
20
A. 'ax %enefit;*remium paid can be claimed under expenses for tax benefit as per Income 'ax ?ct (India)$ 18-1. 1) Hhat is Zmaturit date/ 'he date on which the FDFlexi contract expires. 2) Hhat is Zstri"e price/ 'his is also called Nxercise *riceO. 'his is the rate boo"ed b an exporter or importer on the date of the contract. For xample: 7n 91 March$ 2B$ an exporter bus and 7ptions contract$ maturit date for 9 3eptember 2B 3&+I,! rate on 91 March$ 2B Q 98.0 7ptions boo"ed b the exporter for 9 3eptember 2B 7ptions rate boo"ed b the exporterQ A.Q 3ti"e price +3tri"e !ate 9) Hhat are the tpes of 7ptions contract 7ptions for importers Importers have to pa in foreign currenc for their imports. ?s such importers bu foreign currenc and sell rupees. Gence$ Importers can boo" an 7ptions contract and boo" the rate at which the will bu foreign currenc. 7n the maturit date$ importers can bu foreign currenc at the rate boo"ed or the mar"et rates whichever is lower. 'his is also "nown as a call option contract. For e.g. an importer boo"s an 7ptions contract on 91 March$ 2B$ maturit date 9 3eptember 2B at the rate of 98.. 3cenario analsis: Mar"et rate on 9 3eptember$ 2BQ 98.0
2-
'he importer will convert the foreign exchange at the rate boo"ed b him i.e. 98. as that is lower than the mar"et rate and hence more favorable for an importer. 7ptions for exporters xporters receive pament in foreign currenc. ?s such exporters sell foreign currenc and bu rupees. Gence an exporter can boo" an 7ptions contract and boo" a rate at which the will sell foreign currenc. 7n the maturit date$ exporters can sell foreign currenc at the rate boo"ed or the mar"et rates whichever is lower. 'his is also "nown as a put option
contract.
For e.g. an exporter boo"s an 7ptions contract on 91 March$ 2B$ maturit date 9 3eptember 2B at the rate of A.. >III. Forex Channels 'he various channels through which to avail Forex 3ervices are 1. &ealer; 'o a select group of clients$ ban"s offer the service of directl contacting the foreign exchange dealers to ta"e Juotes and+or boo" deals with them. 2. !elationship+'reasur Manager; Clients can contact the relationship+treasur manager assigned to them for rates and deals. 9. Forex over the *G7,;3ome ban"s offer the facilit whereb clients who do not have access to ban"s/ dealing room or dealers$ can call up centrali
!eal time platform of forex rates
2
•
•
'ransaction through a secure networ" ,o need to call up %ranch+ dealer for rates
Parti!i*ants in 0oreign e!"ange 'ar)et
'he main plaers in foreign exchange Mar"et are as follows: 1. C3'7M!3 'he customers who are engaged in foreign trade participate in v foreign exchange Mar"et b availing of the services of ban"s. xporters reJuire converting the dollars in to rupee and importers reJuire converting rupee in to the dollars$ as the have to pa in dollars for the goods+services the have imported. 2. C7MM!CI?@ %?,6: the are most active plaers in the forex Mar"et. Commercial ban" dealing with international transaction offer services for conversion of one currenc in to another. 'he have wide networ" of branches. 'picall ban"s bu foreign exchange from exporters and sells foreign exchange to the importers of goods. ?s ever time the foreign exchange bought or oversold position. 'he balance amount is sold or bought from the Mar"et. To* 16 !urren!& traders of overall volume$ Ma 21 !an" ,ame Mar"et 3hare
5erman &eutsche %an" 3wit
1B.- 11.9 11.B .-8 -.0 -.90 A.00 A.AA A.2B 2.81
2B
9. C,'!?@ %?,6 In all countries Central ban" have been charged with the responsibilit of maintaining the external value of the domestic currenc. 5enerall this is achieved b the intervention of the ban". A. xchange %!76!3 Forex bro"ers pla ver important role in the foreign exchange Mar"et. Gowever the extent to which services of foreign bro"ers are utili!3?3 F7!D Mar"et 'oda the dail global turnover is estimated to be more than 3 1.0 trillion a da. 'he international trade however constitutes hardl 0 to of this total turnover. 'he rest of trading in world forex Mar"et is constituted of financial transaction and speculation. 'IMI,53: ?s we "now that the forex Mar"et is 2A;hour Mar"et$ the da begins with 'o"o and thereafter 3ingapore opens$ thereafter India$ followed b %ahrain$ Fran"furt$ *aris$ @ondon$ ,ew Eor"$ 3dne$ and bac" to 'o"o. 0. 3*C@?'7!3 the speculators are the major plaers in the forex Mar"et %an" dealing are the major speculators in the forex ¬. Mar"et with a view to ma"e profit on account of favorable movement in exchange rate$ ta"e position i.e. if the feel that rate of particular currenc is li"el to go up in short term. 'he bu that currenc and sell it as Corporation/s particularl¬soon as the are able to ma"e Juic" profit. Multinational Corporation and transnational corporation having business operation beond their national frontiers and on account of their cash flows being large and in multi currencies get in to foreign exchange exposures. Hith a view to ma"e advantage of exchange rate movement in their favor the either dela covering exposures or do Individual li"e share
28
dealing¬not cover until cash flow materiali
F..!.? . and F..M.?. (Foreign xchange !egulation ?ct ?,& Foreign xchange Management ?ct)
•
Histori!a% -a!)ground :
•
Gistorical %ac"ground 'he Foreign xchange !egulation ?ct of 189 (F!?) nacted in 189
•
In the bac"drop of acute shortage of Foreign xchange in the countr.
•
F!? had a controversial 2 ear stint during
which man bosses of the
Indian Corporate world found themselves at the merc of the nforcement &irectorate (.&.). Foreign xchange !egulation ?ct •
'he Foreign xchange !egulation ?ct (F!?) was legislation passed b the Indian *arliament in 189 b the government of Indira 5andhi
•
It came into force with effect from 4anuar 1$ 18A.
•
F!? imposed stringent regulations on certain "inds of paments.
•
It deals in foreign exchange and securities and the transactions which had an indirect impact on the foreign exchange and the import and export of currenc.
•
'he purpose of the act$ inter alia$ was to \regulate certain paments$ dealings in foreign exchange and securities$ transactions indirectl affecting foreign exchange and the import and export of currenc$ for the conservation of foreign exchange resources of the countr\.
9
•
F!? was repealed in 1888 b the government of ?tal %ihari >ajpaee.
•
It replaced b the Foreign xchange Management ?ct$which liberalised foreign exchange controls and restrictions on foreign investment.
Foreign xchange Management ?ct •
'he Foreign E!"ange 'anage#ent A!t (FM?) was an act passed in the winter session of *arliament in 1888 which replaced Foreign xchange !egulation ?ct.
•
'his act see"s to ma"e offenses related to foreign exchange civil offenses.
•
It extends to the whole of India.
•
FM?$ which replaced Foreign xchange !egulation ?ct(F!?).
•
It had become the need of the hour since F!? had become incompatible with the pro;liberalisation policies of the 5overnment of India.
•
FM? has brought a new management regime of Foreign xchange consistent with the emerging framewor" of the Horld 'rade 7rganisation(H'7).
•
It is another matter that the enactment of FM? also brought with it the *revention of Mone @aundering ?ct 22$ which came into effect from 1 4ul 20.
•
O=e!tive O0 F$E$R$A +F$E$'A
•
1) 'o help !%I in maintaining exchange rate stabilit.
•
2) 'o conserve precious foreign exchange.
•
9) 'o prevent+regulate Foreign business in India.
91
•
A) 'o consolidate and amend the law relating to foreign exchange with the object to facilitating external trade and paments and for promoting the foreign exchange mar"et in India.
•
0) 3o the new law is for the management of foreign exchange instead of regulation of foreign exchange.
•
-) 'he draconian provisions were droped out in new enactment.
•
) 'he si
•
7bjectives
B) 'o facilitate external trade and paments
8) 'o promote the orderl development and maintenance of foreign exchange mar"et
•
DIFFERENCE -ET2EEN FERA AND FE'A :
1);'he objective of F!? was to conserve forex and to prevent its misuse. 'he objective of FM? is to facilitate external trade and paments and maintenance of forex mar"et in india. 2;>iolation of F!? was a criminal offence whereas violation of FM? is a civil offence. 9; 7ffences under F!? were not compoundable 7ffences under FM? are compoundable. A; Citi
while sta of more than 1B2 das in India is the criteria to decide residential status under FM?. 0; ?lmost all current account transactions are free$ except a few. F!? ^ FM? 7bject to conserve and prevent misuse >iolation was Criminal 7ffence and was non compoundable It was a draconian police law 'o facilitate external trade and paments >iolation is a civil offence and is compoundable It is a civil law •
Current A!!ount and Ca*ita% A!!ount transa!tions
nder the FM? regime$ the thrust was on regulation and control of the scarce foreign exchange$ whereas under the FM?$ the emphasis is on the management of foreign exchange resources. nder F!? it was safe to presume that an transaction in foreign exchange or with a non;resident was prohibited unless it was generall or speciall p ermitted. FM? has formall recognised the distinction between current account and capital account transactions. •
•
'wo golden rules or principles in FM? are mentioned as follows:
all current account transactions are permitted unless otherwise prohibited.
all capital account transactions are prohibited unless otherwise permitted.
Current ?ccount 'ransactions
99
•
?n person ma sell or draw foreign exchange to or from an authori
•
'he Central 5overnment ma$ in public interest and in consultation with the !eserve %an"$ impose such reasonable restrictions for current account transactions as ma be reJuired from time to time.
CG?*'! A I,'!,?'I7,?@%7,& M?!6'
De0inition o0 -ond 'ar)et
'he environment in which the issuance and trading of debt securities occurs. 'he bond mar"et primaril includes government;issued securities and corporate debt securities$ and facilitates the transfer of capital from savers to the issuers or organi
9A
sensitivit to interest rates. %ecause of the inverse relationship between bond valuation and interest rates$ the bond mar"et is often used to indicate changes in interest rates or the shape of the ield curve. 'he ield curve is the measure of \cost of funding\. De0inition o0 Internationa% -ond
&ebt investments that are issued in a countr b a non;domestic entit. International bonds are issued in countries outside of the nited 3tates$ in their native countr[s currenc. 'he pa interest at specific intervals$ and pa the principal amount bac" to the bond[s buer at maturit. International %ond:;? bond issued in a countr or currenc other than that of the investor or bro"er . 'he include urobonds$ which are issued in a foreign currenc$ foreign bonds$ which are issued b a foreign government or corporation in the domestic mar"et$ and global bonds$ which are issued in both domestic and international mar"ets. nli"e domestic bonds$ international bonds are usuall subject to currenc ris" . Caution is reJuired when investing international bonds because the ma be subject to different regulator and taxation reJuirements than the ones with which the investor or bro"er is familiar.
Investopedia explains [International %ond[:QInternational bonds include eurobonds$ foreign bonds and global bonds. ? different tpe of international bond is the %rad bond$ which is issued in .3. currenc. %rad bonds are issued in order to help developing countries better manage their international debt. International bonds are also private corporate bonds issued b companies in foreign countries$ and man mutual funds in the nited 3tates hold these bonds.
INTERNATIONAL -OND IS FURTHER CLASSIFIED IN T2O TBPES
?. urobond %. Foreign bond &efinition of [urobond[O;? bond issued in a currenc other than the currenc of the
countr
or
mar"et
in which
it is
issued.
90
suall$ a eurobond is issued b an international sndicate and categori
the domestic mar"et[s currenc. ? foreign bond is most often issued b a foreign firm to raise capital in a domestic mar"et that would be most interested in purchasing the firm[s debt. For foreign firms doing a large amount of business in the domestic mar"et$ issuing foreign bonds is a common practice. 'pes of foreign bonds include bulldog bonds$ matilda bonds and samurai bonds. FEATURES OF INTERNATIONAL -OND
It is a fund raising mar"et
It is debt mar"et
Fixed income instrument
Issued in foreign currenc
THE PROCESS OF -RI3IN3 A NE2 INTERNATIONAL -OND TO THE 'AR>ET
3tep 1:;? borrower will contact an investment ban"er as" it to serve as lead manager of an underwriting sndicate that will bring the
bonds
to
mar"et. 3tep 2:; 'he lead manager will usuall invite other ban"s to form a managing group to help negotiate terms with the borrower$ ascertain
mar"et
conditions$ and manage the issuance.
9-
3tep 9:;'he managing group$ along with other ban"s$ will serve as underwriters for the issue$ i.e.$ the will commit their own capital to
bu the issue from the borrower at a
discount from the issue price. 3tep A:;'he various members of the underwriting sndicate receive a spread (usuall in the range of 2 to2.0 percent of the the number and tpe of functions the
portion of the
issue si
perform.
3tep 0:;'he lead manager receives the full spread$ and a ban" serving as onl
a
member of the selling group receives a smaller portion.
RIS> OF IN?ESTIN3 IN -OND
1. Inflation !is" 2. Interest rate !is" 9. &efault !is" A. &owngrade !is" 0. @iJuidit !is" -. !einvestment !is" . !ip;off !is" AD?ANTA3ES + DISAD?ANTA3ES OF INTERNATIONAL -OND
AD?ANTA3ES :
&iversif our portfolio
International fund raising instrument
Fixed income mar"et
9
Investment avenue(short term as well as long term
Disadvantages:( Investing in internationa% ond 0unds can help ou diversif our
portfolio. Gowever$ there are some potential drawbac"s that ou need to "now about. Gere are four disadvantages of investing in international bond funds. 1$ Out*er0or#ed & 'utua% Funds:;Hhen ou invest mone into an indexed bond
'F$ ou are going to run the ris" of being outperformed. Man activel managed mutual funds can outperform these tpes of funds. 'herefore$ ou ma not be choosing the best place to put our mone. $
Fees:;Man people that invest in these tpes of funds li"e to bu and sell shares
freJuentl. Hhen ou do this$ ou are going to incur fees. 'hese fees can significantl cut into the amount of return that is made from the international bond fund. investing in this tpe of fund$ ou are ta"ing on extra ris". Eou have to 7$ Ris):;% be aware of international mar"et concerns as well as geopolitical and economic ris"s. $ Li#ited Se%e!tioN:( If ou want to invest in international bond funds$ ou are going to find that ou have a ver limited selection to choose from. Hhile there are hundreds of 'Fs to choose from$ those that specialiET FIED RATE -ONDS 91 o0 #ar)et in 667G ( Fixed maturit date (long term)$
fixed coupon rate ( of face value)$ issued in K$ $ $ or . Interest onl bonds (non; amorti
9B
FLOATIN3(RATE NOTES FRNG. 8 o0 'ar)et ; 3tarted in 18. suall
medium term (1;1 ear) bonds with a Juarterl or semi;annual floating+variable coupon rate$ li"e an ?!M$ issued mostl in and . Indexed to some reference interest rate li"e - month @I%7! (CG 11). 3emi;annual pmt (reset at the beginning of each - month period) would be .0 ( @I%7! R !is" *remium) of face value$ ris" premium usuall 1+B percent (.120) for firm[s with ver good credit rating. xample3 !ate is: @I%7! R . 120$ and @I%7! Q -.-. 3emi;annual coupon pmts for ever 1 face value would be: .0 (-.- R .120) (1) Q 99.-20. In six months if @I%7! is 0.$ the pament would be: .0 (0. R .120) (1) Q 28.120. ?dvantage of F!,s ; compared to fixed rate bonds$ ver little interest rate ris" (capital or price ris")$ i.e.$ the price of the bond will fluctuate between reset dates$ but will adjust bac" to par (1) after the Juarterl or semi;annual reset date. Hh might the F!, not sell at par$ even at the reset date xample3 ,ational %an" of 6uwait issued A0m of 9;ear F!,s in 22$ indexed to @I%7! R 20 bp (1+A). EUITB(RELATED -ONDS (9 Mar"et) -onds wit" 2arrants ; Fixed rate bond with call options (warrants) on the compan[s
stoc". 'he warrant allows the bondholder to bu a certain number of eJuit shares at a predetermined price on or before a fixed date. Hh issue Hhen would ou exercise ERO COUPON -ONDS ; %onds that do not pa interest over their life. 3old at a deep
discount off face value (1)$ with one pament onl$ at maturit. 4dvantages5 Compan can borrow mone$ have no debt paments. It can actuall deduct interest as a taxable expense. Investors avoid reinvestment rate ris" (fixed duration). In countries li"e 4apan (and urope) with no long term capital gains tax$
long;term capital gain (Face >alue ; *rice) is non;taxable. xample3 1;ear
98
DUAL(CURRENCB -ONDS :;3tarted in mid;Bs. Fixed rate coupon pmts are made in
one currenc (3F or )$ maturit value (principal) is paid in another currenc (). 'he maturit value is fixed$ so a dual;currenc bond includes a long term forward contract. If dollar appreciates (depreciates)$ the value of the bond rises (falls). &ual;currenc bonds are ris"ier for investors$ so the ield (coupon rate) is higher. 4apanese M,Cs have issued Een+ dual currenc bonds$ coupons paid in Een$ principal paid in $ to finance F&I in .3. xample3 Gonda might issue dual currenc Een+&ollar bonds to expand or establish factor in .3. @ong;term investment$ ma not be profitable for 1 ears. 'he loan can be serviced in Een from 4apan$ and the principal can be paid with long;term dollar profits earned in the .3. bond instruments and currenc distribution: and bonds account for BA of the mar"et. has grown in importance$ 3F and C have declined. 2HAT IS EURO-OND @
(1) nderwritten b an international sndicate$ (2) 7ffered at issuance simultaneousl to investors in a number of countries (9) Issued outside the jurisdiction of an single countr. &efinition of [urobond[O;? bond issued in a currenc other than the currenc of the
countr
or
mar"et
in which
it is
issued.
Investopedia explains [urobond[:;suall$ a eurobond is issued b an international sndicate and categori
A
'he French government issues euro;denominated bonds on the 4apanese financial mar"ets. T"e Pro!edures 0or t"e Euroond Issuan!e Pro!ess:( Se%e!t a Lead 'anager:;urobonds are issued b underwriting sndicates. 'hese
sndicates are made up of investment and merchant ban"s and ma be formed in different was. 5enerall$ the borrower chooses one investment ban" to be the lead manager of the bond issue. 'he lead manager then negotiates with other ban"s to form the sndicate. %orrowers ma also use existing sndicates or as" a particular investment ban"er to act as lead manager. Organi,e a S&ndi!ate :;'he lead manager negotiates with other ban"s to form a
managing group. 'his group then negotiates the terms of the bond issue with the borrower. Members of the managing group will also form another group to act as underwriters in the bond issue. 'he underwriters will commit their own mone to bu the bond issue from the borrower ;; at a set minimum price. 'he then sell the bonds on to secondar mar"ets at an agreed profit. 'he managing group will also negotiate with other ban"s to form a selling group ;; this is the group of ban"s that will actuall sell the bonds to investors. Se%%ing t"e -onds:( 7nce the sndicate is formed and the terms of the issue are agreed
upon$ the managing group bus the bonds from the borrower. 'he managing group then sells the eurobonds to the underwriters$ and the underwriters sell the bonds to the selling group. 'he ban"s that ma"e up the selling group then sell the bonds on to investors. 7ne thing to "eep in mind is that although there are several roles ;; managers$ underwriters and sellers ;; these roles usuall overlap$ so that managers ma also be underwriters and sellers. Prin!i*a% Pa&ing Agent :;? principal agent is chosen. 'his is the ban" that is responsible
for receiving interest paments from the borrower and passing them on to the investors
A1
who bu the bonds. ? fiscal agent or trustee ma also be appointed b the borrower to handle the paperwor" and legal aspects of the eurobond issue and act as principal agent. 'he trustee will also represent the purchasers of the bond if the borrower defaults. 'rustees and fiscal agents are generall ban"s$ and not individuals. UNIUE CHARACTERISTICS OF EURO-OND
1 FACE?ALUEJ PAR?ALUE: 'he face value isthe amount of mone a holder will get bac"$once a bond matures. 2) COUPON THE INTEREST RATEG: 'he couponis the amount the bondholder will receive asinterest paments. It/s called coupon becausein earl das there were phsical couponsattached to the bond certificate 9G 'ATURITB: It is the date in the future onwhich the investor s principal will be repaid. A) ISSUER : urobonds are mostl issued bcorporate 0)DENO'INATIONS: various currencies arecommonl used the 3 is used the most$denominating ;0 of urobonds. -)SECONDARB 'AR>ET : urobonds have asecondar mar"et which is different fromcommon stoc" mar"et+exchange. ) RATIN3S : 'he bond rating sstem helpsinvestors determine a compans credit ris". B TAATION : urobonds are not subject to taxlargel free from government regulation.
AD?ANTA3ES
+
DIS
AD?ANTA3ES
FOR
CO'PANIES
TO
ISSUE
EURO-ONDS
A2
T"ere are severa% advantages 0or !o#*anies to issue Euroonds: Large a#ounts Freedo# and F%eii%it&
Lower !ost o0 issue
Lower interest !ost
Longer #aturities
Against t"ese advantages. t"ere are so#e disadvantages to !onsider: •
there are issue costs to ta"e into account
•
if the debt is not matched against a foreign currenc asset$ the urobond issuing firm ma be open to foreign exchange ris".
•
AD?ANTA3ES + DISAD?ANTA3ES FOR IN?ESTOR TO ISSUE EURO-ONDS T"ere are severa% ene0its to an investor w"o does *ut its #one& into EuroondsK: Ta 0ree in!o#e Low Ris) invest#ent
Converti%e to E/uit&
Li/uid invest#ent
As 0or disadvantages to t"e investor:
A9
•
Investing in a urobond is not a good idea for investors who ma need a repament of the investment at short notice.
•
'here is alwas the ris" of the issuing compan going under and the maturit value of the urobond not being paid.
De0inition o0 Foreign -ond:( ? bond that is issued in a domestic mar"et b a foreign
entit$ in the domestic mar"et[s currenc. ? foreign bond is most often issued b a foreign firm to raise capital in a domestic mar"et that would be most interested in purchasing the firm[s debt. For foreign firms doing a large amount of business in the domestic mar"et$ issuing foreign bonds is a common practice. 'pes of foreign bonds include bulldog bonds$ matilda bonds and samurai bonds. Investo*edia e*%ains Foreign -ond:( Foreign bonds are regulated b the domestic
mar"et authorities and are usuall given nic"names that refer to the domestic mar"et in which the are being offered. 3ince investors in foreign bonds are usuall the residents of the domestic countr$ investors find them attractive because the can add foreign content to their portfolios$ without the added exchange rate exposure. ? debt securit issued b a borrower from outside the countr in whose currenc the bond is denominated and in which the bond is sold. ? bond denominated in .3. dollars that is issued in the nited 3tates b the government of Canada is a foreign bond. ? foreign bond allows an investor a measure of international diversification without subjection to the ris" of changes in relative currenc values.
T"ree !"ara!teristi!s o0 0oreign onds
? foreign bond has three distinct characteristics: •
'he
bond
is
issued
b
a
foreign
entit
(such
as
a
government$ municipalit or corporation) •
'he bond is traded on a foreign financial mar"et
•
'he bond is denominated in a foreign currenc.
AA
-ond #ar)ets
%ond mar"ets in India have witnessed a sea change since the earl 188s. 'he government securities mar"et has practicall emerged since the mid;188s. 'rading platforms and settlement mechanisms have improved and new instruments have been experimented with$ with varing degrees of success. In comparison$ with practicall no new primar mar"et issuance of corporate bonds (except in the private placement segment)$ the current state of the corporate bond mar"et in India is till nascent although in the last 2;9 ears it has witnessed significant reform activities. 'he pac"age of regulator and infrastructural changes recommended b the *atil committee in 20$ partl implemented alread$ is li"el to increase the primar and secondar mar"et activit.'he mar"et for asset securiti
DEFINITION :
%onds issued
and traded within the internal mar"et of a countr and denominated in the currenc of that countr. %onds issued in the countr and currenc in which the are traded. nli"e international bonds$ domestic bonds are not subject to currenc ris" . 'he usuall carr less ris" $ as the regulator and taxation reJuirements are usuall "nown to investors in domestic bonds$ or at least to their bro"ers and accountants.
A0
Pu%i! Se!tor Underta)ing -onds
o
If ou[re loo"ing for a medium; to long;term investment in the Indian bond mar"et$ a *ublic 3ector nderta"ing bond can be a good choice. *3s are issued and bac"ed b the government of India$ but the[re usuall sold on a private basis. In other words$ the Indian government targets investors themselves and offers the bonds to these investors at fixed rates. ?n investment ban"er usuall onl serves as a middleman in this situation.
Cor*orate -onds
o
'hese are more traditional bond instruments$ which are offered b private corporations in India for terms that can last up to 10 ears. nli"e the government bonds mentioned earlier$ anone can purchase a corporate bond. Gowever$ there is a higher ris" of default and that can depend upon the corporation bac"ing the bond$ mar"et conditions$ the compan[s industr and its investment rating. %ut the ris" comes with a higher return on the investment.
Finan!ia% Institutions and -an)s
o
%onds issued b financial institutions and ban"s in India are a vibrant financial instrument and ma"e up more than B percent of the bond mar"et in that countr. 'he reasons are simple. %onds issued b financial institutions and ban"s are regulated well and come with good bond ratings. @arge;scale investors are some of the most important investors in this categor. A-
E#erging 'ar)ets -onds
o
'hese bonds$ issued b the Indian government$ are issued abroad as hard currenc to raise capital for economic development in third;world countries. Hhat[s different about these bonds is that the are usuall issued in .3. dollars or the uro$ which can ma"e them more attractive to investors in those countries. ?lso ma"ing these M bonds attractive is the interest rate$ which while high is tpicall paid b the issuer. 'he ris" comes in that countries li"e India have a lower credit rating and the success of the bonds is tied to the success of the countr[s economic development.
Ta(Savings -onds
o
'he Indian government issues special bonds that allow its citi
LOAN SBNDICATION
'he si
A
purpose$ business details of his countr and its econom. 'hen he receives bids (after this the borrower and the lender sit across the table to discuss about the terms and conditions of lending this process of negotiations is called Zsndication/.) 'he process of sndication starts with an invitation for bids from the borrower. 'he mandate is given to a particular ban" or institution that will ta"e the responsibilit of sndicating the loan while arranging the financing ban"s. 3ndication is done on a best effort basis or an underwriting basis. It is usuall the lead manager who acts as the sndicator of loans$ the lead manager has dual tas"s that is$ formation of sndicate documentation and loan agreement. Common documentation is signed b the participation ban"s or common terms and conditions. 'hus$ the advantages of the sndicated loans are the si
AB
a single project. @oan sndication is basicall done to share the total loss or liabilit. TBPES OF LOANS SBNDICATION
5loball$ there are three tpes of underwriting for sndications: an underwritten deal$ best;efforts sndication$ and a club deal. 'he uropean leveraged sndicated loan mar"et almost exclusivel consists of underwritten deals$ whereas the .3. mar"et contains mostl best;efforts.
UNDER2RITTEN DEAL
] ?n underwritten deal is one for which the arrangers guarantee the entire commitment$ and then sndicate the loan. ] If the arrangers cannot full subscribe the loan$ the are forced to absorb the difference$ which the ma later tr to sell to investors. ] If it is not get sold than the arranger ma be forced to sell at a discount and$ potentiall$ even ta"e a loss on the paper. ] ?rrangers underwrite loans for several reasons. First$ offering an underwritten loan can be a competitive tool to win mandates.
A8
] 3econd$ underwritten loans usuall reJuire more lucrative fees because the agent is on the hoo" if potential lenders bal". -EST(EFFORTS SBNDICATION
] ? best;efforts sndication 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 mar"et. ] 'raditionall$ best;efforts sndications were used for ris" borrowers or for complex transactions. ] 3ince the late 188s$ however$ the rapid acceptance of mar"et;flex language has made best;efforts loans the rule even for investment;grade transactions.
CLU- DEAL
? club deal is a smaller loan usuall 20S1 million$ but as high as 10 million#that is pre mar"eted to a group of relationship lenders. 'he arranger is generall a first among eJuals$ and each lender gets a full cut$ or nearl a full cut$ of the fees. STA3ES AND PROCESS OF LOAN SBNDICATION PRE ( 'ANDATE PHASE
'he prospective borrower ma liaise with a single ban" or it ma invite competitive bids from a number of ban"s. 'he lead ban" identifies the needs of the borrower$ designs an appropriate loan structure$ develops a persuasive credit proposal$ and obtains internal approval. 'he mandate is created. 'he documentation is created with the help of specialist lawers. PLACIN3 THE LOAN
0
'he lead ban" can start to sell the loan in the mar"et place. 'he lead ban" needs to prepare an information memorandum$ term sheet$ and legal documentation and approach selected ban"s and invite participation. 'he lead manager carries out the negotiations and controversies are ironed out. 'he sndication deal is closed$ including signing of the mandate. POST ( CLOSURE PHASE
'he agent now handles the da;to;da running of the loan facilit. CG?*'! A 5@7%?@ C?*I'?@ M?!6' Indian companies are permitted to raise foreign currenc resources through two main sources: • •
Issue of Foreign Currenc Convertible %onds (FCC%s) Issue of 7rdinar eJuit shares through depositor receipts$ namel$ 5lobal &epositor !eceipts+ ?merican &epositor !eceipts to foreign investor/s i.e. institutional investors or investors residing abroad.
? &epositor !eceipt (&!) is an negotiable instrument in the form of a certificate denominated in 3 dollars. 'he certificate is issued b an overseas depositor ban" against certain underling stoc"s+shares. 'he shares are deposited b the issuing compan with the depositor ban". 'he depositor ban" in turn tenders &!s to the investors. ? &! represents a particular bunch of shares on which the receipt holder has the right to receive dividend$ other paments and benefits which compan announces from time to time for the shareholders. Gowever$ it is non;voting eJuit holding. &!s facilitate cross border trading and settlement$ minimi
?merican &epositar !eceipts (?&!s) are securities offered b non;3 companies who want to list on an of the 3 exchange. ach ?&! represents a certain number of a compan[s regular shares. 'hese are deposited in a custodial account in the 3. ?&!s allow 3 investors to bu shares of these companies without the costs of investing directl in a foreign stoc" exchange. ?&!s are issued b an approved ,ew Eor" ban" or trust compan against the deposit of the original shares. Hhen transactions are made$ the ?&!s change hands$ not the certificates. 'his eliminates the actual transfer of stoc" certificates between the 3 and foreign countries. 5lobal &epositar !eceipts (5&!s) are negotiable certificate held in the ban" of one 01
countr representing a specific number of shares of a stoc" traded on the exchange of another countr. 'his is a financial instrument used b the companies to raise capital in either dollars or uros. 5&!s are also called uropean &epositar !eceipt. 'hese are mainl traded in uropean countries and particularl in @ondon. Gowever$ ?&!s and 5&!s ma"e it easier for individuals to invest in foreign companies$ due to the widespread availabilit of price information$ lower transaction costs$ and timel dividend distributions. 2HB DO CO'PANIES 3O FOR ADRs OR 3DRs@
Indian companies need capital from time to time to expand their business. If an foreign investor wants to invest in an Indian compan$ the follow two main strategies. ither the foreign investors can bu the shares in Indian eJuit mar"ets or the Indian firms can list their shares abroad in order to ma"e these shares available to foreigners. %ut the foreign investors often find it ver difficult to invest in India due to poor mar"et design of the eJuit mar"et. Gere$ the have to pa heft transaction costs. 'his is an obvious motivation for Indian firms to bpass the incompetent Indian eJuit mar"et mechanisms and go for the well;functioning overseas eJuit mar"ets. Hhen the issue shares in forms of ?&!s or 5&!s$ their shares commanded a higher price over their prices on the Indian bourses. ?nother problem faced b the foreign investors is restrictions on eJuit ownership b foreigners. 7nl foreign institutional investors can bu shares in India whereas in case of ?&!s or 5&!s$ anone can bu this. FIIs face restrictions of ceilings or sta"es in Indian companies. In contrast$ there is no such restriction on 5&!s or ?&!s$ and hence 5&!s or ?&!s generall enjo a premium. 2HICH INDIAN CO'PANIES ARE LISTED A-ROAD@
Infoss 'echnologies was the first Indian compan to be listed on ,?3&?= in 1888. Gowever$ the first Indian firm to issue sponsored 5&! or ?&! was !eliance industries @imited. %eside$ these two companies there are several other Indian firms are also listed in the overseas bourses. 'hese are 3atam Computer$ Hipro$ M',@$ >3,@$ 3tate %an" of India$ 'ata Motors$ &r !edd[s @ab$ !anbax$ @arsen ^ 'oubro$ I'C$ ICICI %an"$ Gindalco$ G&FC %an" and %ajaj ?uto. 2HAT ARE THE PRICES OF INDIAN ADRs + 3DRs@
'he ?&! and 5&! prices of the Indian companies are much higher compared to the prices on the Indian bourses. Hhile$ Infoss trades at 2.1A at ,?3&?=$ it Juotes at !s 2$2A0 on the %3. 3atam at 2A.20$ Hipro at 21.0$ 'ata Motors at 1.2$ M',@ at -.9A$ &r !edd[s @ab at 1-.2$ G&FC %an" at A1.8A$ %ajaj ?uto at 2B.1A$ !I@ at 2A.B9 and I'C at 90.9 were all Juoting at a higher price than their Indian peers.
02
HO2 TO TRADE IN ADRs@
?&!s can be traded either b trading existing ?&!s or purchasing the shares in the issuer[s home mar"et and having new ?&!s created$ based upon availabilit and mar"et conditions. Hhen trading in existing ?&!s$ the trade is executed on the secondar mar"et on the ,ew Eor" 3toc" xchange (,E3) through &epositor 'rust Compan (&'C) without involvement from foreign bro"ers or custodians. 'he process of buing new$ issued ?&!s goes through 3 bro"ers$ Gelsin"i xchanges and &'C as well as &eutsche %an". 2HAT ARE THE NOR'S FOR INDIAN ADRs AND 3DRs@
'here are no ceilings on investment in ?&!s or 5&!s. ?n applicant compan see"ing the government[s approval in this regard should have a consistent good trac" record for a minimum period of 9 ears. 'his condition can be relaxed for infrastructure projects such as power generation$ telecomm$ petroleum exploration and refining$ ports$ airports and roads. 'here is no restriction on the number of 5&!s or ?&!s to be floated b a compan or a group of companies in a financial ear. 'he government has also relaxed the conversion and re;conversion (i.e. two;wa conversion or fungibilit) of shares of Indian companies into depositor receipts listed in foreign bourses. 'he companies have been allowed to invest 1 per cent of the proceeds of ?&! or 5&! issues for acJuisitions of foreign companies and direct investments in joint ventures. -ASIS FOR CO'PARISON
ADR
3DR
?cronm
?merican &epositor !eceipt
5lobal &epositor !eceipt
Meaning
?&! is a negotiable instrument
5&! is a negotiable instrument
issued b a 3 ban"$ representing issued b the international non;3 compan stoc"$ trading
depositor ban"$ representing
in the 3 stoc" exchange.
foreign compan[s stoc" trading globall.
!elevance
Foreign companies can trade in
Foreign companies can trade in
09
-ASIS FOR
ADR
CO'PARISON
3 stoc" mar"et.
3DR
an countr[s stoc" mar"et other than the 3 stoc" mar"et.
Issued in
nited 3tates domestic capital
uropean capital mar"et.
mar"et.
@isted in
?merican 3toc" xchange such ,on;3 3toc" xchange such as as ,E3 or ,?3&?=
@ondon 3toc" xchange or @uxemberg 3toc" xchange.
,egotiation
In ?merica onl.
?ll over the world.
&isclosure
7nerous
@ess onerous
!etail investor mar"et
Institutional mar"et.
!eJuirement
Mar"et
Eterna% Co##er!ia% -orrowings ?n mone that has been borrowed from foreign sources for financing the commercial activities in India are called xternal Commercial %orrowings. 'he 5overnment of India permits C%s as a source of finance for Indian Corporates for expansion of existing capacit as well as for fresh investment. 'he C%s are defined as mone borrowed from foreign resources including the following: Commercial ban" loans %uers/ credit and suppliers/ credit 3ecuritised instruments such as Floating !ate ,otes and Fixed !ate %onds etc. Credit from official export credit agencies and commercial borrowings from the private sector window of Multilateral Financial Institutions such as International Finance Corporation (Hashington).
7bjective of C% 5overnment permits the C%s as an additional source of financing for expanding • the existing capacit as well as for fresh investments. 'he C% polic of the 5overnment see"s to emphasi
0A
•
'here is also emphasis on the need of capital for 3mall and Medium scale enterprises.
How EC- is di00erent 0ro# FDI@ •
C% means an "ind of funding other than Juit. If the foreign mone is used to finance the Juit Capital$ it would be termed as Foreign &irect Investment. 'he C% should satisf the C% regulations stipulated b the 5overnment or its agencies such as !%I. 'he %onds$ Credit notes$ ?sset %ac"ed 3ecurities$ Mortgage %ac"ed 3ecurities or anthing of that nature are included in C%. *lease note that the following are not included in the C%s:
•
?n Investment made towards core capital of an organi
CG?*'! 0 INTERNATIONAL FINANCIAL REPORTIN3 STANDARDS I$F$R$S$M
A!!ounting Standards issued & t"e ICAI ?ccounting 3tandards are written documents$ polic documents issued b expert accounting bod or 5ovt.$ or other regulator bod covering the aspects of recognition$ measurement$ treatment$ presentation and disclosure of accounting transaction in the financial statement. ?ccounting 3tandards in India are issued b the IC?I. ?3 1 &isclosure of ?ccounting *olicies ?3 2 >aluation of Inventories ?3 9 Cash Flow 3tatements ?3 A Contingencies and vents 7ccurring after the %alance 3heet &ate ?3 0 ,et *rofit or @oss for the period$ *rior *eriod Items and Changes in ?ccounting *olicies ?3 - &epreciation ?ccounting ?3 Construction Contracts (revised 22) ?3 B ?ccounting for !esearch and &evelopment ?3 8 !evenue !ecognition ?3 1 ?ccounting for Fixed ?ssets ?3 11 'he ffects of Changes in Foreign xchange !ates (revised 29)
00
Hithdrawal of the ?nnouncement issued b the Council on Z'reatment of exchange differences under ?ccounting 3tandard (?3) 11 (revised 29)$ 'he ffects of Changes in Foreign xchange !ates vis;;vis 3chedule >I to the Companies ?ct$ 180-/ ?3 12 ?ccounting for 5overnment 5rants ?3 19 ?ccounting for Investments ?3 1A ?ccounting for ?malgamations ?3 10 (revised 20) mploee %enefits @imited !evision to ?ccounting 3tandard (?3) 10$ mploee %enefits (revised 20) ?3 10 (issued 1880)?ccounting for !etirement %enefits in the Financial 3tatement of mploers ?3 1- %orrowing Costs ?3 1 3egment !eporting ?3 1B$ !elated *art &isclosures ?3 18 @eases ?3 2 arnings *er 3hare ?3 21 Consolidated Financial 3tatements ?3 22 ?ccounting for 'axes on Income. ?3 29 ?ccounting for Investments in ?ssociates in Consolidated Financial 3tatements ?3 2A &iscontinuing 7perations ?3 20 Interim Financial !eporting ?3 2- Intangible ?ssets ?3 2 Financial !eporting of Interests in 4oint >entures ?3 2B Impairment of ?ssets ?3 28 *rovisions$ Contingent @iabilities and Contingent ?ssets ?3 9 Financial Instruments: !ecognition and Measurement and @imited !evisions to ?3 2$ ?3 11 (revised 29)$ ?3 21$ ?3 29$ ?3 2-$ ?3 2$ ?3 2B and ?3 28 ?3 91$ Financial Instruments: *resentation ?ccounting 3tandard (?3) 92$ Financial Instruments: &isclosures$ and limited revision to ?ccounting 3tandard (?3) 18$ @eases
International ?ccounting 3tandards
I?3 1 *resentation of Financial 3tatements 'his 3tandard prescribes the basis for presentation of general purpose financial statements to ensure comparabilit both with the entit/s financial statements of previous periods and with the financial statements of other entities. It sets out
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overall reJuirements for the presentation of financial statements$ guidelines for their structure and minimum reJuirements for their content.
I?3 2 Inventories 'he objective of this 3tandard is to prescribe the accounting treatment for inventories. ? primar issue in accounting for inventories is the amount of cost to be recognised as an asset and carried forward until the related revenues are recognised. 'his 3tandard provides guidance on the determination of cost and its subseJuent recognition as an expense$ including an write;down to net realisable value. It also provides guidance on the cost formulas that are used to assign costs to inventories.
I?3 3tatement of Cash Flows 'he objective of this 3tandard is to reJuire the provision of information about the historical changes in cash and cash eJuivalents of an entit b means of a statement of cash flows which classifies cash flows during the period from operating$ investing and financing activities
I?3 B ?ccounting *olicies$ Changes in ?ccounting stimates and rrors 'he objective of this 3tandard is to prescribe the criteria for selecting and changing accounting policies$ together with the accounting treatment and disclosure of changes in accounting policies$ changes in accounting estimates and corrections of errors. 'he 3tandard is intended to enhance the relevance and reliabilit of an entit/s financial statements$ and the comparabilit of those financial statements over time and with the financial statements of other entities.
I?3 1 vents after the !eporting *eriod 'he objective of this 3tandard is to prescribe: (a) when an entit should adjust its financial statements for events a fter the reporting periodV and (b) the disclosures that an entit should give about the date when the financial statements were authorised for issue and about events after the reporting period. 'he 3tandard also reJuires that an entit should not prepare its financial statements on a going concern basis if events after the reporting period indicate that the going concern assumption is not appropriate
I?3 11 Construction Contracts 'he objective of this 3tandard is to prescribe the accounting treatment of revenue and costs associated with construction contracts. %ecause of the nature of the
0
activit underta"en in construction contracts$ the date at which the contract activit is entered into and the date when the activit is completed usuall fall into different accounting periods. 'herefore$ the primar issue in accounting for construction contracts is the allocation of contract revenue and contract costs to the accounting periods in which construction wor" is performed.
I?3 12 Income 'axes 'he objective of this 3tandard is to prescribe the accounting treatment for income taxes. For the purposes of this 3tandard$ income taxes include all domestic and foreign taxes which are based on taxable profits. Income taxes also include taxes$ such as withholding taxes$ which are paable b a subsidiar$ associate or joint venture on distributions to the reporting entit. 'he principal issue in accounting for income taxes is how to account for the current and future tax conseJuences of: (a) the future recover (settlement) of the carring amount of assets (liabilities) that are recogni
I?3 1- *ropert$ *lant and Juipment 'he objective of this 3tandard is to prescribe the accounting treatment for propert$ plant and eJuipment so that users of the financial statements can discern information about an entit/s investment in its propert$ plant and eJuipment and the changes in such investment. 'he principal issues in accounting for propert$ plant and eJuipment are the recognition of the assets$ the determination of their carring amounts and the depreciation charges and impairment losses to be recognised in relation to them
I?3 1 @eases 'he objective of this 3tandard is to prescribe$ for lessees and lessors$ the appropriate accounting policies and disclosure to appl in relation to leases. 'he classification of leases adopted in this 3tandard is based on the extent to which ris"s and rewards incidental to ownership of a leased asset lie with the lessor or the lessee. ? lease is classified as a finance lease if it transfers substantiall all the ris"s and rewards incidental to ownership.
I?3 1B !evenue
0B
'he primar issue in accounting for revenue is determining when to recogni
(a) a liabilit when an emploee has provided service in exchange for emploee benefits to be paid in the futureV and (b) an expense when the entit consumes the economic benefit arising from service provided b an emploee in exchange for emploee benefits.
IAS 6 A!!ounting 0or 3overn#ent 3rants and Dis!%osure o0 3overn#ent Assistan!e
'his 3tandard shall be applied in accounting for$ and in the disclosure of$ government grants and in the disclosure of other forms of government assistance.
I?3 21 'he ffects of Changes in Foreign xchange !ates ?n entit ma carr on foreign activities in two was. It ma have transactions in foreign currencies or it ma have foreign operations. In addition$ an entit ma present its financial statements in a foreign currenc. 'he objective of this 3tandard is to prescribe how to include foreign currenc transactions and foreign operations in the financial statements of an entit and how to translate financial statements into a presentation currenc. 'he principal issues are which exchange rate(s) to use and how to report the effects of changes in exchange rates in the financial statements. 'his 3tandard does not appl to hedge accounting for foreign currenc items$ including the hedging of a net investment in a foreign operation. I?3 98 applies to hedge accounting. 'his 3tandard does not appl to the presentation in a statement of cash flows of the cash flows arising from transactions in a foreign currenc$ or to the translation of cash flows of a foreign operation (see I?3 !tatement of ,ash Flows). 08
I?3 29 %orrowing Costs Core principle %orrowing costs that are directl attributable to the acJuisition$ construction or production of a Jualifing asset form part of the cost of that asset. 7ther borrowing costs are recognised as an expense. 6orrowing costs are interest and other costs that an entit incurs in connection with the borrowing of funds.
I?3 2A !elated *art &isclosures 'he objective of this 3tandard is to ensure that an entit/s financial statements contain the disclosures necessar to draw attention to the possibilit that its financial position and profit or loss ma have been affected b the existence of related parties and b transactions and outstanding balances with such parties
I?3 2- ?ccounting and !eporting b !etirement %enefit *lans 'his 3tandard shall be applied in the financial statements of retirement benefit plans where such financial statements are prepared. !etirement benefit plans are arrangements whereb an entit provides benefits for emploees on or after termination of service (either in the form of an annual income or as a lump sum) when such benefits$ or the contributions towards them$ can be determined or estimated in advance of retirement from the provisions of a document or from the entit[s practices. 3ome retirement benefit plans have sponsors other than emploersV this 3tandard also applies to the financial statements of such plans. I?3 2 Consolidated and 3eparate Financial 3tatements 'he objective of I?3 2 is to enhance the relevance$ reliabilit and comparabilit of the information that a parent entit provides in its separate financial statements and in its consolidated financial statements for a group of entities under its control. 'he 3tandard specifies: (a) the circumstances in which an entit must consolidate the financial statements of another entit (being a subsidiar)V (b) the accounting for changes in the level of ownership interest in a subsidiarV (c) the accounting for the loss of control of a subsidiarV and (d) the information that an entit must disclose to enable users of the financial statements to evaluate the nature of the relationship between the entit and its subsidiaries.
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Consolidated financial statements are the financial statements of a group presented as those of a single economic entit. ? group is a parent and all its subsidiaries. ? subsidiar is an entit$ including an unincorporated entit such as a partnership$ that is controlled b another entit ("nown as the parent). Control is the power to govern the financial and operating policies of an entit so as to obtain benefits from its activities.
I4! 78 Investments in 4ssociates
'his 3tandard shall be applied in accounting for investments in associates. Gowever$ it does not appl to investments in associates held b: (a) >enture capital organisations$ or (b) mutual funds$ unit trusts and similar entities including investment;lin"ed insurance funds that upon initial recognition are designated as at fair value through profit or loss or are classified as held for trading and accounted for in accordance with I?3 98 Financial Instruments: !ecognition and Measurement. 3uch investments shall be measured at fair value in accordance with I?3 98$ with changes in fair value recogni
I?3 28 Financial 1eporting in 9yperinflationary conomies 'his 3tandard shall be applied to the financial statements$ including the consolidated financial statements$ of an entit whose functional currenc is the currenc of a hperinflationar econom
I?3 91 Interests in 4oint >entures 'his 3tandard shall be applied in accounting for interests in joint ventures and the reporting of joint venture assets$ liabilities$ income and expenses in the financial statements of venturers and investors$ regardless of the structures or forms under which the joint venture activities ta"e place. Gowever$ it does not appl to venturers/ interests in jointl controlled entities held b: (a) venture capital organisations$ or
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(b) mutual funds$ unit trusts and similar entities including investment;lin"ed insurance funds that upon initial recognition are designated as at fair value through profit or loss or are classified as held for trading and accounted for in accordance with I?3 98 Financial Instruments3 1ecognition and Measurement .
? :oint venture is a contractual arrangement whereb two or more parties underta"e an economic activit that is subject to joint control. ;oint control is the contractuall agreed sharing of control over an economic activit$ and exists onl when the strategic financial and operating decisions relating to the activit reJuire the unanimous consent of the parties sharing control (the venturers). ,ontrol is the power to govern the financial and operating policies of an economic activit so as to obtain benefits from it. ? venturer is a part to a joint venture and has joint control over that joint venture. 4oint ventures ta"e man different forms and structures. 'his 3tandard identifies three broad tpes#jointl controlled operations$ jointl controlled assets and jointl controlled entities#that are commonl described as$and meet the definition of$ joint ventures.
I4! <7 Financial Instruments3 *resentation
'he objective of this 3tandard is to establish principles for presenting financial instruments as liabilities or eJuit and for offsetting financial assets and financial liabilities. It applies to the classification of financial instruments$ from the perspective of the issuer$ into financial assets$ financial liabilities and eJuit instrumentsV the classification of related interest$ dividends$ losses and gainsV and the circumstances in which financial assets and financial liabilities should be offset. ? financial asset is an asset that is: (a) cashV (b) an eJuit instrument of another entitV (c) a contractual right (d) a contract that will or ma be settled in the entit/s own eJuit instruments ? financial liaility is an liabilit that is: (a) a contractual obligation (b) a contract that will or ma be settled in the entit/s own eJuit instruments
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?n e.uity instrument is an contract that evidences a residual interest in the assets of an entit after deducting all of its liabilities.
I4! << arnings per !hare
'he objective of this 3tandard is to prescribe principles for the determination and presentation of earnings per share$ so as to improve performance comparisons between different entities in the same reporting period and between different reporting periods for the same entit. 'he focus of this 3tandard is on the denominator of the earnings per share calculation. 'his 3tandard shall be applied b entities whose ordinar shares or potential ordinar shares are publicl traded and b entities that are in the process of issuing ordinar shares or potential ordinar shares in public mar"ets. ?n entit that discloses earnings per share shall calculate and disclose earnings per share in accordance with this 3tandard. ?n ordinar share is an eJuit instrument that is subordinate to all other classes of eJuit instruments. ? potential ordinar share is a financial instrument or other contract that ma entitle its holder to ordinar shares.
I?3 9A Interim Financial !eporting 'he objective of this 3tandard is to prescribe the minimum content of an interim financial report and to prescribe the principles for recognition and measurement in complete or condensed financial statements for an interim period. 'imel and reliable interim financial reporting improves the abilit of investors$ creditors$ and others to understand an entit/s capacit to generate earnings and cash flows and its financial condition and liJuidit. 'his 3tandard applies if an entit is reJuired or elects to publish an interim financial report in accordance with International Financial !eporting 3tandards. Interim financial report means a financial report containing either a complete set of financial statements (as described in I?3 1 *resentation of Financial !tatements (as revised in 2)) or a set of condensed financial statements (as described in this 3tandard) for an interim period. Interim period is a financial reporting period shorter than a full financial ear.
I4! <= Impairment of 4ssets
'he objective of this 3tandard is to prescribe the procedures that an entit applies to ensure that its assets are carried at no more than their recoverable amount. ?n -9
asset is carried at more than its recoverable amount if its ca rring amount exceeds the amount to be recovered through use or sale of the asset. If this is the case$ the asset is described as impaired and the 3tandard reJuires the entit to recogni *rovisions0 ,ontingent ?iailities and ,ontingent 4ssets 'he objective of this 3tandard is to ensure that appropriate recognition criteria and measurement bases are applied to provisions$ contingent liabilities and contingent assets and that sufficient information is disclosed in the notes to enable users to understand their nature$ timing and amount. I?3 9 prescribes the accounting and disclosure for all provisions$ contingent liabilities and contingent assets$ except:
(a) those resulting from financial instruments that are carried at fair valueV (b) those resulting from executor contracts$ except where the contract is onerous. xecutor contracts are contracts under which neither part has performed an of its obligations or both parties have partiall performed their obligations to an eJual extentV (c) those arising in insurance entities from contracts with policholdersV or (d) those covered b another 3tandard. I?3 9B Intangible ?ssets 'he objective of this 3tandard is to prescribe the accounting treatment for intangible assets that are not dealt with specificall in another 3tandard. 'his 3tandard reJuires an entit to recognise an intangible asset if$ and onl if$ specified criteria are met. 'he 3tandard also specifies how to measure the carring amount of intangible assets and reJuires specified disclosures about intangible assets. ?n intangible asset is an identifiable non;monetar asset without phsical substance
I?3 98 Financial Instruments: !ecognition and Measurement 'he objective of this 3tandard is to establish principles for recogni
-A
'he objective of this 3tandard is to prescribe the accounting treatment for investment propert and related disclosure reJuirements I?3 A1 ?griculture 'he objective of this 3tandard is to prescribe the accounting treatment and disclosures related to agricultural activit. IAS 1 T"e E00e!ts o0 C"anges in Foreign E!"ange Rates
as issued at 1 4anuar 212. Includes IF!3s with an effective date after 1 4anuar 212 but not the IF!3s the will replace. 'his extract has been prepared b IF!3 Foundation staff and has not been approved b the I?3%. For the reJuirements reference must be made to International Financial !eporting 3tandards. ?n entit ma carr on foreign activities in two was. It ma have transactions in foreign currencies or it ma have foreign operations. In addition$ an entit ma present its financial statements in a foreign currenc. 'he objective of this 3tandard is to prescribe how to include foreign currenc transactions and foreign operations in the financial statements of an entit and how to translate financial statements into a presentation currenc. 'he principal issues are which exchange rate(s) to use and how to report the effects of changes in exchange rates in the financial statements. 'his 3tandard does not appl to hedge accounting for foreign currenc items$ including the hedging of a net investment in a foreign operation. I?3 98 applies to hedge accounting. 'his 3tandard does not appl to the presentation in a statement of cash flows of the cash flows arising from transactions in a foreign currenc$ or to the translation of cash flows of a foreign operation (see I?3 3tatement of Cash Flows).
Functional currenc Functional currenc is the currenc of the primar economic environment in which the entit operates. 'he primar economic environment in which an entit operates is normall the one in which it primaril generates and expends cash. ?n entit considers the following factors in determining its functional currenc: (a) the currenc: (i) that mainl influences sales prices for goods and services (this will often be the currenc in which sales prices for its goods and services are denominated and settled)V and -0
(ii) of the countr whose competitive forces and regulations mainl determine the sales prices of its goods and services. (b) the currenc that mainl influences labour$ material and other costs of providing goods or services (this will often be the currenc in which such costs are denominated and settled). !eporting foreign currenc transactions in the functional currenc Foreign currenc is a currenc other than the functional currenc of the entit. 3pot exchange rate is the exchange rate for immediate deliver. xchange difference is the difference resulting from translating a given number of units of one currenc into another currenc at different exchange rates. ,et investment in a foreign operation is the amount of the reporting entit/s interest in the net assets of that operation. ? foreign currenc transaction shall be recorded$ on initial recognition in the functional currenc$ b appling to the foreign currenc amount the spot exchange rate between the functional currenc and the foreign currenc at the date of the transaction. ?t the end of each reporting period: (a) foreign currenc monetar items shall be translated using the closing rateV (b) non;monetar items that are measured in terms of historical cost in a foreign currenc shall be translated using the exchange rate at the date of the transactionV and (c) non;monetar items that are measured at fair value in a foreign currenc shall be translated using the exchange rates at the date when the fair value was measured. xchange differences arising on the settlement of monetar items or on translating monetar items at rates different from those at which the were translated on initial recognition during the period or in previous financial statements shall be recognised in profit or loss in the period in which the arise. Gowever$ exchange differences arising on a monetar item that forms part of a reporting entit/s net investment in a foreign operation shall be recognised in profit or loss in the separate financial statements of the reporting entit or the individual financial statements of the foreign operation$ as appropriate. In the financial statements that include the foreign operation and the reporting entit (eg consolidated financial statements when the foreign operation is a subsidiar)$ such exchange differences shall be recognised initiall in other comprehensive income and reclassified from eJuit to profit or loss on disposal of the net investment. Furthermore$ when a gain or loss on a non;monetar item is recognised in other comprehensive income$ an exchange component of that gain or loss shall be recognised in other comprehensive income. Conversel$ when a gain or loss on a non;
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