Factoring Vs Forfaiting

Factoring	Forfaiting
For Short Term receivables	For medium / long term receivables
Discounting charges are borne by seller	All expenses are pushed to buyer (from seller)
With / without recourse	Always without recourse
90% payment on shipping of docs	100% payment as soon as shipping docs are handed over
No other additional instruments are required	Will insist for LC or avalized banker acceptance (from buyer’s bank)

Class 1A

International Finance

Class 1 & 2

Issues in International Finance

· Raising Finance from International Market

§ Raise from Domestic Market

§ Raise from International Market

ü Short Term Finance

· Trade related exposure

· Domestic Expenses (Foreign Currency loan to meet export order; Import machine – Capital Expansion)

ü Medium Term Finance

ü Long Term Finance

· Equity Issue – Retain funds from international market on long term loans

Ø ADR – US (American) Deposit receipts. Company feels easy to raise equity from international market

· Debt

Ø FCCB – Foreign currency convertible bond. Till 7 years, it is debt, post which it can be converted to equity at a pre-determined price

· Managing the Risk (Exposure)

§ Commercial

ü Institutional Shield

ü Instruments (manage risks)

§ Country

ü Consultancy to provide country data

ü Own methods of qualitative / quantitative survey

§ Currency

· Country specific regulation – If domestic currency can’t earn inside, pressure on foreign currency

· Sector wise gap – To dis-allow foreign investor to take over industry

· Local tax discrimination between domestic & foreign investments. Ex – China. Ajanta Quartz faced protests from local people in China as they paid less tax than local companies

· Different accounting practices (which norm to follow for financial reporting)

Company wants to go for massive expansion (like $ 300 million) – Syndication Process

Emerging Trends

1) Cross border movement of Capital / Goods. Example – Euro Trade union & Euro (consolidate strength of 11 European countries)

2) Open economy –

a. Significant shifts – Easy inflow & outflow of money

b. Liberalization of imports (capital goods imports)

c. Concentrated efforts for export promotion – liberal borrowing policy of country (local & foreign currency loans) & FDI. Example – Indonesia allowed loan in foreign currency before crisis of 1997 without loan applicant to specify the purpose of loan

d. Through exports, a country actually earns actual trade surplus (real foreign exchange)

3) Freedom for raising capital from global market (cost of funds are cheaper)

4) Cheaper credit from off-shore market

5) Reduction of currency control

Global Economy

Carry Trade Losses

In 2008, USD = 123 Yen. Interest Rate on Yen is 0.17%. Hence, a trader borrows 123 Yen @ 0.17%, converts it into USD and in-turn in INR and invests in India at 8%.

In 2009, USD = 90 Yen. Hence, the profit earned in India is eroded when USD is converted back to Yen and now 1 USD only gives 90 Yen instead of 123 Yen.

Corporate today

1) Euro / Dollar (Off-shore Market) – USD $ traded outside USA. After World War-2, Russian market started accepting USD $.

2) Reuter / Bloomberg Screen

3) Currency Movements

4) Interest Rate Difference

5) Arbitrage opportunity

6) Joint Ventures / Cross border trades (Tata Steel taking over Corus)

7) One Set of transactions (Lending by Europe to Nigeria via Singapore Market)

8) Joint Ventures in SA pharma today

9) Trading office in Dubai / Singapore

Need for International Finance

1) Counter party can be anywhere

2) Country need not to consume / produce all items (hence, need to export. Hence, may need international finance to support the export)

3) Domestic projects needs external finance, domestic funds may not be sufficient (Infra-structure, Power Project). Example – China’s investment in India in 2010-11 is $ 8.4 billion dollars

4) Cost of funding may be cheaper in foreign market

Euro $ / Offshore Market

1) Ceiling on interest rate for deposits in USA, hence, funds move outside the country

2) Deposits

a. Insure Deposits. Hence, pay premium of 0.05%

b. Reserve with Central Bank (CRR) – 5%

c. Interest on deposits – 6%

d. Hence, Cost of funds = 6% + 0.05% = 6.05%

3) Balance of Payment Crisis (1960s)

a. US put restrictions on giving loans (VFCRP)

b. Tax on interest earnings – 1963 (IET)

c. GBP can be used to only finance UK industries

d. Hence, US dollar mobilized outside US and off-shore market developed

$ 4.2 Trillion / day = Forex Transaction (70% in London Market) = Easy to quote bid / offer prices

Nostro Account – Actual mobilization of $ account in US, but in books of foreign country bank. Because of it, US sustain huge trade deficit (as though money moves within US banks only, the owners are outside US / non-US companies)

Balance of Trade = Difference between exports and imports (only physical goods are included, no services)

Capital account transaction =Resident company creating asset / liability in foreign currency (loan) raised in home country

· Resident company raising loan in domestic currency – No effect on current or capital account (as home currency is not affected by any currency fluctuation outside)

· Example – All non-resident of Singapore creating an asset / liability in Singapore by investing in a company is Capital Account Transaction

Current Account Transactions – Inflow + Outflow (is +ve if Inflow > Outflow)

· Inflow of foreign exchange

ü Physical exports (Current Account Transaction)

ü Invisible services (Current Account Transaction)

§ Repatriation of Income by Non residents

§ Example – Providing software solution

ü Foreign aids / Donation / Gifts (Current Account Transaction)

§ Collection from entire globe / subsidiaries transferred to Central / Parent office

ü Interest & Dividend receipts (Current Account Transaction)

§ Dividend declared locally after 60 days after finalizing balance sheet of foreign subsidiaries

ü Freight Collections

§ Selling their currency to buy local – even medical tourism

ü Other Sources

§ FDI – Technology + Management control + minimum locking period + long term (Capital Account Transaction)

§ FII – more concerned about short term gains (Capital Account Transaction)

§ External Commercial borrowings (ECB) (Capital Account Transaction)

§ FCCB (ADR, GDR issues) – Equity raised in foreign market (Capital Account Transaction)

§ NRI – Non Resident investment (Capital Account Transaction)

· Outflow of foreign exchange

ü Physical import (Current Account Transaction)

ü Repatriation of FDI (Capital A/C Transaction)

ü Repayment of loans (FCCB), foreign investment (Capital A/C Transaction)

Capital Account + Current Account = Balance of Payment

Forex Reserve

Components

1) Balance of payment surplus

2) Gold reserve

3) Undrawn SDR (special drawing rights) – OD facility depending on contribution to IMF funds to countries

a. Can be used when the country has advance balance of payment position

b. Can be used when the currency movement is erratic

4) Balance with IMF (contribution to IMF or payment left with IMF)

Convertibility of a currency

Full convertibility – It is the freedom to

1) Possess foreign exchange – In any currency, in any account

2) Use foreign exchange for any purpose – Bank will not ask reason while remitting

3) Exchange rate of currency to be decided by market forces

Example – USD, Euro, Pound Sterling, Swiss Franks

Impact of BOP / BOT data

Currency is under pressure, if BOT is under deficit (more import)

When a company can go for full convertibility

1) Rate of inflation to be under control (Inflation can’t be zero)

2) No erratic movement of exchange rate

3) NPA level of banking system

1991 – IMF lending condition to lend to India

1) Financial sector reform – Government control to be lessened on banks, NPA level to be brought down (24% in 1991)

2) Full convertibility in phased manner – 1994 (current account convertibility)

3) CRR should be brought down (as it is low yielding)

a. CRR - From 18.5% to 5%

b. SLR – From 38.5% to 25%

c. Priority Sector lending – Remains at 16%

d. Reduction ensured 17% availability (73% to 57%)

e. Earlier only 27% was left to lend to general public

4) Minimum reserve maintenance for meeting 6 month import commitment

5) People /company can take dividend out

Sample Paper - End Term Exam

International Finance – Prof. Parmeshwaram

End Term Exam - GMBA Nov 10

Time: 90 Minutes

Marks: 40

Part A (5 X 4 = 20)

1) When a country can go for full convertibility? Your answer should be based on some of the economic crisis in the global market.

2) How a “line of credit” facility is operating? How it differs from a “Buyer’s Credit”?

3) Write a short note on evaluation of country risk.

4) What are the factors a corporate will consider before opting for raising equity through ADR option?

5) One of the companies has exposures in more than 5 major currencies. Suggest the appropriate currency risk management strategy they should adopt?

Part B (20 Marks)

1) With the following market information, arrive at the forward differentials (Both Buy & Sell – Bid / Ask)

Currency	Spot
GBP / USD	1.6000 / 50
EUR / USD	1.3200 / 50

Present LIBOR and LIBID for 6 months: (annualized)

Currency	Interest Rates
	LIBID	LIBOR
USD	2.50%	3.00%
EUR	2.00%	2.25%
GBP	3.25%	3.50%

2) One of the leading Singapore oil companies wants to raise a loan in USD 100 million for 60 days for payment of their import bill. They have the option of borrowing in USD or JPY. From the following data, find out the best option. The company would like to cover their foreign currency exposure (360 days in a calendar year)

	Spot	Forward Differentials for 60 days	Interest Rates Annualized
USD / SGD	1.2880 / 90	20 / 25	USD 2.5%
USD / JPY	80.50 / 60	30 / 20	JPY 1.25%

3) One of the US firm has 90 days receivable of CHF 50 million (inward remittance on CHF). They would like to convert this CHF into USD. This company has access to domestic as well as offshore markets. Inter-bank rates are: (360 days in a calendar year)

USD / CHF = 0.9870 / 80

90 days FWD differentials = 30 / 20

Money Market	Bid / Offer
Interest Rate for USD	2.00 / 2.25
Interest Rate for CHF	1.25 / 1.50

By booking the forward contract, how much USD the firm will receive. If the firm wants to opt for money market route, how much USD they will receive. Please work out and find out the better option.

4) One of the power plants in Philippines, Bataan 2020 Inc, Baesa Quezon city, imports steam turbine generator from Thermax India for value of USD 2,000,000 payment maturing December 2011. Following is the exchange rate and interest rate prevailing in both countries:

Currency	Spot	6 Month FWD
USD / INR	44.60 / 61	120 / 121
USD / PHP	43.10 / 12	160 / 162
Interest Rate prevailing – 6 month annualized
USD	2%
INR	8%
PHP	10%

Practice Set 3

INDIVIDUAL ASSIGNMENT (Prof. K Parmeshwaram)

Inter-bank exchange rate schedule

Currency	Spot	Forward
London market quotes
		One month	Three month	Six month
GBP/USD	1.5915/20	22/21	61/60	123/120
EUR/USD	1.3240/45	05/10	20/30	35/40
USD/CHF	0.9990/95	20/15	30/20	45/40
USD/JPY	80.05/10	50/45	105/100	150/145
USD/NOK	5.8450/75	10/15	45/50	80/85
Singapore inter bank
USD/SGD	1.3240/50	10/15	30/35	40/45
USD/THB	32.36/38	20/25	35/38	60/65
Mumbai interbank
USD/INR	44.40/41	25/26	60/62	105/110

1. One of the leading shipping companies in India has ordered for a cargo vessel with a Norwegian shipping compnay. Value of the cargo vessel is NOK 6 mn. Payment will be due in the month of May 2011. The company wants to book 6 months forward contract. What will be the INR outflow on the due date? Bank will be loading INR 0.03 as their profit margin. (3 paise)

USD/INR USD/NOK

Working: Spot exchange rate: 44.41 + 5.8450 +

FWD differentials 01.10 0.0080

FWD rate: 45.51 5.8530

NOK/INR 45.51/5.8530 = 7.7755

Profit margin: 0.0300

Merchant Rate: 7.8055or 7.81

Total Rupee outflow: 6,000,000 x 7.8055

= Rs.46,833,000 or

= Rs.46,860,000

2. You have availed a medium term loan in JPY. You want to remit the loan amount from your SGD account with OCBC, Singapore. Find out the conversion rate. (spot rate to be worked out)

Loan repayment in JPY.

Spot exchange rate for JPY/SGD = 1.3250/80.05 = 0.01655

or

SGD/JPY = 80.05/1.3250 = 60.4150

3. One of the companies in Bangkok has placed an order for import of capital equipments from Germany. Contract will be due for payment in the month of Feb 2011. Find out the cross rate for EUR/THB for 3 months FWD.

Import payment in EUR against THB

Conversion will be THB to USD and USD to EUR

USD/THB EUR/USD

Spot 32.38+ 1.3245+

FWD differentials for 3months 00.38 0.0030

FWD exchange rate 3^rd month 32.76 1.3275

Cross rate for EUR/THB = 1.3275 x 32.76 = 43.4889

4. Your company wants to take over one of the British companies. Take over price is fixed as GBP 5 mn. Your investments are in CHF. You wish to remit GBP 5 mn from your CHF account. Find out GBP/CHF cross rate.(spot rate)

Spot rate for GBP/CHF for outward remittance:

Spot rate ; USD/CHF GBP/USD

0.9995 1.5920

GBP/CHF 1.5920 x 0.9995 = 1.5912

For GBP5mn = 5,000,000 x 1.5912 = CHF7,956,000

5. With the following market information, arrive at the forward differentials:

Currency	Spot
EUR/USD	1.3500/50

Present LIBOR for 6 months: (annualized)

Currency	INTEREST RATES BID /OFFER
USD	2.50/3.00%
EUR	2.00/2.25%

Find out the forward exchange rates for EUR/USD for 6 months for export receivables

EUR	USD
Borrow EUR 1 @ 2.25 for 6 months: Principal: 1.00000 Interest: 0.01125 Total outflow 1.01125	Invest USD 1.3500 @ 2.50% for 6 months: Principal: 1.35000 Interest: 0.016875 Totalinflow 1.366875
1.00125 EUR = 1.366875 USD 1 EUR – 1.366875/1.00125 = 1.35166
Applying the formula: (1 + 2.5/2 x100) 1.3500 x -------------------- (1 + 2.25/2 x100)

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