Paper 307 A - International Financial Management

Paper: 406 A – International Financial Management
1. International Financial Environment (06)

1.1. International Financial Management: Evolution
1.2. International Financial Management- Goals, Features & scope
1.3. Domestic V/s International Financial Management.
1.4. Role of Financial Manager in International Environment
2. Foreign Exchange Market and Exchange Rate (12)

2.1 Wholesale & Retail Market,
2.2 Participants in the Foreign Exchange Market
2.3 Quotations- Direct & Indirect Quote, Bid Rate & Ask Rate, Cross Rates of Exchange
2.4 Factors affecting Exchange Rate
2.5 Exchange Rate Determination (Currency Forecasting)
2.5.1 Purchasing Power Parity Theory
2.5.2 Interest Rate Parity
2.5.3 International Fischer Effect
2.6 Spot Market and the Forward Market
2.7 Global Derivative Market –
Foreign Currency Futures, Option & Swap, Speculation, Arbitrage, Hedging
2.8 Arbitrage – Two Point and Triangular Arbitrage
2.9 Functions of Foreign Exchange Market
2.10 Foreign Exchange Risk Exposure –
Transaction Exposure, Translation Exposure, Economic Exposure
3. International Accounting (06)

3.1. Convergence to International Financial Reporting Standards
Introduction, Advantages of adopting IFRS, Applicability
3.1.2.Comparison of IFRS and Ind –AS
3.1.3. IND-AS1 Presentation of Financial Statements
3.2. Transfer pricing- Meaning and Important Issues
4. Financing Foreign Operations (10)

4.1 Financing of foreign trade
4.1.1 Documentation, Modes of Payment, Methods of Financing
4.1.2 EXIM Bank
4.1.3 Recent amendments in EXIM policy
4.2 International Transaction Mechanism
4.2.1 Nostro, Vostro and Loro Account
4.2.2 Payment Systems - SWIFT, CHIP, CHAP, Telegraphic Transfer (TT)
4.3 Types of Central Bank Intervention in Currency Market
4.4 Eurocurrency Market -
4.4.1 Characteristics, Instruments & Rate of Eurocurrency Market
4.4.2 Domestic Issues Vs. Euro Issues
4.5 Depository Receipts – ADR and GDR
5. International Monetary system (6)

5.1. Establishment of International Monitory Fund (IMF)
5.2 Constitution, Role & Responsibility of IMF
5.3 Funding facilities, International liquidity
5.4 Special Drawing Rights (SDR)
6. Balance of Payment (8)

6.1. India’s Balance of Payment
6.2. Importance, Functions, Principles & Components of Balance of Payment
6.3. Accounting of Balance of Payment: Deficit & Surplus
6.4. Elasticity approach Vs Absorption Approach
6.5. General Equilibrium approach
6.6. Balance of Payment Vs Exchange Rate
6.7. Balance of Payment and Money Supply
Unit 1. International Financial Environment
1.1. International Financial Management: Evolution
1.3. Domestic V/s International Financial Management.
1.1 International Financial Management: Evolution

There have been four phases/ stages in the evolution of the international monetary system:
• Gold Standard (1875-1914)
• Inter-war period (1915-1944)
• Bretton Woods system (1945-1972)
• Present International Monetary system (1972-present)
1) Gold Standard
1. The gold standard is a monetary system in which each country fixed the value of its currency
in terms of gold. The exchange rate is determined accordingly.
2. Let’s say- 1 ounce of gold = 20 pounds (fixed by the UK) and 1 ounce of gold = 10 dollars
(fixed by the US).
3. Hence, the dollar-pound exchange rate will be 20 pounds = 10 dollars or 1 pound = 0.5
dollars
4. The Gold standard created a fixed exchange rate system.
5. There was free convertibility between gold and national currencies.
6. Also, all national currencies had to be backed by gold. Therefore, the countries had to keep
enough gold reserves to issue currency.
7. One advantage of the gold standard was that the Balance of payments (BOP) imbalances
were corrected automatically.
8. Let’s say- there are only two countries in the world – The UK and France. The UK runs a BOP
deficit as it has imported more goods from France. France runs a BOP surplus.
9. This will obviously result in the transfer of money (gold) from the UK to France as payment
for more imports.
10. The UK will have to reduce its money supply due to a decline in gold reserves. The reduction
in the money supply will bring down prices in the UK.
11. The opposite will happen in France. Its prices will increase.
12. Now, the UK will be able to export cheaper goods to France. On the other hand, the imports
from France will slow down. This will correct the BOP imbalances of both countries.
13. Another advantage was that the gold standard created a stable exchange rate system that
was conducive to international trade.
2) Inter-war Period
After the world war started in 1914, the gold standard was abandoned.
Countries began to depreciate their currencies to be able to export more. It was a period
of fluctuating exchange rates and competitive devaluation.
3) Bretton Woods System
1. In the early 1940s, the United States and the United Kingdom began discussions to rebuild
the world economy after the destruction of two world wars. Their goal was to create a fixed
exchange rate system without the gold standard.
2. The new international monetary system was established in 1944 in a conference organized
by the United Nations in a town named Bretton Woods in New Hampshire (USA).
3. The conference is officially known as the United Nations Monetary and Financial
Conference. It was attended by 44 countries.
4. India was represented in the Bretton-woods conference by Sir C.D. Deshmukh, the first
Indian Governor of RBI.
5. The Bretton-woods created a dollar-based fixed exchange rate system.
6. In the Bretton-woods system, only the US fixed the value of its currency to gold. (The initial
peg was 35 dollars = 1 ounce of gold). All the other currencies were pegged to the US dollar
instead. They were allowed to have a 1 % band around which their currencies could
fluctuate.
7. The countries were also given the flexibility to devalue their currencies in case of an
emergency.
8. It was similar to the gold standard and was described as a gold-exchange standard.
9. There were some differences. Only the US dollar was backed by gold. Other currencies did
not have to maintain gold convertibility.
10. Also, this convertibility was limited. Only governments (not anyone who demanded it) could
convert their US dollars into gold.
4) Present International Monetary System

1. The Bretton Woods system collapsed in 1971. The United States had to stop the
convertibility to gold due to high inflation and trade deficit in the economy.
2. Inflation led to an increase in the price of gold. Hence, the US could not maintain a fixed
value of 35 dollars to 1 ounce of gold.
3. In 1973, the world moved to a flexible exchange rate system.
4. In 1976, the countries met in Jamaica to formalize the new system.
5. The floating exchange rate system means that the exchange rate of a currency is determined
by the market forces of demand and supply.
India’s Monetary Policy system

Managed float.
India has managed floating exchange rate system. The exchange rate is determined by market
forces. But the RBI intervenes in the currency market to curb volatility.

a) What Is Financial Management?
Financial management is an important activity in any organization. It is the process of planning,
organizing, controlling, and monitoring the financial resources with a view to attain organizational
goals and objectives. It is the best approach for controlling the financial activities of an organization
such as procurement of funds, utilization of funds, accounting, payment, risk assessment, and
everything that is related to money management.
b) Objectives of Financial Management
The foremost aim of financial management is to manage the finances of an organization so that
businesses are compliant with necessary rules and regulations and are successful in their field. This
process involves extensive planning and its proper execution. When done precisely, businesses
flourish and profitability increases. This is the primary reason why the finance department, along
with finance or revenue managers, plays a significant role in any organization. Accordingly, the basic
objective of financial management are:
• Ensuring a regular and suitable supply of funds for the organization.
• To ensure optimum use of funds. Once the funds are procured, they should be used in the
maximum possible way at minimum cost.
• Creation of a stable capital structure. The capital distribution should strike a steady balance
between debt and equity.
• Ensuring the safety of investments. The funds should be invested in safe ventures to
guarantee adequate returns.
• Ensuring adequate returns for the organization and the shareholders.
c) Scope of Financial Management
Financial management helps a particular organization to utilize their finances most profitably. This is
achieved via the following two conducts.
The scope of financial management is divided into two categories:
• Traditional Approach
• Modern Approach
Let us discuss the two approaches in brief.
d) Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to make estimation with regards
to capital requirements of the company. This will depend upon expected costs and profits
and future programmers and policies of a concern. Estimations have to be made in an
adequate manner which increases earning capacity of enterprise.
2. Determination of capital composition: Once the estimation has been made, the capital
structure has to be decided. This involves short- term and long- term debt equity analysis.
This will depend upon the proportion of equity capital a company is possessing and
additional funds which have to be raised from outside parties.
3. Choice of sources of funds: For additional funds to be procured, a company has many
choices like-
a. Issue of shares and debentures
b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of each source and period of financing.
4. Investment of funds: The finance manager has to decide to allocate funds into profitable
ventures so that there is safety on investment and regular returns is possible.
5. Disposal of surplus: The net profits decision has to be made by the finance manager. This
can be done in two ways:
a. Dividend declaration - It includes identifying the rate of dividends and other benefits
like bonus.
b. Retained profits - The volume has to be decided which will depend upon expansional,
innovational, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards to cash
management. Cash is required for many purposes like payment of wages and salaries,
payment of electricity and water bills, payment to creditors, meeting current liabilities,
maintenance of enough stock, purchase of raw materials, etc.
7. Financial controls: The finance manager has not only to plan, procure and utilize the funds
but he also has to exercise control over finances. This can be done through many techniques
like ratio analysis, financial forecasting, cost and profit control, etc.
e) Nature of Financial Management
Finance management is a long-term decision-making process which involves lot of planning,
allocation of funds, discipline and much more. Let us understand the nature of financial
management with reference of this discipline.
• Risk and Returns Evaluation

Nature of financial management basically involves decision where risk and return are linked with
investment. Generally high-risk investment yield high returns on investments. So, role of financial
manager is to effectively calculate the level of risk company is involve and take the appropriate
decision which can satisfy shareholders, investors or founder of the company.
• Capital Requirement Estimation

Using financial management to forecast working capital and fixed capital requirements for
conducting business operations, it is possible to plan ahead of time for money. It is necessary to
have a proper balance between debt and equity in order to keep the cost of capital as low as
possible. Financial management determines the appropriate allocation of various securities
(common equity, preferred equity and debt).
• Wealth Management
The finance manager keeps track of all cash movements (both inflow and outflow) and guarantees
that the company does not experience a cash shortage or surplus.
• Valuation of Company
Primary nature of financial management focus towards valuation of company. That is the reason
where all the financial decisions are directly linked with optimizing / maximization the value of a
company. Finance functionality like investment, distribution of profit earnings, rising of capital, etc.
are the part of management activities.
• Improve Company’s Stock / Shareholder Value

Increase the amount of return to shareholders by lowering the cost of operations and increasing
earnings, according to the company’s mission statement. The finance manager’s primary focus
should be to increase revenue by obtaining cash from a variety of sources and investing.
• Source of Funds
In every organization, the source of funding is a critical decision to make. There are long-term,
medium-term and short-term source of funds. Every organization should thoroughly research and
evaluate various sources of money (e.g., stocks, bonds, debentures, and so on) before selecting the
most appropriate sources of funds with the least amount of risk.
• Selective Investment
Before committing the funds, it is necessary to thoroughly examine and assess the investment
proposal’s risk and return characteristics. Appropriate decision needs to be made for selecting right
type of investment options.
• Control Management
The implementation of financial controls assists the firm in maintaining its real costs of operation
within reasonable bounds and generating the projected profits.
➢ Few Additional Nature and Scope of Financial Management

There are other techniques that may be used, such as setting specific standards for company in
advance, comparing the actual cost or performance with pre-established criteria, and implementing
all necessary corrective actions as needed. Few other scope and nature of financial management is
listed below.
• Finance is a foundation of economic activities. The person who Manages finance is called as
financial manager. Important role of financial manager is to control finance and implement
the plans. For any company financial manager plays a crucial role in it. Many times, it
happens that lack of skills or wrong decisions can lead to heavy losses to an organization.
• Financial Management is an important function in company’s management. Financial factors
are considered in all the company’s decisions and all the departments of an organization. It
affects success, growth and volatility of a company. Finance is said to end up being the
lifeline of a business.
• Finance management is one of the important educations which has been realized word
wide. Now a day’s people are undergoing through various specialization courses of financial
management. Many people have chosen financial management as their profession.
• The nature of financial management is never a separate entity. Even as an operational
manager or functional manager one has to take responsibility of financial management.
• Nature of financial management is multi-disciplinary. Financial management depends upon
various other factors like: accounting, banking, inflation, economy, etc. for the better
utilization of finances.
• Approach of financial management is not limited to business functions but it is a backbone
of commerce, economic and industry.
1.3. Domestic V/s International Financial Management

IFM –
International financial management, also known as international finance, is the management of
finance in an international business environment; that is, trading and making money through the
exchange of foreign currency. The international financial activities help the organizations to connect
with international dealings with overseas business partners- customers, suppliers, lenders etc. It is
also used by government organization and non-profit institutions.
DFM –
Domestic financial management can include financial operations in a home country for a
government or corporation. This term is also used in reference to controlling household finances.
The intended meaning is typically clear from the context of the term. Coursework and degrees in
both senses of the term are available for people like accountants, political scholars, and members of
the financial industry
➢ Difference Between IFM & DFM

1. Exposure to foreign exchange:
The most significant difference is of foreign currency exposure. Currency exposure impacts almost
all the areas of an international business starting from your purchase from suppliers, selling to
customers, investing in plant and machinery, fund raising etc. Wherever you need money, currency
exposure will come into play and as we know it well that there is no business transaction without
money.
2. Macro business environment
An international business is exposed to altogether a different economic and political environment.
All trade policies are different in different countries. Financial manager has to critically analyze the
policies to make out the feasibility and profitability of their business propositions. One country may
have business friendly policies and other may not.
3. Legal and tax environment
The other important aspect to look at is the legal and tax front of a country. Tax impacts directly to
your product costs or net profits i.e., ‘the bottom line’ for which the whole story is written.
International finance manager will look at the taxation structure to find out whether the business
which is feasible in his home country is workable in the foreign country or not.
4. The different group of stakeholders
It is not only the money which along matters, there are other things which carry greater importance
viz. the group of suppliers, customers, lenders, shareholders etc. Why these group of people
matter? It is because they carry altogether a different culture, a different set of values and most
importantly the language also may be different. When you are dealing with those stakeholders, you
have no clue about their likes and dislikes. A business is driven by these stakeholders and keeping
them happy is all you need.
5. Foreign exchange derivatives
Since, it is inevitable to expose to the risk of foreign exchange in a multinational business.
Knowledge of forwards, futures, options and swaps is invariably required. A financial manager has
to be strong enough to calculate the cost impact of hedging the risk with the help of different
derivative instruments while taking any financial decisions.
6. Different standards of reporting
If the business has a presence in tell US and India, the books of accounts need to be maintained in
US GAAP and IGAAP.  It is not surprising to know that the booking of assets has a different
treatment in one country compared to other. Managing the reporting task is another big difference.
The financial manager or his team needs to be familiar with accounting standards of different
countries.
7. Capital management
In an MNC, the financial managers have ample options of raising the capital. A number of options
create more challenge with respect to the selection of the right source of capital to ensure the
lowest possible cost of capital.  There may be such more points of difference between
international and domestic financial management. Mentioned above are a list of major differences.
We need to consider each of them before taking any decision involving multinational financial
environment.

A financial manager is a person who is responsible for taking care of all the essential financial
functions of an organization. Nowadays, Finance Managers spend less time producing financial
reports and prefer to invest more time in conducting data analysis, planning and strategizing, or
advising senior managers or top executives.
Responsibilities of Finance Manager:
• Raising of funds: to meet the needs of the business, it is essential to have cash and liquidity
so, that a firm can raise funds by way of equity or debt. A financial manager is responsible
for maintaining the right balance between equity and debt.
• Allocation of funds: After the funds are raised, the next important thing is to allocate the
funds. The best possible manner of allocating the funds:
• Size of the organizations and their growth capability
• Status of assets about long term or short term
• The mode by which the funds are raised
These types of financial decisions can, directly and indirectly, influence other activities.
• Profit Planning: It is one of the primary functions of any business organizations. Profit
earning is essential for the survival and livelihood of any organization. Profits emerge due to
various factors such as pricing, industry competition, state of the economy, mechanism of
demand and supply, cost and output.
• Understanding capital markets: Shares of a company are traded on the stock exchange for a
continuous sale and purchase. It is understood that the capital market is an essential factor
for a financial manager. Hence, it is the responsibility of a concern person to understand and
calculate the risk involved in this trading of shares debts.
Role of a Financial Manager
The role of a financial manager is rapidly increasing due to advance technology which has
significantly reduced the amount of time that was occupied to produce financial reports.
• They analyze market trends to find opportunities for expansion or for acquiring companies.
• They have to do some tasks that are specific to their organization or industry
• They manage company credit
• Make some dividend pay-out decisions
• Keep in touch with the stock market if the company is listed
• Appreciate the financial performance concerning return investments
• They maximize the wealth for company shareholders
• To handle financial negotiations with banks and financial institutions
Types of Financial Managers:
• Controllers: They direct the preparation of financial reports that summarize and forecast the
organization's financial reports such as income statements, balance sheets, etc.
• Treasures and finance officers: These officers direct their organization's budgets to meet its
financial goals to oversee the investment of funds.
• Credit managers: They manage the organization's credit business.
• Cash managers: They monitor the flow of the cash that comes in and goes out of the
company to meet the investment needs of an organization.
• Risk managers: They control financial risk by using strategies to limit the probability of a
financial loss.
Unit 2. Foreign Exchange Market and Exchange Rate
2.1 Wholesale & Retail Market,
2.3 Quotations- Direct & Indirect Quote, Bid Rate & Ask Rate, Cross Rates of Exchange
2.5 Exchange Rate Determination (Currency Forecasting)
2.7 Global Derivative Market –
Foreign Currency Futures, Option & Swap, Speculation, Arbitrage, Hedging
2.1 Wholesale & Retail Market

A) Wholesale Market
Wholesale Definition:
Wholesale is an important component distribution channel and it can be defined as “a business
activity of the buying and selling of goods in large quantities at cheaper prices, mostly to small
business and shop when then sell them to end-users”. Collins Dictionary
1. Wholesaler
A wholesaler is a person or firm that buys goods in large quantity directly from the manufacturer
and sell them in small quantities to shops. A wholesaler engaged primarily in business-to-business
activities rather than business-to-consumer activities.
2. Wholesaling
Wholesaling is the process of buying products from the manufacturers at a lower price; adding
some margin price on the products, and then selling it to the other businesses like retailers or small
shops.
3. Key Benefits of Wholesale
Instead of selling the products directly to the customers; the manufacturer chooses to sell his goods
and products to the wholesaler. Here are some of the key benefits of wholesale if one is interested
in the wholesale business;
4. Saves Money
Wholesale means buying a huge bulk of products at a low price; it’s often 50% off the selling price
and then setting the manufacturer’s price as a sale price. In other words, round about 50% profit on
the sale of the product.
5. Brand Creation and Propagation
Wholesalers usually rebrand the product when it comes under their umbrella. Shopping malls,
grocery stores, and marts are a very good example of wholesale rebranding because they don’t
manufacture any products, instead, they add a label of their store line to brand themselves.
The wholesaler gets the opportunity to be in direct contact with the manufacturer and the customer
at the same time, which gives him an opportunity to brand himself and remove the manufacturer
out of the picture by putting his brand label.
6. Become an Expert
Being directly in contact with the customers, you’ll observe which manufacturing product is selling
more. Then you can use this knowledge to your own business advantage and focus only on that
specific product which would attract more customers to your store.
7. Diversification
Wholesaling provides you an opportunity to diversify the market risk by starting with the sale of
running items i.e. pencils, legal pads, etc. Once your wholesale brand starts growing, then you can
expand your market share by adding some bigger items which are in demand.
8. Build Supply Network
By dealing with different products and manufacturers at the same time; it helps you to compare
different aspects of manufacturers like quality, timely delivery, etc. Once you’re familiar with all the
suppliers’ networks, then you can build your own network of suppliers who’ll deliver you the quality
product on time. So, you can deliver the same thing to your customers.
❖ Functions of Wholesale
A wholesaler performs the following functions;
1. Buying and Assembling: Wholesaling begins with choosing a reliable supplier or a manufacturer
and then buying goods and products from him at a bulk quantity; sometimes, it involves importing
products from abroad.
2. Warehousing: Now, the wholesaler has the product, the next step is to store the product in the
warehouse for a considerable time. Once the demand is created in the market, then the wholesaler
can make the product available to retailers and customers.
3. Packaging: As we know that wholesalers buy products in a bulk quantity; then they sub-classify it
into smaller lots or packages to distribute it to the smaller business and retailers by tagging their
wholesaling brand name on it.
4. Transportation: Many wholesalers provide transportation services for the delivery of products
from the warehouse to the retailers; transportation not only adds value to the product but also
makes it easier for the retailers.
5. Financing: A very important function of wholesaling is that the wholesalers usually buy products
from the manufacturers on a cash basis; then they offer credit to the retailers. Both parties are in
short of money; maintaining this cash flow and financing both parties put wholesaler at a very
important position.
6. Risk Bearing: Greater profit of wholesaling also comes with bearing the greater risk as well. For
instance, how long the product has to be stored in the warehouse, some products can be damaged
with time. A wholesaler is the one who absorbs all the risks.
➢ Types of Wholesalers
There are different types of wholesalers who deal with different products; some of them are as
follows;
1. Merchant Wholesalers: Merchant wholesalers are the ones who don’t have any prior knowledge
of the product; what they know is the list of profitable items. They deal with all of the kinds of
goods and products and then sell it to the distributors, resellers, retailers and etc.
2. General Wholesalers: As the name implies, this type of wholesaler often deals with generals
items of different products from a variety of manufacturers and suppliers for a range of customers.
They usually buy product in a bulk quantity, then sell it in a small quantity to the retailers or small
business owners over a period of time.
3. Specialty Wholesalers: Special wholesalers are very knowledgeable about their product because
they are very precise and specific about their product category and industry. They may have
multiple suppliers of the same product category, but the product category and industry doesn’t
change with manufacturers and suppliers.
4. Cash and Carry Wholesalers: Cash and carry wholesalers fall in the line of limited wholesaler’s
type who offers very limited services to their resellers and retailers. It is because of fast-moving and
subtle products like the retailers have to get the product by themselves, no delivery service. For
instance, flowers, fruits, vegetables and etc.
5. Discount Wholesalers: Discount wholesalers usually deal with off seasoned, returned and
discontinued products; then selling it by offering some discounts to attract the retailers and
customers.
6. Dropship Wholesalers: Drop shipping is a type of wholesalers that directly delivers the products
to the customers, but they use the online platform and traffic of retailers to approach their target
customer. In order to do that they sign an online contract with the retailers to make things run
smoothly.
7. Online Wholesalers: This type of wholesaler sells products online by offering a discount on
certain products. They don’t have overhead costs like office, building and etc, by reducing such costs
they make a profit out of a discounted price.
❖ Examples of Wholesalers
The simplest example of wholesale chain includes manufacturer, wholesaler, retailer and consumer.
But there are wholesalers who directly sell to consumers. For example, Costco Wholesale
Corporation offers bulk quantity of goods at a discounted price.
Another example of wholesale business is Amazon and Ali Baba. These two b2b marketplaces
connect manufactures, wholesalers and buyers. Wholesalers attract buyers because they have the
luxury to offer products at lower prices than the retailers and luxury retail store, because they use
warehouses which minimize overhead and marketing cost.
B) Retail Market
What Is Retail?
Retail is the final channel of distribution where small quantities of goods (or services) are sold
directly to the consumer for their own use.
Two key phrases in this definition that separate retail from wholesale are –
• Small quantities of goods: Unlike manufacturing or wholesale, the number of goods
involved in a retail transaction is very less.
• Directly to the consumer: Retail stores are the last channels of distribution where the actual
sales to the customer happen.
1. What Is Retailing?
Retailing is the distribution process of a retailer getting the goods (either from the manufacturer,
wholesaler, or agents) and selling them to the customers for actual use.
In simple terms, retailing is the transaction of small quantities of goods between a retailer and the
customer where the good is not bought for resale purpose.
2. What is A Retailer?
A retailer is a person or a business that sells small quantities of goods to customers for actual use.
Remember –
• Retail is a channel of distribution
• Retailing is a business process
• Retailer is a business or person
3. Importance Of Retailing
Retailing is important for the creators, customers, as well as the economy.
Retail stores are the places where most of the actual sales to the customers take place. They act as
both a marketing tool for the brands and a support tool for the customers to exchange and
communicate important information.
Besides this, retailing is a great asset to the economy. It provides jobs, adds to the GDP, and acts as
a preferred shopping channel during the holiday season.
4. How Retail Works?
Retail works on a simple revenue model of markup. The retailers buy the goods at a cost price, add
up the cost of labour, equipment, and distribution to it along with the desired profit margin, and sell
it at a higher price.
5. Retailing Types
Retailing can be divided into five types. Here are the types of retailing that exists today –
• Store retailing: This includes different types of retail stores like department stores, speciality
stores, supermarkets, convenience stores, catalogue showrooms, drug stores, superstores,
discount stores, extreme value stores etc.
• Non-store retailing: Non-store retailing is a type of retailing where the transaction happens
outside conventional shops or stores. It is further divided into two types – direct
selling (where the company uses direct methods like door-to-door selling) and automated
vending (installing automated vending machines which sell offer a variety of products
without the need of a human retailer).
• Corporate retailing: It involves retailing through corporate channels like chain stores,
franchises, and merchandising conglomerates. Corporate retailing focuses on retailing goods
of only the parent or partner brand.
• Internet retailing: Internet retailing or online retailing works on a similar concept of selling
small quantities of goods to the final consumer, but they serve a larger market and don’t
have a physical retail outlet where the customer can go and touch or try the product.
• Service retailing: Retailers not always sell tangible goods; retail offerings also consist of
services. When a retailer deals with services, the process is called service retailing.
Restaurants, hotels, bars, etc. are examples of service retailing.
6. Characteristics Of Retailing
Retailing can be differentiated from wholesaling or manufacturing because of its certain distinct
characteristics, which include –
• Direct contact with the customer – Retailing involves direct contact with the end customer
and retailers act as a mediator between the wholesaler and the customer or the
manufacturer and the customer depending upon the distribution channels used.
• Relationship with the customers – Retailers form a bond with the customers and help them
decide which products and services they should choose for themselves.
• Stock small quantities of goods – Retailers usually stock small quantities of goods compared
to manufacturers and wholesalers.
• Stock goods of different brands – Retailers usually stock different goods of different brands
according to the demand in the market.
• Customers’ contact with the company – Retailers act as the company’s representatives to
the end customers who give them their feedback and suggestions.
• Have a limited shelf space – Retail stores usually have very limited shelf space and only
stock goods which have good demand.
• Sells the goods at maximum prices – Since retailing involves selling the products directly to
the customers, it also witnesses the maximum price of the product.
7. Functions Of Retailing
Retailers have many important functions to perform to facilitate the sale of products. These
functions include –
a. Sorting
Manufacturers produce large quantities of similar goods and like to sell their inventories to a few
buyers who buy in lots. While customers desire many varieties of goods from different
manufacturers to choose from. Retailers balance the demands of both sides by collecting and
assorting the goods from different sources and placing them according to the customers’ needs.
b. Breaking Bulk
Retailers buy goods from manufacturers and wholesalers in sufficiently large quantities but sell to
the customers in small quantities.
c. Channel Of Communication
Since retail involves direct contact with the end consumers, it forms a very important
communication channel for companies and manufacturers. The manufacturer tries to communicate
the advantages of their products as well as the offers and discounts through retailers.
Retail also acts as a mediator between the company and the customer and communicates the
feedback given by the customers back to the manufacturer or wholesaler.
d. Marketing
Retail stores are the final channels where the actual decisions are made. Hence, they act as
important marketing channels for the brands. The manufacturers execute smart placements,
banners, advertisements, offers, and other strategies to increase their sales in retail stores.
o Retailing Examples
The most common examples of retailing are the traditional brick-and-mortar stores like Walmart,
Best Buy, Aldi, etc. But retailing isn’t limited to them. It also includes small kiosks at the malls, online
marketplaces like Amazon and eBay, and even restaurants which sell food and service.
➢ Retail Marketing Mix: The 6 Ps

As noted earlier, the four Ps of marketing are product, pricing, place, and promotion. The retail
marketing mix adds two more: people and presentation.
Product: The product is the item purchased by a customer. An effective product must capably solve
a customer need or perform a desired function. A product may be combined with related products
and purchased in a set or bundle.
Price: The price of a product is set by the retailer and designates how much money the consumer
pays to receive it. Price can play a role in the popularity of a product, especially if consumers
perceive that a product’s price is low relative to the value it provides.
Placement: Placement refers to where the product is sold. For example, does a retailer sell a
product in its store, on its website or in both places? In addition, some products might be sold in
some stores (like supermarkets) but not other stores (like department stores).
Promotion: Promotion refers to the assorted marketing activities to generate interest in the
product and drive sales. Promotional tactics include advertising, public relations and special sales
(for example, discounts or special offers).
People: People refers to company representatives (for example, employees, contractors, or
partners) who interact with customers in a retail setting. These representatives might answer
questions about products or verify product details, such as availability and sale price. In some retail
settings (for example, the sale of large, flat-screen televisions), people can be directly responsible
for converting “just looking” visitors into purchasing customers.
Presentation: Presentation refers to the experiential design of a retail setting. Presentation
elements include furniture, signage, wallpaper and retail space layout. The Apple Store is known for
its sleek aesthetic and design—an all-glass front side, with long rows of tables featuring Apple
products.
➢ Non-store-based retail marketing

Outside of a physical store, retailers still have a variety of marketing tools at their disposal. These
include traditional choices like catalogs, posters, referrals, and even direct mail. Plus more modern
methods such as websites, social media profiles, and email and SMS campaigns.
• Direct mail: Making sure customers know what you offer is a major hurdle for retail
marketers. Sending out physical catalogs and promotional information might sound old-
fashioned, but it can be a cost-effective option for stores that want to get the word out to
local buyers. Direct mail is ideal for physical stores that cater to a specific location.
• Posters: Posters are often associated with movies, fundraisers, and other events, but they
can be used to advertise almost any discount or promotion. Remember to use text that’s
large enough for viewers to read from at least five or ten feet away.
• TV ads: TV marketing is another good way to get in touch with local consumers. Local TV ads
can be highly targeted, and video content offers a lot more room for creativity compared to
things like posters and mailers.
• Press releases: if you have a unique or interesting offer, such as an event or very special
promotion, you can write press releases for local journalists. They may cover the event or
promotion in their newspapers (or TV news if it’s particularly special) that can drive traffic to
your store.
• Word of mouth: Word-of-mouth marketing is an incredibly valuable resource for both
physical and digital businesses. Consumers trust input from their friends, family members,
and neighbors far more than they trust conventional promotions. Referral programs are an
easy way to incentivize recommendations and generate more referrals from your existing
customer base.
Digital retail marketing

• Website: Even if you don’t sell any products online, it’s important to have a professional
website that illustrates your brand image while giving visitors information about what you
offer. Keep in mind that adding tracking pixels to your site will enable you to leverage
website activity data for use in retargeting campaigns.
• Social media marketing: With nearly 4 billion active social media users on Earth, you can’t
afford to miss out on the large and diverse audience that social media offers.
• SMS marketing: SMS marketing is expected to grow by an average of over 20 percent per
year between 2019 and 2025. When possible, you should give customers the option to
receive your communications through email, SMS, or even other channels. Read our guide
on SMS marketing if you’re considering using this channel.
• Email newsletters: $1 spent on email marketing leads to roughly $42 in return, making it
one of the most lucrative channels out there. A weekly or monthly newsletter will help you
stay connected to your core audience and maximize the lifetime value of each lead.

Definition of Forex Market
The Foreign Exchange Market (Forex Market, FX, or Currency Market) is a worldwide regionalized
market for currency trading. Forex Market regulates the relative values of different currencies. It
involves trading between a range of buyers and sellers around the clock, except for weekends. In
addition, there are dealers from the banking sector & insurance sector who are actively involved
in Forex trading.
Characteristics of the Forex Market

• The enormous trading volume with negligible variation in exchange rates leads to high
liquidity.
• Its allocation is geographical.
• The market operates uninterrupted, i.e., the Forex trading hours are 24 hours a day, except
for weekends.
• The availability and access to information on the Forex Market provide easy surveillance of
Currency prices.
• It retains a low trading cost, which reduces the chance of enduring a loss.
• The usability of leverage to elevate one’s profit or loss margin.
The Three Key Essentials of the Forex Market

• Leverage: In the Forex market, it is known as leverage when a firm avails an amount of debt
or loan to finance its assets. A firm is highly leveraged when it has less equity than debt.
• Margin: It is the minimum installment the trader requires to commence an exchange in the
Forex market. Suppose a trader borrows an amount to obtain or purchase securities or
stocks. Then, it refers to as “buying on margin.”
• Equity: The at-hand balance in a trading account, evaluated after a profit or loss from open
positions, is established as equity.
➢ Participants in the Foreign Exchange Market
a) Forex Dealers
Forex dealers are amongst the biggest participants in the Forex market. They are also known as
broker dealers. Most Forex dealers in the world are banks. It is for this reason that the market in
which dealers interact with one another is also known as the interbank market. However, there are
some notable non-bank financial institutions also that deal in foreign exchange.
These dealers participate in the Forex markets by providing bid-ask quotes for currency pairs at all
times. All brokers do not participate in all currency pairs. Rather, they may specialize in a specific
currency pair. Alternatively, a lot of dealers also use their own capital to conduct proprietary trading
operations. When both these operations are combined, Forex dealers have a significant
participation in the Forex market.
b) Brokers
The Forex market is largely devoid of brokers. This is because a person need not deal with brokers
necessarily. If they have sufficient knowledge, they can directly call the dealer and obtain a
favorable rate. However, there are brokers in the Forex market. These brokers exist because they
add value to their clients by helping them obtain the best quote. For instance, they may help their
clients obtain the lowest buying price or the highest selling price by making available quotes from
several dealers. Another major reason for using brokers is creating anonymity while trading. Many
big investors and even Forex dealers use the services of brokers who act as henchmen for the
trading operations of these big players.
c) Hedgers
There are many businesses which end up creating an asset or a liability priced in foreign currency in
the regular course of their business. For instance, importers and exporters engaged in foreign trade
may have open positions in several foreign currencies. They may therefore be impacted if there is a
fluctuation in the value of foreign currency. As a result, to protect themselves against these losses,
hedgers take opposite positions in the market. Therefore if there is an unfavorable movement in
their original position, it is offset by an opposite movement in their hedged positions. Their profits
and losses and therefore nullified and they get stability in the operations of their business.
d) Speculators
Speculators are a class of traders that have no genuine requirement for foreign currency. They only
buy and sell these currencies with the hope of making a profit from it. The number of speculators
increases a lot when the market sentiment is high and everyone seems to be making money in the
Forex markets. Speculators usually do not maintain open positions in any currency for a very long
time. Their positions are transient and are only meant to make a short term profit.
e) Arbitrageurs
Arbitrageurs are traders that take advantage of the price discrepancy in different markets to make a
profit. Arbitrageurs serve an important function in the foreign exchange market. It is their
operations that ensure that a market as large, as decentralized and as diffused as the Forex market
functions efficiently and provides uniform price quotations all over the world. Whenever
arbitrageurs find a price discrepancy in the market, they start buying in one place and selling in
another till the discrepancy disappears.
f) Central Banks
Central Banks of all countries participate in the Forex market to some extent. Most of the times, this
participation is official. Although many times Central Banks do participate in the market by covert
means. This is because every Central Bank has a target range within which they would like to see
their currency fluctuate. If the currency falls out of the given range, Central Banks conduct open
market operations to bring it back in range. Also, whenever the currency of a given nation is under
speculative attack, Central Banks participate extensively in the market to defend their currency.
g) Retail Market Participants
Retail market participants include tourists, students and even patients who are travelling abroad.
Then there are also a variety of small businesses that indulge in foreign trade. Most of the retail
participants participate in the spot market whereas people with long term interests operate in the
futures market. This is because these participants only buy/sell currency when they have a
personal/professional requirement and dealing with foreign currencies is not a part of their regular
business.
The participants have been listed in descending order. This means that dealers are the most active
traders in the Forex markets, followed by brokers and so on. It would also be fair to say that dealers
have the maximum information about the market, followed by brokers and so on.
➢ Instruments of Forex Market

1. Foreign Exchange Forwards:
A foreign exchange forwards is a contract to deal with the exchange of currencies. It entails an
agreement to buy or sell any specific currency at a predetermined date in the future with a rate
agreed upon, called the forward rate.
In this case, if a buyer and seller agree on an exchange rate for a future date, the transaction will
take place on that date regardless of the market rates. Usually, the buyer & seller decides the
transaction date, and the time period of the trade can be a day, a few days, months, or even years.
2. Currency Futures:
Also known as Foreign exchange (Forex), a Future is a future contract to exchange one currency for
another at a specified date and a future exchange rate. It is similar to a forward contract but with a
few exceptions. Currency futures contracts are traded on exchange markets, and forward contracts
are traded on over-the-counter markets (OTC). In addition, futures contracts are settled down daily
on a market-to-market basis. In contrast, forward contracts are settled only at expiration.
This contract has physical delivery, i.e., the buyer expects the delivery of a specified standard
commodity at a specified location. In this type of contract, an investor can close their contracts any
time before the contract’s delivery date. Investors enter into such types of contracts for speculating
or hedging purposes.
3. Currency Swaps:
Currency swaps are closely related to interest rate swaps; these are traded over the counter and are
known as over-the-counter derivatives. In a foreign currency swap, there is an exchange of
borrowings, where the principal amount and interest payments in one currency are exchanged for
the principal amount and interest payments in another currency. Generally, corporates with long-
term debt or foreign liability enter into currency swaps to get cheaper debt and hedge against
exchange rate fluctuations. Swaps consist of fixed and floating rates of interest. An example of a
swap transaction is, paying a fixed dollar and receiving floating foreign currency, i.e., Pound interest.
4. Currency Options:
In Currency Options, the option writer grants the option holder the right to purchase a specified
Forex market instrument, i.e., currency at a specified price within a specified period. If the option
holder exercises the right, the option writer is obligated. Futures and Forwards contracts confer
obligations on both parties to sell and buy a commodity on an end-specified date. However, an
options contract gives the right to one party and an obligation to the other.
A financial derivative signifies a contract sold by the option writer (seller) to the option holder
(buyer). This type of contract offers the buyer the right but not the obligation to buy or sell a stock
or security at an agreed-upon price on a future specified date. Currency options are of two types,
Call option & Put option. The Call option means the right to buy, and the Put option is the right to
sell.
An investor can hedge against foreign currency risk by purchasing any currency options. For
example, suppose an investor believes that the GBP/INR will increase from 83.00 to 85.00, i.e., it will
become more expensive for an Indian investor to buy Great Britain Pound. Thus, the investor would
buy a call option on GBP/INR to gain from an increase in the exchange rate.
2.3 Quotations- Direct & Indirect Quote, Bid Rate & Ask Rate Cross Rates of Exchange
Nomenclature
Any Foreign exchange market quotation always uses the abbreviation of the currency under
question. There are standard currency keys or currency codes that have been created by
International Standards Organization (ISO). These keys are used for transactions worldwide.
The key is made up of 3 alphabets. The first two alphabets of the key denote the country to which
the currency belongs whereas the third alphabet of the key is the first alphabet of the currency.
Hence, United States dollar is referred to as the USD, Indian Rupee is referred to as INR, Great
Britain Pound is referred to as GBP and the Japanese Yen is abbreviated as JPY.
The exceptions to this rule would be currencies like Euro which is abbreviated as EUR and most
importantly the Swiss Franc which is abbreviated as CHF.
1] Direct Quotation
What is a Direct Quote?
A direct quote is an exchange rate quotation in the foreign exchange market. It quotes a
fixed unit of a foreign currency against a variable amount of the domestic currency. In other
words, a direct quote depicts the amount of foreign currency that can be bought for a
certain unit of the domestic currency. The exact opposite of the direct quote is known as the
indirect quote.
• Meaning: Under this method, the quote is expressed in terms of domestic currency. This
means that the rate expresses how one unit of domestic currency relates to the foreign
currency. Therefore, if unit of the domestic currency were to be exchanged, how many units
of the foreign currency would it beget? This method is also alternatively referred to as the
price quotation method.
Therefore, if the value of the domestic currency increases, a smaller amount of it would have to be
exchanged. Conversely a decline in value would create a situation where a large amount of the
domestic currency would have to be exchanged. Hence, it can be said that the quotation rate has an
inverse relationship with the value of the domestic currency.
The value of the domestic currency is assumed to be 1 in case of a direct quotation. The price being
quoted explains the number of units of foreign currency that can be exchanged for a single unit of
domestic currency.
• Example: An example of direct quotation would be
USD/JPY: 143.15/18
This quote suggests that roughly 143 units of Japanese Yen can be exchanged for 1 unit of United
States Dollar. The two rates provided are bid and ask rates i.e. the different rates at which the
market maker is willing to buy and sell the currency.
• Usage: The direct quote method is one of the most widely used quotation methods across
the world. This is the norm for quoting Forex prices and is assumed de facto until another
method has been explicitly mentioned.
2] Indirect Quotation
What is an Indirect Quote?
An indirect quote is an exchange rate quotation in the foreign exchange market that quotes
a variable amount of a foreign currency against a fixed unit of the domestic currency.
The indirect quote is also popularly referred to as a “quantity quotation.” It basically reflects
the quantity of foreign currency needed to buy a certain unit of the domestic currency.
• Meaning: This method is the opposite of the direct quotation method. Under this method,
the quote is expressed in terms of foreign currency. Therefore this rate assumes one unit of
foreign currency. It then expresses how many units of domestic currency are required to
obtain a single unit of a foreign currency. Sometimes this quote is also expressed in terms of
100 units of foreign currency. This method is often referred to as the quantity quotation
method.
Since this method is quoted in terms of foreign currency, the quoted rate has a direct correlation
with the domestic rate. If the quote goes up, so does the value of the domestic currency and vice
versa.
• Example: An example of indirect quotation would be: EUR/USD: 0.875/79
In this case, the first currency i.e. EUR is the domestic currency. Therefore, the indirect quote refers
to approximately 0.875 EUR being exchanged for 1 unit of USD. Once again the two rates provided
are the bid ask rate i.e. the two different rates at which market makers are willing to buy and sell
the currency.
• Usage: The usage of indirect currency quotation is extremely rare. It is only in the
Commonwealth countries like United Kingdom and Australia that the indirect quotation
method is used as a result of convention.
Direct Quote and Indirect Quote Example
• For example, if the exchange rate between the US dollar and the Chinese yuan is 0.56 yuan
per US dollar, it is a direct quote for China, as the domestic currency for China is represented
per unit of the US dollar (foreign currency).
• Similarly, the exact currency quote above is an indirect quote for the USA, as a USD1.79 per
yuan.
Key Takeaways
• Bid rate is the price at which a potential buyer of an asset is willing to pay to buy it
• Similarly, the ask price gives the minimum price at which the seller is willing to sell the
security
• The difference between the bid rate and ask rate is called the bid-ask spread
➢ What is a Bid Rate?

Bid rate is the price at which a potential buyer of an asset is willing to pay to buy it. Similarly, the ask
price gives the minimum price at which the seller is willing to sell the security. A transaction or trade
occurs when both seller and buyer agree on the same price for the security which is not lower than
the ask price and not greater than the bid rate.
The difference between the bid rate and ask rate is called the bid-ask spread and it is an important
indicator of the liquidity of an asset. Generally, the more liquid an asset is, the less wide is the
spread.
Example of Bid-Ask Quotation
If the price of a security is quoted as Rs 50/Rs51. This means that the market maker is willing to buy
the security at Rs50 and is willing to sell the security at Rs 51.
➢ Cross Rates of Exchange

A cross rate is a foreign currency exchange transaction between two currencies that are both valued
against a third currency. In the foreign currency exchange markets, the U.S. dollar is the currency
that is usually used to establish the values of the pair being exchanged
As the base currency, the U.S. dollar always has a value of one.
When a cross-currency pair is traded, two transactions are actually involved. The trader first trades
one currency for its equivalent in U.S. dollars. The U.S. dollars are then exchanged for another
currency.
Understanding the Cross Rate
In the transaction described above, the U.S. dollar is used to establish the value of each of the two
currencies being traded.
For example, if you were calculating the cross rate of the British pound versus the euro, you would
first determine that the British pound, as of June 6, 2022, was valued at 1.25 to one U.S. dollar,
while the euro was valued at 1.07 to one U.S. dollar.

Exchange rates are one of the most watched and analysed economic measures across the world and
are a key indicator of a country's economic health. The exchange rate can be defined as the rate at
which one country's currency may be converted into another. Rates are not just important to
governments and large financial institutions. They also matter on a smaller scale, having an impact
on the real returns of an investor's portfolio.
There are several forces behind exchange rate movements and it is useful to have a basic
understanding of how these affect one country's trading relationship with other countries. Strong
currencies make a nation's exports more expensive and imports from foreign markets cheaper,
whereas weaker currencies make exports cheaper and imports more expensive. Higher exchange
rates adversely affect a country's balance of trade but lower exchange rates have a positive effect
on it.
➢ Common Factors Affecting Exchange Rates

1. Inflation Rates
Changes in inflation cause changes in currency exchange rates. Generally speaking, a country with a
comparatively lower rate of inflation will see an appreciation in the value of its currency. The price
of goods and services increases at a slower rate when inflation is low. Countries with a continually
low inflation rate exhibit an increasing currency value, whereas a country with higher inflation
typically experiences depreciation of its currency and this is usually accompanied by higher interest
rates.
2. Interest Rates
Interest rates, inflation and exchange rates are all correlated. Central banks can influence both
inflation and exchange rates by manipulating interest rates. Higher interest rates offer lenders a
higher return compared to other countries. Any increase in a country's interest rate causes its
currency to increase in value as higher interest rates mean higher rates to lenders, thus attracting
more foreign capital, which in turn, creates an increase in exchange rates.
3. Recession
In the event a country's economy falls into a recession, its interest rates will be dropped, hindering
its chances of acquiring foreign capital. The consequence of this is that its currency weakens in
comparison to that of other countries, thereby lowering the exchange rate.
4. Current Account/Balance of Payments
A country's current account reflects its balance of trade and earnings on foreign investment. It
comprises of the total number of transactions including exports, imports and debt. A deficit in its
current account comes as a result of spending more of its currency on importing products than
through exports. This has the effect of lowering the country's exchange rate to the point where
domestic goods and services become cheaper than imports, thereby generating domestic sales and
exports as the goods become cheaper on international markets.
5. Terms of Trade
Terms of trade relate to a ratio which compares export prices to import prices. If the price of a
country's exports increases by a higher rate than its imports, its terms of trade will have improved.
Increasing terms of trade indicate a greater demand for a country's exports. This, in turn, results in
an increase in revenue from exports which has the effect of raising the demand for the country's
currency and an increase in its value. In the event the price of exports rises by a lower rate than its
imports, the currency's value will decline in comparison to that of its trading partners.
6. Government Debt
Government debt is public debt or national debt owned by the central government. Countries with
large public deficits and debts are less attractive to foreign investors and are thus less likely to
acquire foreign capital which leading to inflation. Foreign investors will forecast a rise government
debt within a particular country. As a result, a decrease in the value of this country's exchange rate
will follow.
7. Political Stability and Performance
A country's political state and economic performance can affect the strength of its currency. A
country with a low risk of political unrest is more attractive to foreign investors, drawing investment
away from other countries perceived to have more political and economic risk. An increase in
foreign capital leads to the appreciation in the value of the country's currency, but countries prone
to political tensions are likely to see a depreciation in the rate of their currency.
2.5 Exchange Rate Determination

Determination of the Exchange Rate – Meaning
Every nation has a distinct methodology to decide its currency’s exchange rate.. It can be decided
via three methods which are : fixed exchange rate, managed floating exchange rate or pegged
exchange rate, and flexible exchange rate.
1. Flexible Exchange Rate
This exchange rate is decided by the marketplace forces of demand and supply. It is also known as
the floating exchange rate. As represented in the given figure, the exchange rate is decided where
the demand curve converges with the supply curve, that is, at point e on the y-axis. Point q on the x-
axis decides the quantity of US $ that has been demanded and supplied on exchange rate. In a fully
flexible system, the Central banks do not interfere in the foreign exchange marketplace.
2. Speculation
Money, in any nation, is an asset. If Indians credit that the British pound would go high in value
compared to that of the rupee, then they would want to hold pounds. Hence, the exchange rates
also get impacted when people hold foreign exchange in the anticipation that they can accrue
profits from the appreciation of the currency.
3. Exchange Rate and Interest Rates
Another aspect that is significant in deciding the exchange rate is the distinctive interest rates, that
is, the difference between the interest rates between the nations. There are immense amounts of
funds owned by banks, MNCs, and affluent individuals that move around the globe in search of the
highest percentage interest rates.
4. Exchange Rates in the Long Run
The theory of PPP or purchasing power parity is utilised to make long-run anticipations regarding
the exchange rates in a flexible exchange rate structure. Conforming to the theory, if there are no
frontiers to the business like taxes (tariffs on business) and quotas (quantitative constraints on
imports), then the exchange rates must gradually adapt so that the same products cost the same
prices whether quantified in rupees in India, yen in Japan, or dollars in the US, except for the
dissimilarities in terms of transportation.

Purchasing power parity (PPP) is a theory which states that exchange rates between currencies
are in equilibrium when their purchasing power is the same in each of the two countries. This
means that the exchange rate between two countries should equal the ratio of the two countries'
price level of a fixed basket of goods and services. When a country's domestic price level is
increasing (i.e., a country experiences inflation), that country's exchange rate must depreciated in
order to return to PPP.
The basis for PPP is the "law of one price". In the absence of transportation and other transaction
costs, competitive markets will equalize the price of an identical good in two countries when the
prices are expressed in the same currency.

The interest rate parity (IRP) is a theory regarding the relationship between the spot exchange
rate and the expected spot rate or forward exchange rate of two currencies, based on interest rates.
The theory holds that the forward exchange rate should be equal to the spot currency exchange
rate times the interest rate of the home country, divided by the interest rate of the foreign country.
What is interest rate parity?
Interest rate parity is an economic theory which states that the difference between the interest
rates of two countries is equal to the difference between the forward rate and the spot rate of both
the countries.
Spot rate – Also called forex spot rate, it is the current exchange rate or current price of a currency
pair in the market. When you are trading in forex with a broker such as Angel One, you will mostly
trade in the spot rate.
Forward rate – Forward rates are fixed for forward contracts, also known as future contracts. This is
the projected value of a currency pair in a future date.
How interest parity helps in currency trading

Interest rate parity doesn’t always exist because it only occurs when interest rates are the same for
foreign and domestic assets. It is assumed that, if there is any difference in interest rates, it is due to
expected appreciation or depreciation in the foreign or domestic currencies.
For example, if the domestic interest is 8% and foreign interest rate is 5%, this means that the
market expects the foreign currency to appreciate by 3% or conversely investors expect the
domestic currency to depreciate by 3%. Understanding interest rate parity meaning is important if
you are trading in currencies.
How to calculate interest parity?
Interest rate parity is used to calculate the forward exchange rate.
The current exchange rate of a currency pair (e.g. INR/USD) is called the spot exchange rate. The
forward exchange rate is a projection of the two currencies in a predetermined date in the future. A
currency is considered to be trading at a forward premium if the difference between the forward
rate and spot rate (forward rate – spot rate) is positive. If the difference is negative, then the
currency is trading at a forward discount. In the above formula, country A is the foreign currency
and country B is the domestic currency.
Why is interest rate parity important?
For currency traders and other market participants, understanding the interest rate parity
meaning is important because it helps them analyze the direction of currency rates. Interest parity is
based on the premise that money will flow to the country with the higher interest rate and cause
the currency to appreciate in value.
If you are a currency trader, learning about interest rate parity is one of the fundamental steps to
evolving a trading strategy. However, to understand this concept fully, you must first learn basic
concepts such as hedging, forward exchange rates, spot exchange rates, interest rates, etc.
Once you are armed with this knowledge, you can use changes and differences in interest rates of
two countries or currency pairs to your advantage.

What is the International Fisher Effect (IFE)?
The International Fisher Effect (IFE) states that the difference between the nominal interest rates in
two countries is directly proportional to the changes in the exchange rate of their currencies at any
given time. Irving Fisher, a U.S. economist, developed the theory.
The International Fisher Effect is based on current and future nominal interest rates, and it is used
to predict spot and future currency movements. The IFE is in contrast to other methods that use
pure inflation to try to predict and understand movements in the exchange rate.
International Fisher effect principle
Fisher emphasized that interest rates provide a strong indication of the performance of a
country’s currency. In looking at the relationship between the difference in nominal interest rates
and changes in exchange rates, he takes several assumptions:
a. 1. Capital freely flows between countries
b. 2. Real interest rates are the equal between countries in the world
c. 3. Difference in nominal interest rates between countries equals expected inflation
(expected inflation)
d. 4. Capital markets are internationally integrated
e. 5. No currency controls
How to Calculate the Fisher Effect
The formula for calculating the IFE is as follows:
E = [(i1-i2) / (1+ i2)] (i1-i2)
Where:
E = Percentage change in the exchange rate of the country’s currency
I1 = Country’s A’s Interest rate
I2 = Country’s B’s Interest rate

a) Spot Market
A spot market is a financial market where financial instruments and commodities are traded for
instantaneous delivery. Delivery refers to the physical exchange of a financial instrument or
commodity with a cash consideration. The spot market is also known as the cash market or physical
market because cash payments are processed immediately, and there is a physical exchange of
assets.
Types of Spot Markets
There two main types of spot markets – over-the-counter (OTC) and organized market exchange.
1. Over-the-Counter (OTC)
Over-the-counter (OTC) is a place where buyers and sellers meet to trade bilaterally through
consensus. There is no third-party supervisor of a transaction or a central exchange institution to
regulate the trade. Assets being traded may not be standardized in terms of quantity, price, or other
terms, as is the norm on organized exchanges.
Hence, buyers and sellers negotiate all terms of trade and transact on the spot. Prices in OTC
markets may not be published, as trades are largely private. The currency exchange market is the
most active and widely known OTC market.
2. Market Exchanges
In an organized market exchange, buyers and sellers meet to bid and offer financial instruments and
commodities available. Trading can be carried out on an electronic trading platform or a trading
floor. Electronic trading platforms have made trading more efficient, where prices are determined
instantaneously, given the large number of trades in some exchanges.
Exchanges deal in several financial instruments and commodities, or they may carve a niche on
specific types of assets. Trading is usually completed through brokers of the exchange who act as
the market makers. Assets traded on exchanges are standardized, as per the exchange standard.
➢ Advantages of Spot Markets

• Spot markets facilitate trading in a transparent environment, where transactions occur at
prevailing prices that are public information and known to all parties. Basically, it is easier to
execute spot market contracts.
• Traders in spot markets can hold and find a better deal if they are not satisfied with current
prices and terms.
• Trades are done and completed on the spot.
• There may be no minimum capital requirements in spot market transactions compared to
some contracts on the futures market that have minimum investment amounts for a single
contract.
➢ Disadvantages of Spot Markets
• Due to the volatility of some financial instruments and commodities, investors can buy on
the spot at inflated prices before assets find their “true price.” Hence, trading on the spot
market can present significant risks, especially for volatile assets.
• There may be no recourse if a party notices some irregularities in the trade after the spot
market transaction is concluded.
• There is usually a lack of planning in spot trades, as opposed to forwards and futures trading
where parties agree on settlement and delivery at a future date.
• The spot market is not flexible in terms of timing, as parties will have to handle physical
delivery on the spot.
• The interest rate spot market is affected by counterparty default risk.
• Currency trading in spot markets is prone to counterparty risk due to the solvency of the
market maker.
b) Forward Market
Definition of Forward Market
The forward market is the marketplace that sets the price of the assets and the financial
instruments (Bonds, Swaps, Equity, Cap, Futures, Forward rate agreements, Bills of exchange, etc.)
for future delivery and it is used for the trading of financial instruments, in the simple words, the
market where we can sale and purchase financial instruments and assets for the future delivery is
known as forward market.
Explanation
The market which is used for determining the price and used for the sale and purchase of forward
contracts, financial instruments, and assets is known as forward market. Such a market is used for
the trading of instruments. The forward market provides a customization option to the parties to
the contract where they are free to decide the time, quantity, and rate of the contract to be
executed.
Features of Forward Price
The features of the forward market are given below-
• In the forward market, the delivery price is the forward price.
• The contract size depends upon needs and requirements.
• The settlement of the contract is made on the date which is agreed between the parties.
• All the terms of the contracts are negotiated by the parties.
• All the transactions of such a market are done by telephone, with a particular broker.
• All the transactions are made based on the Principal to principal concept.
• All the participants should examine the credit risk and maintain the credit limit for all the
opposite parties.
• If there is any transaction which is made through a broker, a certain amount of commission
is charged from buyer and seller otherwise no commission is charged.
• The participants normally deal with one another but some parties are entered into the
contracts through one or more dealers.
• There is no money transaction until delivery but a small margin deposit may be required of
non-dealer customers on certain occasions.
• In the forward market, trading is mostly unregulated.
How Does It Work?

The forward market is the market that creates forward contracts. One of the main functions of the
forward market is to minimize the risk and fixed the price of an asset or financial instrument for the
future period.
When any party wants to minimize the risk and fixed the price of any asset or financial instrument,
such a person can enter into a contract through the forward market. The forward market offers
forward as well as future contracts.
Example of Forward Market
Mr. A has some financial instruments (Equity/Shares) of a particular company, the price of such
company’s shares is continuously decreasing and he is unsure about the price of such share after 3
months. In this case, he entered into a forward contract with Mr. B by locking the price at which he
will sell such shares to Mr. B in the upcoming 3 months. The market in which such transaction is
made is known as the forward market.
Problems of Forward Market
The forward market has several problems. The main problem of the forward market is “lack of
centralization of trading, liquidity, and counterparty risk. In the case of the forward market, there is
very much difficult to find a similar counterparty who wants to enter into a similar contract. Another
problem with the forward market is flexibility and generality. Normally the contracts which are
made in the forward market are fixed, cannot be canceled i.e. there is a lack of flexibility. In this
market, the contract is made based on certain terms which are based on the very risky issues.
Why Is the Forward Market Important?
The importance of the forward market is given below-
• It is very helpful for the certain corporation and for the individual to hedge their forex
contract to remove the uncertainty of the future.
• It helps the participants to fix the price at which the assets/ financial contracts will be
exchanged.
• It is very helpful to secure the contract and receive/pay a certain amount on a future date.
• It is very helpful for those who want customization for their contracts.
➢ Advantages
The following are the advantages of the forward market:
• Customization- In the forward market, the parties on their own will, may enter and decide
the quantity, time, and rate at the time of delivery as per their need, requirement, and
specification. It is very flexible and convenient for both parties.
• Offers full hedge- It is very advantageous for those parties who have certain commodities
that they need to exchange in future. The forward market provides the full hedge and tries
to avoid various uncertainties by which the party can secure their contracts.
• Over-the-counter products- In the forward market the products are generally dealt with over
the counter. Most of the investor institutional wants to deal with them rather than entering
into the future contracts. Over-the-counter, products give them the advantage of the
flexibility to suit the duration, contract size, and strategy as per their requirements.
• Matching of exposure- Now the parties can match their exposure with the time frame of the
period according to which they can enter in the contract. On the basis of this, they can
customize to suit any party and modify the duration.
➢ Disadvantages
The following are the disadvantages of the forward market:
• Cancellation problems- In the forward market if a contract is entered, it cannot be canceled,
and also being unregulated there are chances that parties become defaulters.
• Finding counterparty- In the case of the forward market, there is very difficult to find a
counter party to enter into a contract.
2.7 Global Derivative Market – Foreign Currency Futures, Option & Swap, Speculation,
Arbitrage, Hedging
1] Global Derivatives
Global derivatives are financial contracts between buyers and sellers for future payment and
delivery of an underlying asset. During the life of the contract, the value of the derivative fluctuates
with the value of the asset. Global derivatives are mainly used to protect against and manage risk.
They also can be used for speculation and investment purposes.
What is the Derivatives Market?
The derivatives market refers to the financial market for financial instruments such as futures
contracts or options that are based on the values of their underlying assets.
Participants in the Derivatives Market
The participants in the derivatives market can be broadly categorized into the following four groups:
1. Hedgers: Hedging is when a person invests in financial markets to reduce the risk of price
volatility in exchange markets, i.e., eliminate the risk of future price movements. Derivatives are the
most popular instruments in the sphere of hedging. It is because derivatives are effective in
offsetting risk with their respective underlying assets.
2. Speculators: Speculation is the most common market activity that participants of a financial
market take part in. It is a risky activity that investors engage in. It involves the purchase of any
financial instrument or an asset that an investor speculates to become significantly valuable in the
future. Speculation is driven by the motive of potentially earning lucrative profits in the future.
3. Arbitrageurs: Arbitrage is a very common profit-making activity in financial markets that comes
into effect by taking advantage of or profiting from the price volatility of the market. Arbitrageurs
make a profit from the price difference arising in an investment of a financial instrument such as
bonds, stocks, derivatives, etc.
4. Margin traders: In the finance industry, margin is the collateral deposited by an investor investing
in a financial instrument to the counterparty to cover the credit risk associated with the investment.
❖ Types of Derivative Contracts

Derivative contracts can be classified into the following four types:
1. Options: Options are financial derivative contracts that give the buyer the right, but not the
obligation, to buy or sell an underlying asset at a specific price (referred to as the strike price) during
a specific period of time. American options can be exercised at any time before the expiry of its
option period. On the other hand, European options can only be exercised on its expiration date.
2. Futures: Futures contracts are standardized contracts that allow the holder of the contract to buy
or sell the respective underlying asset at an agreed price on a specific date. The parties involved in a
futures contract not only possess the right but also are under the obligation, to carry out the
contract as agreed. The contracts are standardized, meaning they are traded on the exchange
market.
3. Forwards: Forwards contracts are similar to futures contracts in the sense that the holder of the
contract possesses not only the right but is also under the obligation to carry out the contract as
agreed. However, forwards contracts are over-the-counter products, which means they are not
regulated and are not bound by specific trading rules and regulations.
Since such contracts are unstandardized, they are traded over the counter and not on the exchange
market. As the contracts are not bound by a regulatory body’s rules and regulations, they are
customizable to suit the requirements of both parties involved.
4. Swaps: Swaps are derivative contracts that involve two holders, or parties to the contract, to
exchange financial obligations. Interest rate swaps are the most common swaps contracts entered
into by investors. Swaps are not traded on the exchange market. They are traded over the counter,
because of the need for swaps contracts to be customizable to suit the needs and requirements of
both parties involved.
▪ Criticisms of the Derivatives Market

1. Risk: The derivatives market is often criticized and looked down on, owing to the high risk
associated with trading in financial instruments.
2. Sensitivity and volatility of the market: Many investors and traders avoid the derivatives market
because of its high volatility. Most financial instruments are very sensitive to small changes such as
a change in the expiration period, interest rates, etc., which makes the market highly volatile in
nature.
3. Complexity: Owing to the high-risk nature and sensitivity of the derivatives market, it is often a
very complex subject matter. Because derivatives trading is so complex to understand, it is most
often avoided by the general public, and they often employ brokers and trading agents in order to
invest in financial instruments.
4. Legalized gambling: Owing to the nature of trading in financial markets, derivatives are often
criticized for being a form of legalized gambling, as it is very similar to the nature of gambling
activities.
2] Foreign Currency Futures

Every country has a currency, and the value of that currency changes all the time in relation to other
currencies. The value of a country's currency is determined by a variety of factors, including the
status of the economy, foreign exchange reserves, supply and demand, and central bank policy.
Investors are attracted to a currency that is stable and strong. NSE Currency futures can be used to
do this.
Currency futures are a forex futures trading instrument with a currency future exchange rate as the
underlying asset, such as the euro to US dollar exchange rate or the British Pound to US dollar
exchange rate. Currency futures are fundamentally the same as all other futures markets (index and
commodity futures markets) and are traded in the same manner.
➢ What are Currency Futures?
Currency futures are based on two different currencies' exchange rates. The euro and the dollar
(EUR/USD) are an example of a currency pair with an exchange rate. The first currency indicated in
the pair is the governing currency.
Futures dealers are concerned about the euro price in this situation. Traders purchase a contract for
a specific amount, and the contract's value fluctuates with the value of the euro.
Currency futures only trade in one contract size, so traders must trade in multiples of that.
➢ Features of Currency Futures
Mentioned below are the key attributes of currency futures prices:
• Underlying Asset: This is the currency exchange rate that has been specified.
• Expiration Date: This is the final settlement for cash-settled futures. It is the date on which
the currencies are exchanged for physically delivered futures.
• Size: The sizes of contracts are all the same.
• Margin Requirement: An initial margin is necessary to enter into a futures contract. A
maintenance margin will be established, and if the original margin goes lower than this level
- a margin call will occur, requiring the trader or investor to deposit money in order to raise
the initial margin over the maintenance margin.
➢ Importance of Investing in Currency Futures
Like other futures - foreign exchange futures can be utilized for hedging or speculative objectives. FX
futures are purchased by a party who knows they will require foreign currency in the future but
does not want to buy it now.
This will function as a hedge against any potential exchange rate volatility. They will be assured of
the FX futures contract's exchange rate when the contract expires, and they need to acquire the
currency.
Similarly - if a party anticipates receiving a cash flow in a foreign currency in the future, they might
use futures to hedge their position.
Speculators frequently use currency futures as well. If a trader believes a currency would appreciate
against another. He or she might buy the FX futures contracts to profit from the fluctuating
exchange rate. Because the initial margin retained is typically a fraction of the contract size, these
contracts can be beneficial to speculators. This effectively allows them to leverage up their position
and increase their exposure to the exchange rate.
Interest rate parity can also be checked using currency futures. If interest rate parity does not hold -
a trader may be able to earn solely on borrowed funds and the utilization of futures contracts by
employing an arbitrage technique.
Due to the opportunity to modify these over-the-counter contracts, currency forwards is frequently
used by investors wishing to hedge a position. Currency futures are popular among speculators
because of their high liquidity and ability to leverage their positions.
▪ Settlements of Currency Futures
A currency futures contract can be settled in one of two ways. The vast majority of the time, buyers
and sellers will take an opposing position to offset the original positions before the last day of
trading (which varies depending on the contract). The profit/loss is credited to or debited from the
investor's account when an opposite position closes the trade before the last day of trading.
Contracts are typically held until the maturity date, after which they are either cash-settled or
physically delivered, depending on the contract and exchange. The physical delivery of most
currency futures takes place four times a year, on the third Wednesday of March, June, September,
and December.
Only a small percentage of currency futures transactions are completed by a buyer and seller
physically delivering foreign money. When a currency futures contract is kept until it expires and is
physically settled, both the applicable exchange and the participant are responsible for completing
the delivery.
3] Option & Swap

▪ What Are Options?
Options is a derivative contract between the buyer and seller. Here, the party to the contract can
either buy or sell but are not obliged or mandated to do so. In futures, the party to the contract has
to fulfill the contract, but in options, the investor has the choice to carry out the deal or not. The
types of options are as follows: call option and put option. This financial derivative is used by the
investors or traders to take leverage of the underlying security at a lower price, resulting in
minimizing the risk exposure.
▪ What Are Swaps?
A swap is another derivative financial instrument used by two parties when they enter into a swap
contract. Here, exchange of cash flows or liabilities takes place between the agreed parties of the
contract. An investor or trader exchanges their financial instrument with another investor or trader
in the swap contract. While cash flow remains constant, the other varies according to the currency
rates, index rates, etc. Swap contracts are done over the counter whereas options are dealt on the
stock exchange. There are many types of swap contracts such as interest rate
swaps, currency swaps, commodity swaps, foreign exchange swaps, credit default swaps, etc. The
major benefit of trading swaps is that investors get to hedge against any kind of risks associated
with the trade.
➢ Options
Right to buy or sell the asset at a pre agreed price at a particular date. Important terms used in this
are exercise date, strike price and option premium. It is in the non-recoverable amount.
• Exercise date - Date on which option should be exercised.
• Strike price - Price at which option should be exercised.
• Option premium - Price paid to acquire option.
The types of options are as follows−
• Call option - At pre agreed date and price, buyer has right to buy financial asset.
• Put option - At pre agreed date and price, buyer has right to sell financial asset.
• Exchange traded instruments - These are traded only in organized exchanges at
standardized investment sizes.
• Over the counter instruments - In absence of structured exchange, these agreements can
materialize.
➢ Swaps
To exchange the financial instruments, parties arrive at an agreement. Cash flow is common swaps.
The different types of swaps are as follows −
• Interest rate swaps - Parties exchange based on notional principal amount to hedge against
interest risk.
• Commodity swaps - Commodity swapped instead of amount. in this one commodity will
have fixed rate and other commodity will have floating rate.
• Foreign exchange - Interest and principal amounts are exchanged based on different
currencies. Generally, it takes place in terms of net present value.
• Plain vanilla - It is the most basic type of swap contract.
▪ Differences
The major differences between options contract and swap contract are as follows −
Sr.No Options contract Swap contract
1 It’s a right to buy or sell financial It’s an agreement between parties to

assets at a set price on a specific exchange financial instruments.
date.
2 Bought or sold through It’s over the counter financial products.

exchange/developed over the
counter.
3 Premium payment is paid. No premium payments are required.
4 Types of options contracts are call Types of swap contracts are interest rate
option and put option. swaps, foreign currency (FX) swaps and
commodity swaps.
4] Speculation
▪ What is speculation?
Speculation (also known as speculative trading) is a financial term that refers to the act of
purchasing an asset (a commodity, good or real estate) that has a substantial risk of losing value but
also holds the hope of gaining value in the near future. An investor who's into
speculative trading purchases an asset in an attempt to gain profit from small fluctuations in the
market. These are high-risk, high gain investments that are made for a short amount of time and
once the investor gets the desired profit, the investment is sold. For example- An investor who
invests in foreign currency buys some currency in the hopes of selling it at an appreciated rate
when market fluctuations happen. This type of speculation is known as currency speculation.
▪ How does speculation work?
Without the prospect of huge gains, there would be next to no motivation to be a part of
speculation trading. There’s a thin line that separates speculation and simple investment which
makes it pretty difficult for the market players to differentiate between them. Real estate is the
perfect example of this. Buying real estate for the purpose of renting it out is
considered investing but buying several apartments with the intention of earning a quick profit by
reselling them after a short duration. Speculation traders provide market liquidity and can narrow
the difference between the bid price and the asking price for an asset in the market. Speculative
trading not only keeps the rampant bullishness in check but also prevents the risk of the formation
of asset price bubbles through betting on successful outcomes.
▪ Types of speculative transactions
There are a number of transactions that facilitate speculative dealing which can be classified into
the following types:
a. Option Dealings Option dealing is an arrangement of the right to buy or sell a specific
number of securities within a prescribed time at a price determined earlier. Options dealing
is a highly risky transaction in securities as their prices change very frequently and very
heavily. Option dealings can be further classified into Call, Put and Call & Put option dealings.
b. Margin Trading In margin trading, the client opens an account with the broker by depositing
a certain amount of securities or cash. The client purchases securities with the funds that he
borrowed from the broker and then the price difference is credited or debited to or from the
client's account.
c. Blank Transfer This is a transfer method in which securities are transferred without
mentioning the name of the transferee. With this process, shares can be transferred any
number of times and finally the transferee who wanted the shares can get them registered
under his/her name saving stamp duty that is charged during transfers.
d. Arbitrage In Arbitrage, speculators earn profit out of the differences in prices of a security in
two different markets. This process is known to level the pricing of that security in those two
markets. It is a highly specialized speculative activity that requires skills.
e. Wash Sales Wash sales are used to create artificial demand in the market which will lead to a
rise in prices. This is done by selling securities and then buying the same securities at a
higher price. Wash sales are sometimes also called fictitious transactions as the only purpose
of these transactions is to jack up the prices.
f. Carry Over or Budla Transactions Carry over transactions are usually done when the prices of
a particular financial instrument move against what the speculator expected. This happens in
the case of forward delivery contracts, the contract is settled on the next settlement
date only if both parties agree to it.
g. Cornering A corner refers to the condition of the market in which the entire supply of a
particular security is controlled by an individual or a group of individuals. The speculators
enter such a market and make purchasing contracts with the bears until they have a
substantial amount of the securities available in the market thus making them go out of the
market. In these cases, bears will struggle to make the delivery on the fixed date. This
process turns a bear into a lame duck.
h. Rigging the Market Rigging as the name suggests means forcing the price of a security in the
market to go up. This process is generally carried out by the Bulls in the market. When the
security reaches the desired prices they sell their securities and earn a substantial profit.
5] Arbitrage
Arbitrage is an investment strategy in which an investor simultaneously buys and sells an asset in
different markets to take advantage of a price difference and generate a profit. While price
differences are typically small and short-lived, the returns can be impressive when multiplied by a
large volume. Arbitrage is commonly leveraged by hedge funds and other sophisticated investors.
▪ Types Of Arbitrage
1. Pure Arbitrage
Pure arbitrage refers to the investment strategy above, in which an investor simultaneously buys
and sells a security in different markets to take advantage of a price difference. As such, the terms
“arbitrage” and “pure arbitrage” are often used interchangeably.
Many investments can be bought and sold in several markets. For example, a large multinational
company may list its stock on multiple exchanges, such as the New York Stock Exchange (NYSE) and
London Stock Exchange. Whenever an asset is traded in multiple markets, it’s possible prices will
temporarily fall out of sync. It’s when this price difference exists that pure arbitrage becomes
possible.
Pure arbitrage is also possible in instances where foreign exchange rates lead to pricing
discrepancies, however small.
Ultimately, pure arbitrage is a strategy in which an investor takes advantage of inefficiencies within
the market. As technology has advanced and trading has become increasingly digitized, it’s grown
more difficult to take advantage of these scenarios, as pricing errors can now be rapidly identified
and resolved. This means the potential for pure arbitrage has become a rare occurrence.
2. Merger Arbitrage
Merger arbitrage, also called risk arbitrage, is a type of arbitrage related to merging entities, such as
two publicly traded businesses.
Generally speaking, a merger consists of two parties: the acquiring company and its target. If the
target company is a publicly traded entity, then the acquiring company must purchase the
outstanding share of said company. In most cases, this is at a premium to what the stock is trading
for at the time of the announcement, leading to a profit for shareholders. As the deal becomes
public, traders looking to profit from the deal purchase the target company’s stock—driving it closer
to the announced deal price.
The target company’s price rarely matches the deal price, however, it often trades at a slight
discount. This is due to the risk that the deal may fall through or fail. Deals can fail for several
reasons, including changing market conditions or a refusal of the deal by regulatory bodies, such as
the Federal Trade Commission (FTC) or Department of Justice (DOJ).
In its most basic form, merger arbitrage involves an investor purchasing shares of the target
company at its discounted price, then profiting once the deal goes through. Yet, there are other
forms of merger arbitrage. An investor who believes a deal may fall through or fail, for example,
might choose to short shares of the target company’s stock.
3. Convertible Arbitrage
Convertible arbitrage is a form of arbitrage related to convertible bonds, also called convertible
notes or convertible debt.
A convertible bond is, at its heart, just like any other bond: It’s a form of corporate debt that yields
interest payments to the bondholder. The primary difference between a convertible bond and a
traditional bond is that, with a convertible bond, the bondholder has the option to convert it into
shares of the underlying company at a later date, often at a discounted rate. Companies issue
convertible bonds because doing so allows them to offer lower interest payments.
Investors who engage in convertible arbitrage seek to take advantage of the difference between the
bond’s conversion price and the current price of the underlying company’s shares. This is typically
achieved by taking simultaneous positions—long and short—in the convertible note and underlying
shares of the company.
Which positions the investor takes and the ratio of buys and sells depends on whether the investor
believes the bond to be fairly priced. In cases where the bond is considered to be cheap, they
usually take a short position on the stock and a long position on the bond. On the other hand, if the
investor believes the bond to be overpriced, or rich, they might take a long position on the stock
and a short position on the bond.
6] Hedging
What is Hedging?
To grasp the concept of hedging in Stock Market, consider it as a type of insurance. When people
opt to hedge, they are protecting themselves against the financial effect of a negative event. This
does not preclude all bad occurrences from occurring. However, if a bad event occurs and you are
adequately hedged, the impact of the occurrence is mitigated.
Hedging happens nearly everywhere in practice. When you get homeowner’s insurance, for
example, you are protecting yourself against fires, break-ins, and other unanticipated calamities.
What is Hedging in the Stock Market?
Hedging is the purchase of one asset with the intention of reducing the risk of loss from another
asset. In finance, hedging is a risk management technique that focuses on minimizing and
eliminating the risk of uncertainty. It aids in limiting losses that may occur as a result of
unforeseeable variations in the price of the investment. It is a typical strategy used by stock
market participants to protect their assets from losses. This is also done in the places listed below:
Weather: It is also one of the areas in which hedging is an option.
Interest rate: It consists of lending and borrowing rates. Interest rate risks are the hazards
connected with this.
Currencies: Foreign currencies are included. There are numerous dangers connected with it, such as
currency risk, volatility risk, and so on.
Securities: It covers investments in stocks, equities, indexes, and so on. These hazards are referred
to as equity risk or securities risk.
Commodities: Agricultural items, energy products, metals, and so on are all included. Commodity
risk is the risk associated with these.
➢ What’s a Hedge Fund?
The hedge fund manager gets money from an outside investor and then invests it according to the
plan provided by the investor. There are funds that concentrate on long-term equities, buying only
common stock and never selling short. There are other funds that invest in private equity, which
entails purchasing entire privately owned firms, typically taking over, upgrading operations, and
ultimately supporting an IPO. There are hedge funds that trade bonds and also invest in real estate;
some invest in specific asset classes such as patents and music rights.
➢ Types of Hedges:
Hedging is widely classified into three kinds, each of which will assist investors in making money by
trading different commodities, currencies, or securities. They are as follows:
Forward Contract: It is a non-standardized agreement between two independent parties to
purchase or sell underlying assets at a certain price on a predetermined date. Forward contracts
include contracts such as forward exchange contracts for currencies, commodities, and so on.
Futures Contract: It is a standardized agreement between two independent parties to acquire or sell
underlying assets at a predetermined price on a certain date and amount. A futures contract
includes a variety of contracts such as commodities, currency futures contracts, and so on.
Money Markets: It is a key component of financial markets that involves short-term lending,
borrowing, purchasing, and selling with a maturity of one year or less. It encompasses a wide range
of financial transactions such as currency trading, money market operations for interest, and calls
on stocks where short-term loans, borrowing, selling, and lending occur with maturities of one year
or more.
▪ Advantages of Hedging
i. It can be used to secure profits.
ii. Allows merchants to endure difficult market conditions.
iii. It significantly reduces losses.
iv. It enhances liquidity by allowing investors to invest in a variety of asset classes.
v. It also saves time since the long-term trader does not have to monitor/adjust his portfolio in
response to daily market volatility.
vi. It provides a more flexible pricing strategy since it necessitates a lesser margin expenditure.
vii. On effective hedging, it provides the trader with protection from commodity price changes,
inflation, currency exchange rate changes, interest rate changes, and so on.
viii. Hedging using options allows traders to employ complicated options trading techniques in
order to optimize profit.
ix. It contributes to increased liquidity in financial markets

a) Two Point Arbitrage
Buying a currency in one market and selling it at higher price in another geographically different
market is called two-point arbitrage.
Normally exchange rate for a given currency should be same in every part of the world. However,
due to some discrepancies in the market the prices might be differ in various markets and in such
case, arbitrageur would buy the currency in the market where its price is lower and then sell the
currency in the market where its price is higher.
If the exchange rate differential is higher than the transaction cost, an arbitrage profit can be made.
Two point arbitrage is totally different from Covered Interest Arbitrage, where arbitrager takes
advantage of interest rate differential between two countries.
b) Triangular Arbitrage
Triangular arbitrage is the simultaneous buying and selling of three different currencies and
attempts to exploit inconsistencies between their exchange rates. Profits can arise when the cross
rates of the three currencies do not really match.
Understanding the situation with the help of an example might help.
Let’s say, on a particular date, EUR/USD is trading at a rate of 0.8667.
The exchange rate between USD/GBP is 1.5027
And, EUR/GBP for 1.3020
In the above scenario, the Euro is undervalued against the Pound, creating an opportunity for
arbitraging.
You can calculate the cross-currency rate = 0.8667x 1.5027 or 1.3024
To initiate a triangular arbitraging spread, the trader must undertake the following actions.
Sell dollars for euros, while simultaneously selling euros for ponds. And to complete the final leg,
sell pounds for dollars. Here is how it takes place.
Selling dollars for euros $1000,000 x 0.8667= € 8,66,700
Selling euros for pounds € 8,66,700 x 1.3020 = £11,28,443
Selling pounds for dollars £11,28,443 x 1.5027= $16,95,711
The process of orchestrating a triangular arbitrate involves several steps.
– Identifying a triangular arbitraging opportunity – it occurs when the quoted exchange rate doesn’t
match the cross-currency exchange rate
– Calculating the difference between the cross-rate and implied cross-rate
– If a difference is present at the prices calculated in the step above, then trade the base currency
for the other currency
– The next step involves trading the second currency for a third
– In the final step, the trader converts the third currency back into the initial currency, and after
calculating the costs involved in trading, earns a net profit

The Foreign Exchange Market is a market where buyers and sellers trade foreign currencies. Simply
stated, a foreign exchange market is a market where various countries' currencies are bought and
sold.
The FOREX market trading is a financial network that allows for global exchanges. The key functions
of the foreign exchange market, which are the product of its operation, are as follows:
1. Function of Transfer
The movement of funds (foreign currency) from one country to another for payment settlement is
the most essential and noticeable feature of the foreign exchange market. It essentially involves
the exchange of one currency for another, with FOREX's function being to shift purchasing power
from one country to another.
For example, if an Indian exporter imports goods from the United States and the payment is to be
made in dollars, FOREX trading online would facilitate the conversion of the rupee to the dollar.
Credit instruments such as bank drafts, foreign exchange bills, and telephone transfers are used to
carry out the transfer purpose.
2. Function of Credit
FOREX offers importers a short-term loan to help with the seamless transfer of products and
services from one country to the next. An importer can fund foreign purchases with credit. If an
Indian company wants to buy machinery in the United States, it can pay for it by issuing a bill of
exchange in the foreign exchange market with a three-month maturity.
3. Function of Hedging
A foreign exchange market's third role is to hedge foreign exchange risks. Foreign exchange
participants are also concerned about variations in exchange rates, or the price of one currency in
terms of another. The party affected by the change in the exchange rate could benefit or lose
money.
As a result of this, FOREX trading online offers services for hedging expected or current
claims/liabilities in return for forward contracts. A forward contract is a 12-week deal to purchase or
sell foreign exchange for another currency at a price decided upon today at a future date. As a
consequence, no money is exchanged during the contracting process.

▪ What is Foreign Exchange Risk?
Foreign exchange risk, also known as exchange rate risk, is the risk of financial impact due to
exchange rate fluctuations. In simpler terms, foreign exchange risk is the risk that a business’
financial performance or financial position will be impacted by changes in the exchange rates
between currencies.
Foreign exchange risk refers to the risk that a business’ financial performance or financial position
will be affected by changes in the exchange rates between currencies
▪ Three Types of Foreign Exchange Risk
There are three main types of foreign exchange risk that can affect your business.
Transaction Risk – Transaction risk is the simplest and most common foreign exchange risk. It
occurs when the actual transaction takes place. The risk comes from the possibility of the rates
changing so that the value of the currency is different than when the transaction started.
Transaction risk is directly related to the delay between committing to a deal and actually making
payment. The longer the time period between the agreement to make payment and the payment
actually occurring, the greater the risk of the value of your currency going down, so that you end up
paying more than what you initially intended.
Economic Risk – This is also known as operating exposure. Economic risk is the risk of a company’s
value being affected by changing currency rates, and is the most complex type of foreign exchange
risk. Any organization that does business internationally will be exposed to economic risk. However,
a company must take measures to protect itself from fluctuations, or it carries the risk of
depreciating currency and value. There can be a considerable impact on a company’s market value
due to the possibility of volatile movement in the foreign currency market.
Translation Risk – This is also known as accounting exposure and affects multinational companies
that have holdings or are operating in other countries. Translation risk happens due to the
translation of the books into the home currency from another currency. Changes in the exchange
rate between the currency in which a company reports and the currency in which it has its assets
and liabilities can lead to big impacts on the balance sheet. Translation risk occurs during financial
reporting of foreign operations that are reported in the home currency. While translation risk can
have a large negative impact on a company’s financial results, balance sheet hedging can mitigate
this risk.
Unit 3. International Accounting
3.1.1. Introduction, Advantages of adopting IFRS, Applicability
3.1.2. Comparison of IFRS and Ind –AS

3.1.1. Introduction, Advantages of adopting IFRS, Applicability
▪ Introduction
With the aim of forming one uniform accounting standard, a London based board known as the
International Accounting Standards Board (IASB) issued International Financial Reporting Standards
(IFRS). They are principle-based standards that outline the broad rules and regulations for financial
reporting.
Currently, our global economy is extremely integrated. Companies raise capital from across
the globe. They also market and sell their products in various countries. This results in them having
tax liabilities in various countries as well. And so this has lead to a demand for a global standard for
accounting.
The ultimate goal of the IFRS is to provide a common global language for global business via
standardized accounting. So if a company has dealings in several countries it only publishes one set
of financial statements that fulfill the statutory requirements of all the countries it operates in. Also
if there is a global standard then it becomes much easier for users of these financial statements to
compare them.
Advantages of adopting IFRS
1] Beneficial to the Economy: If the accounting standards are converged it will promote
international business and increase the influx of capital into the country. This will help India’s
economy grow and expand. International investing will also mean more capital for domestic
companies as well.
2] Beneficial to Investors: Convergence is a boon for investors who wish to invest in foreign markets
or economies. It makes it much easier for them to study and compare the financial statements of
foreign companies. Since the financial statements are made using the same set of standards it is
also easier for the investors to understand and analyze them.
3] Beneficial to the Industry: With globally accepted standards the industry can also surge ahead.
So convergence is important for the industry as well. It will allow the industry to lower the cost of
foreign capital. If companies are not burned by adopting two different sets of standards it will allow
them easier entry into the market.
4] More Transparency : Convergence will benefit the users of the financial statements as well. It will
make it easier for them to understand the financial statements. And this will generate better
transparency and raise the confidence of the investors to invest funds.
5] Cost Saving: Firstly it will exempt companies from maintaining separate accounting books
according to separate standards. This will save a lot of work hours and money for the finance
department. And also planning and executing auditing will also become easier.
3.1.2. Comparison of IFRS and Ind –AS

IND AS has maintained some general differences with the international financial reporting standards
(IFRS):
1. IND AS uses terms different from international financial reporting standards (IFRS). For
example, the term “balance sheet” is used instead of “statement of financial position”, and
the term “statement of profit and loss” is utilized rather than “statement of comprehensive
income.” The words “approval of the financial statements for the issue” is used instead of
“authorization of the financial statements for the issue” in the milieu of financial statements
considered for events after the reporting period.
2. Under international financial reporting standards (IFRS) 1, transitional provisions in other
international financial reporting standards (IFRS) do not appeal to a first-time adopter’s
transition to international financial reporting standards (IFRS) unless otherwise permitted by
international financial reporting standards (IFRS). Indian accounting standards (IND AS) do
not contain transitional provisions of corresponding IFRS/IND AS standards.
Points of difference between IFRS (international financial reporting standards) and IND AS (Indian
accounting standards) are as follows:
Topic IFRS IND AS
IFRS stands for international IND AS stands for Indian

financial reporting standards; it is accounting standards; it is
Definition
a globally recognized accounting additionally known as India
standards. specific version of IFRS.
International accounting Ministry of corporate affairs

Developed by
standards board (IASB) (MCA)
Followed by 144 countries across the world Followed only in India
Companies acting in accordance Such disclosure is not mandatory

with IFRS have to disclose as a for companies complying with
Disclosure
note that the financial statements Indian accounting standards or
comply with IFRS. IND AS.
It comprises of the following:
It comprises of the following: 1. Balance Sheet
1. Statement of financial position. 2. Profit and loss account
Financial 2. Statement of profit and loss. 3. Cash flow statement
statement 3. Statement of changes in equity 4. Statement of changes in
components for the period. equity
4. Statement of cash flows for the 5. Notes to financial statements
period. 6. Disclosure of accounting
policies
Companies acting in accordance Companies complying with IND

with IFRS need specific guidelines AS don’t need to have such
Balance sheet for preparing balance sheets with conditions for balance sheet
format assets and liabilities to be format, but the specifications are
categorized as current and non- defined for presenting balance
current. sheet.

Ind AS 1: Presentation of Financial Statements
PUBLISHED ON:March 3, 2021PUBLISHED IN:Accounting & Bookkeeping
Ind AS 1 is a basic standard, which prescribes the overall requirements for the presentation of
general purpose financial statements, i.e. components of financial statements, like, balance sheet,
statement of profit and loss, statement of cash flows and notes comprising significant accounting
policies, etc. Further, the standard prescribes the minimum disclosures that are to be made in the
financial statements and explains the general features of the financial information. The presentation
requirements specified in the standard are supplemented by the recognition, measurement and
disclosure requirements set out in other Ind AS for specific transactions and other events.
Objective
This standard determines the basis for the presentation of general purpose financial statements to
ensure equivalence:
• With the entity’s financial statements of preceding periods
• Financial statements of other entities.
It sets out general requirements for the presentation of financial statements, guidelines for their
structure and minimum requirements of their content.
Scope
• This standard claims to all types of entities, including those that present:
i. Consolidated financial statements underInd AS 110 consolidated financial statements; and
ii. Financial statements that are separated underInd AS 27.
• This standard does not apply to the structure and content of compressed interim financial
statements prepared underInd AS 35 except for para 15 to 35 of Ind AS 1.
• This standard uses expressions that are suitable for profit-oriented entities, including public
sector business entities.
• Suppose entities with not for profit activities in the private sector or the public sector apply
this standard. In that case, they may need to amend the descriptions used for particular line
items in the financial statements and the financial statements themselves.
• Similarly, the institution that does not have equity as defined in Ind AS 32 financial
instruments
• Presentation and entities whose share capital is not equity may need to adapt the financial
statement presentations of members’ and unit holders’ interests.
Components of financial statements
The financial statements shall comprise:
• The balance sheet at the end of the period
• Statement of profit and loss for the period
• Statement of changes in equity for the period
• Statement of cash flows for the period
• Notes including a summary of significant accounting policies and other explanatory
information
• Relative information in respect of the preceding period as specified in paragraphs 38 and
38A
• The balance sheet as at the beginning of the preceding period when an entity applies an
accounting policy retrospectively
All statements are essential to be presented with equal eminence.
Structure and content
Financial statements must be identified and distinguished from other information in the same
published document and must specify:
• Name of the reporting entity
• Whether the financial statements support the individual entity or a group of entities
• The date of the financial statements
• The presentation currency
• The level of rounding up, if any
Balance sheet
• Present Current and non-current items separately; or
• Present items in order of liquidity i.e. current and non- current assets / liabilities
Reporting period
• Accounts presented at least annually
• If longer or shorter, the entity must disclose the fact.
Statement of cashflows
• Provides user of financial statements with cash flow information- refer to IND AS 7,
statement of cash flows.
Statement of profit & loss
• An entity shall present a single declaration of profit and loss, with profit or loss and other
inclusive income presented in two sections.
• Entities shall present an analysis of expense recognized in profit or loss using a classification
based on the expense method’s nature.
Statement of changes in equity
Information required to be presented:
• Total income for the period, showingseparately explicable to owners or the parent and non-
controlling interest.
• For each constituent of equity, the effects of reflective application/restatement recognized
under IND AS 8,accounting policies, changes in accounting estimates and mistakes.
• Each component in equity reconciliation between the carrying amount at the beginning and
end of the period wasindividually disclosing each change.
• Amount of portionacceptedas distributions to owners during the period

Transfer pricing can be defined as the value which is attached to the goods or services transferred
between related parties. In other words, transfer pricing is the price that is paid for goods or
services transferred from one unit of an organization to its other units situated in different countries
(with exceptions).
Transfer pricing is the internal price system used by related parties. It decides the tax rate that must
be paid and the reported amount of profit. Transfer pricing is crucial for taxpayers and the tax
authorities of both countries.
They are accountable for managing the flow of cross-border transactions within a multinational
corporation (MNCs). We should determine the transfer cost for group companies at an arm's length
rate, and that is the amount that a third party would be able to pay.
The OECD has developed guidelines for how to determine the transfer price. The majority of tax
jurisdictions worldwide adhere to and integrate into their tax laws.
▪ The Arm's Length Principle
All countries have vast variations regarding tax rates. These variations incentivise multinational
corporations to transfer profits from countries with high tax rates to countries with fewer tax
burdens. Profit shifting is easily accomplished through internal transactions. It may include:
a. Manufacturing divisions that give the final product to a distribution branch
b. The holding company that provides financial or consulting services to its affiliates.
c. An associated company is providing services to an additional.
The MNCs can set prices and manage their terms of transactions. Hence, they influence the amount
of profit earned and the consequent amount of tax payable. To avoid this, tax authorities developed
the principle of arm's length, which stipulates that transactions controlled by the tax authorities are
conducted at market prices. The arm's length principle could be defined as "entities connected by
control, management or capital through their controlled transactions.
It should be able to agree on the identical terms and conditions by other entities that are not
related for similar uncontrolled transactions". If this is the case, it is possible to conclude that the
conditions and terms of the specific transaction are at arm's length'.
▪ Transfer Pricing Methods
Traditional methods of analysing transactions highlight each transaction specifically compared to
the overall shape of profit for connected entities in the ALP. OECD Guidelines submit the following
methods as a method for transactions.
a. Comparable Uncontrolled Price (CUP) method
b. Resale Price Method (RPM)
c. Cost-Plus Method (CP method )
Transfer pricing applies during a contract with two or more enterprise associate parties. It is a way
of acting like they are not connected, meaning that there isn't any question of a conflict of interest.
It is easy to explain this as a deal between two independent parties. OECD implemented the
guidelines for the transfer pricing of multinational corporations and tax authorities in 1995. The
guidelines of OECD are widely appreciable. We should decide on transfer pricing under the principle
of the arm's length within the pricing of transfers. Therefore, the price determined is the arm's
length pricing (ALP). According to ALP, the two types of methods for pricing transfers are:
1. Traditional transaction method
2. Methods to earn profit from transactions or non-transacting methods.
▪ Comparable Uncontrolled Price (CUP) Method
This method is where the price in an uncontrolled transaction with comparable entities is
acknowledged and compared with the confirmed price of the entity to determine the arm's length
principle. The CUP method in transfer pricing is the most reliable proof of ALP. The following can
trigger an arm's length cost:
1. Taxpayers or other members from the affiliate group sell the product with comparable sizes
and in similar terms to ALP on similar markets for promotion (internal similar).
2. An ALP company sells the same product in the same quantities and under similar conditions
to other arm's length parties on comparable markets (an external similar).
3. The taxpayer purchases the same quantities in similar amounts and at the same terms from
the associate parties on the markets comparable to them (internal similar).
4. An ALP party purchases the products in similar quantities and with similar terms from an
arm's-length associate in markets similar to the one they are competing with (external
similar).
▪ Resale Price Method (RPM)
The RPM method is akin to CPM. This technique helps when the vendor provides similarly low value
to the goods that associate companies own. In this case, the arm's length price is calculated by
subtracting the gross profit mark-up by the sale price charged to the free entity.
The resale price approach begins with the resale price for arm's-length entities (of the goods
purchased from a non-arm's length company ) which is reduced by a comparable gross margin. A
similar gross margin is established through reference to:
• The price margin for resales earned by an arm's length company in similar transactions that
are not controlled (external similar).
• The profit on resales by a member or group of members in comparable uncontrolled
transactions (internal similar) or
▪ Cost Plus Method (CPM)
The cost-plus method contrasts gross profits with the sales cost. Firstly, you determine the costs the
supplier incurred in the translation. To get the perfect transfer price, you need to add an
appropriate mark-up to this cost.
The more similarity in the risks, aspects and properties, the more likely the cost-plus method will
estimate the arm's length outcome.
▪ Profit Split Method (PSM)
This method is a good way to satisfy the principle of arm's length. It compares the earnings earned
by the parties involved in similar unregulated transactions. PSM is the most suitable method to use
on the services from associated enterprises (AE) within a specific transaction. Firstly, the combined
net profit of all associated enterprises engaged in international or specified domestic transactions is
computed. Then, the contribution proportional to every associated enterprise is assessed by
performing a Functions, Assets and Risks (FAR) analysis. This net profit is divided between the
associated enterprises according to their contributions.
The guidance note on transfer pricing suggests a different approach in which a base return will be
first distributed to AEs considering market forces. The remaining profits will then be divided among
associated enterprises as described above. This method is useful when an associated enterprise
uses exclusive intangibles.
▪ What is Transfer Pricing Audit?
With different requirements in various taxes, determining the appropriate price for transfer is often
a tedious job. Tax authorities from both regional and local tax authorities conduct comprehensive
price checks of financial records to ensure that the business follows the regulations. Audits
on transfer pricing are vital, and tax authorities determine who they will audit and who they do not.
There should be no risks if a business can prove its transfer pricing policies with solid and
substantiated documents.
▪ Transfer Pricing is a Risk
1. Many extra costs are incurred in the form of manpower and time needed to execute transfer
prices and maintain an accounting system to facilitate the process. Pricing for transfers can
be a time-consuming method.
2. There may be disagreements among the departments of an organisation about the policies
on transfer pricing and price.
3. Buyers and sellers pay various duties. Therefore, they are both subject to different risks. For
example, the seller might not assure the item. However, the customer payment paid will
affect this difference.
4. It is difficult to determine the cost of intangible products.
The Benefits of Transfer Pricing
1. Taxes on corporate income in countries with high tax rates by charging more for goods
shipped to countries with lower tax rates can help companies get better profit margins.
2. Transfer pricing assists in reducing the cost of sending goods into countries with high tariffs
using low transfer prices to ensure that the duty base of these transactions lessens.
Unit 4. Financing Foreign Operations
4.1.2 EXIM Bank
4.1.3 Recent amendments in EXIM policy
4.4 Eurocurrency Market -
4.4.2 Domestic Issues Vs. Euro Issues

▪ Introduction
Foreign Trade implies a trade transaction between two parties, each one of whom is located in a
different country. In other words, trading between two different countries is referred to as foreign
trade. It is to be distinguished from the home trade, which takes place within the frontiers of the
same country. The basic task of financing the foreign trade is similar to that of the home trade i.e. to
receive payments from the buyers and to make payments to the sellers. This task is largely
performed through the instrument of bills of exchange, which are called foreign bills of exchange.
Banks play an important role in facilitating the process of receipt of payments in case of foreign
trade. But the international character of foreign trade gives rise to a number of problems which
render the task of financing complicated. These complexities are as follows:
1) Lack of uniformity in the currencies of the two countries;
2) Lack of personal contacts between the buyers and the sellers;
3) Variations in the trade practices and usages in the two countries; and
4) Different legal and regulatory systems in the two countries.
Hence banks adopt their practices and techniques to suit the needs of financing the foreign trade.
Letters of credit play an important role in financing the foreign trade. Reserve Bank of India provides
refinance to the banks at concessional rate. Export Import Bank also provides refinance in respect of
medium term export credit and directly extends export credit. Guarantees issued by Export Credit
Guarantee Corporation of India facilitate the task of financing the foreign trade. First we shall study
the procedure adopted by banks in this regard.
▪ Documentation
Export Procedure
In general, an export procedure initiates with the willingness to send the goods and services to
other foreign nations at some price, these procedures of export are stated below:
• Step 1: Receipt Order: The Indian exporter will receive the order either directly from the
importer or through the indent houses.
• Step 2: Obtaining License and Quota: After receiving the order from the importer, the
Indian exporter is required to obtain an export license from the Government of India, for this
the exporter needs to apply to the Export Trade Control Authority and get a valid license for
this.
• Step 3: Letter of Credit: The exporter then asks the importer for the letter of credit, if the
importer does not send the letter of credit along with the order.
• Step 4: Fixing the Exchange Rate: The rate at which the home currency can be exchanged
with the foreign currency is then fixed. The foreign exchange rate fluctuates from time to
time so they need to fix the rate of exchange.
• Step 5: Foreign Exchange Formalities: As per the Foreign Exchange Regulation Act of India
(FERA), every exporter of the goods is required to furnish a declaration in the form
prescribed in a manner in the Act.
• Step 6: Preparation for Executing the Order: The exporter should make the required
arrangements to execute the order:
• Step 7: Formalities by a Forwarding Agent: Then the formalities are to be performed by the
agent which includes obtaining a permit from the customs department, preparing the
shipping bill, paying the dues after disclosing the required details of the product being
exported.
• Step 8: Bill of Lading: The Indian exporter of the goods presents the receipt copy to the
shipping company and issues the Bill of Lading.
• Step 9: Shipment Advice to the Importer: The Indian exporter sends shipment advice to the
importer of the goods to inform him about the shipment of the goods.
• Step 10: Presentation of Documents to the Bank: The Indian exporter needs to confirm that
he possesses all the necessary shipping documents.
• Step 11: The Realization of Export Proceeds: The exporter of the goods needs to comply
with banking formalities after submission of the bill of exchange.
▪ Export Procedure and Documentation
In the previous section, we have learned about the export procedure formalities here we will know
about the documentation necessary -
• Step 1: Receive an Inquiry: The first step in the shipping documentation process is when
someone urges them to buy products.
• Step 2: Screen the Potential Buyer and Country: After you receive the inquiry from the
buyer, the process is to check their business potentiality to do business with them.
• Step 3: Provide a Proforma Invoice: After screening the buyer, we need to provide
the proforma invoice for the transaction.
• Step 4: Finalize the Sale: The buyer will either reject or accept your proposal thus finalizing
the sale.
• Step 5: Prepare the Goods and the Shipping Documents: Commercial Invoice, Packing List,
Certificate of Origin, Shipper's Letter of Instruction, Bills of Lading all need to be prepared
• Step 6: Run a Restricted Party Screening : Again, the process needs to be run, before the
goods ship for export.
• Step 7: Miscellaneous Forms and Ship Your Goods: There may be other documents that
need to be prepared before exporting the goods.
▪ Documents Required for Exporting

When deciding which documents are necessary for an export procedure, the best place to start is
with your overseas customer/importer or a freight forwarder. You may help your customer in
clearing items with customs in the target market by gathering precise information. Commonly used
expert documents are:
1. Pro Forma Invoice- The document provides a description of the products, such as Price,
quantity, weight, kind, and so on, and is a statement by the seller to provide the customer
with the products and services at the given date and price. 
2. Commercial Invoice- The commercial invoice is a legal document that is exchanged between
the seller and the buyer that clearly outlines the items being sold as well as the price the
customer is to pay.
3. Packing List- This list includes the invoice number, seller, buyer, shipper, carrier, date of
shipping, mode of transport, itemized quantity, description, package type, package quantity,
total net, and gross weight (in kilograms), packaging markings, and measurements.
4. Air Waybill- An air waybill is a document that accompanies goods carried by an international
air carrier. The paperwork contains complete information about the package and enables
tracking.
5. Export Licenses- A government document that allows the transfer of specified commodities
in precise quantities to a specific destination for a defined end-use is known as an export
license.
▪ Formalities of Registration and Export Documentation
Export is a very wide concept with a lot of preparations which is required by an exporter before
starting the export business.
1. Establishing an Organization
2. Opening a Bank Account
3. Obtaining Permanent Account Number (PAN)
4. Obtaining Importer-Exporter Code (IEC) Number
5. Registration cum membership certificate (RCMC)
6. Selection of product
7. Selection of Markets
8. Finding Buyers
9. Sampling
10. Pricing/Costing
11. Negotiation with Buyers
12. Covering Risks through ECGC
▪ Preparation for Executing an Order

The exporter must make the following arrangements in order to carry out the order:
1. Marking and packaging of products to be exported in accordance with the importer's
standards.
2. Obtaining an inspection certificate from the Export Inspection Agency after scheduling a
pre-shipment inspection.
3. Getting an insurance policy from the Export Credit Guarantee Corporation (ECGC) to
safeguard against credit risks.
4. Obtaining the necessary marine insurance coverage.
5. Appoint a forwarding agent, often known as a custom house agent, to handle customs
and other related issues.
▪ Formalities by a Forwarding Agent

The agent must complete the following formalities:
1. The forwarding agency must first get permission from the customs authority before
exporting the items.
2. To the shipping business, agents must provide all needed data about the products to be
shipped, such as kind, amount, and weight.
3. A shipment bill/order must be prepared by the forwarding agent.
4. The forwarding agency is responsible for duplicating the port challans and paying the
fees.
5. The loading of the products on the ship is the responsibility of the ship's captain. The
loading must be done in the presence of customs authorities and on the basis of the
shipping order.
6. When the cargo is loaded into the ship, the ship’s master provides a receipt for them.
▪ Foreign Exchange Formalities

Under exchange control laws, an Indian exporter must comply with specific foreign exchange
procedures. Every exporter of products is obliged under the Foreign Exchange Regulation Act of
India (FERA) to provide a declaration in the form provided in a way. According to the declaration:
1. The foreign exchange gained by the exporter on exports must be disposed of in the
manner and within the timeframe stipulated by the RBI.
2. Authorized foreign exchange dealers are needed to handle shipping documentation and
discussions.
3. Only permitted methods will be used to collect payment for the products shipped.
4. Surrender the foreign exchange to approved dealers through the exchange control
authority.
❖ Modes of Payment
There are 5 main types of payment methods:
1. Cash in Advance
Secure
The cash in advance method is the safest for exporters because they are securely paid before goods
are shipped and ownership is transferred.
Typically payments are made by wire transfers or credit cards.
This is the least desirable method for importers because they have the risk of goods not being
shipped, and it is also not favorable for business cash flow.
Cash in advance is usually only used for small purchases.
No exporter who requires only this method of payment can be competitive.
Cash in Advance Pros & Cons
Pros Cons
Buyer No effect.
Immediate effect on cash flow management
Risk of not receiving shipment, Little recourse if
shipment doesn't arrive.
Becomes insurance-heavy otherwise.
Gets paid before goods are No way to compete in the market, all competitors
Seller
recieved. have this opportunity.
2. Letter of Credit
Safer
A letter of credit, or documentary credit, is basically a promise by a bank to pay an exporter if all
terms of the contract are executed properly. This is one of the most secure methods of payment.
It is used if the importer has not established credit with the exporter, but the exporter is
comfortable with the importer’s bank.
Here are the general steps in a letter of credit transaction:
a. The contract is negotiated and confirmed.
b. The importer applies for the documentary credit with their bank.
c. The documentary credit is set up by the issuing bank and the exporter and the exporter’s
bank (the collecting bank) are notified by the importer’s bank.
d. The goods are shipped.
e. Documents verifying the shipment and all terms of the sale are provided by the exporter to
the exporter’s bank and the exporter’s bank sends the documents to the importer’s issuing
bank.
f. The issuing bank verifies the documents and issues payment to the exporter’s bank.
g. The importer collects the goods.
Letter of Credit Pros & Cons
Pros Cons
Buyer Customizable payment terms Most expensive payment method.

Payment only after shipment is Time-consuming
received
Terms expire
Currency risk impacts the payment heavily
Customizable payment terms Strict documentation requirements

Seller
Sale is secured by the Buyer's bank. Currency risk fluctuations impact the profit
(low risk) margins
3. Documentary Collection
A documentary collection is when the exporter instructs their bank to forward documents related to
the sale to the importer’s bank with a request to present the documents to the buyer as a request
for payment, indicating when and on what conditions these documents can be released to the
buyer.
The importer may obtain possession of goods if the importer has the shipping documents.
The documents are only released to the buyer after payment has been made.
This can be done in two ways.
▪ Documents Against Payment
The exporter gives the ownership documents of an asset to their bank, which then presents them to
the importer after payment is received.
The importer can then use the documents to take possession of the merchandise.
The risk for the exporter is that the importer will refuse to pay, and even though the importer won’t
be able to collect the goods, the exporter has very little recourse to collect.
Here's how Documents Against Payment works:
b. The exporter ships the goods. The exporter gives his bank all documents confirming the
transaction.
c. The exporter’s bank forwards the documents to the importer’s bank.
d. The importer’s bank requests payment from the importer by presenting the documents.
e. The importer pays his bank.
f. The importer’s bank sends payment to the exporter’s bank.
g. The exporter’s bank pays the exporter.
▪ Documents Against Acceptance
The exporter’s bank on behalf of the exporter instructs the importer’s bank to release the
transaction documents to the importer.
Here's how Documents Against Acceptance works:
b. The exporter ships the goods.
c. The exporter presents the transaction documents to their bank.
d. The exporter’s bank forwards the documents to the importer’s bank.
e. The importer’s bank requests payment from the importer by presenting the documents.
f. The importer makes payment and receives the documents and collects the goods.
g. The importer’s bank pays the exporter’s bank and the exporter’s bank pays the exporter.
Documentary Collection Pros & Cons
Pros Cons
Cheaper than letter of credit Relies on the seller to deliver

Buyer the goods as specified.
Payment is made once the Payment is made before
goods are delivered shipment is checked
No guarantee
Cancellation risk
Seller Seller retains ownership of
goods until payment is made
If the buyer cannot pay,
seller is then required to pay
the return shipment
4. Open Account Terms
Risky
An open account is a sale in which the goods are shipped and delivered before payment is due
usually in 30, 60, or 90 days.
This is one of the most advantageous options to the importer, but it is a higher-risk option for an
exporter.
Foreign buyers often want exporters to offer open accounts because it is much more common in
other countries, and the payment-after-receipt structure is better for the bottom line
Open Account Terms Pros & Cons
Pros Cons
Payment not due until good

Buyer no effect
received.
No guarantee that the

payment can be received
Seller Increases sales
and cancellations can
happen at any time.
5. Consignment and Trade Finance
Risky
Consignment is similar to an open account in some ways, but payment is sent to the exporter only
after the goods have been sold by the importer and distributor to the end customer.
The exporter retains ownership of the goods until they are sold.
Exporting on consignment is very risky since the exporter is not guaranteed any payment.
Consignment, however, helps exporters become more competitive because the goods are available
for sale faster.
Selling on consignment reduces the exporter’s costs of storing inventory.
Read more about types of Trade Finance here.
Consignment & Trade Finance Pros & Cons
Pros Cons
Buyer Payment is received only Relies on good faith by the

after the goods are sold seller
Seller Depending which country Delays payment

the good are stored, this
could be a cost-saving
measure
Methods of Financing
1. Payment-in-advance
Payment-in-advance is a pre-export trade finance type that involves an advance payment or even
full payment from the buyer before the goods or services get delivered.
This is risky, and although it can help the supplier in terms of cash flow constraints, it is risky for the
buyer in case the goods are not delivered.
Advance payment is a popular option, but substantially increases non-payment or credit risk for the
supplier.
2. Working capital loans
Working capital loans (or business loans) can be used to finance the upfront cost of doing business
and can cover anything from the cost of raw materials to the cost of labour.
These short-term loans are normally issued on a 6-month tenor.
With secured working capital loans, banks use the company’s assets as a form of security against
non-payment.
Banks may also issue unsecured business loans for a higher cost. Since this type of loan does not
have any assets as collateral is inherently riskier for the bank requiring them to pay a higher fee.
3. Overdrafts
An overdraft is an easy-to-use facility – often already available on business bank accounts –
that enables a company to go ‘overdrawn’ to a certain predefined amount.
Overdrafts are simple to use and flexible but can come with much higher interest rates if businesses
do not monitor them carefully.
4. Factoring
Factoring is a type of post-export finance based on receivables.
Suppliers that sell internationally often do so on account, using payment terms that don’t require
the buyer to actually pay for the goods they buy for multiple months.
4.1.2 EXIM Bank
EXIM Bank or Export-Import Bank of India is India’s leading export financing institute that engages in
integrating foreign trade and investment with the country’s economic growth. Founded in 1982 by
the Government of India, EXIM Bank is a wholly-owned subsidiary of the Indian Government. The
current Managing Director is David Rasquinha. It is headquartered in Mumbai, Maharashtra.
▪ EXIM Bank Foundation
The organization was established in 1982 under the Export-Import Bank of India Act 1981 as a
purveyor of export credit. R.C. Shah was the bank’s first Chairman and Managing Director.
Latest Context related to EXIM Bank –
The government of India has decided to infuse Rs 1,500 crore capital into the state-owned Export-
Import Bank of India in the next financial year. The amount is Rs 200 crore higher than the provision
made by the government for the current fiscal. The government has earmarked Rs 1,300 crore
capital infusion for the bank.
The capital infusion will give an impetus to new initiatives such as supporting the Indian textile
industry, the country’s active foreign policies, changes in the concessional finance scheme, etc.
Information related to the Export-Import bank given in the article would help candidates prepare
for UPSC 2022.
▪ EXIM Bank Functions
The bank’s functions can be grouped under products and services. They are discussed briefly below:
Financial Products
• Buyer’s credit – it is a credit facility program that encourages Indian exporters to explore
new regions across the globe. It also facilitates exports for SMEs by offering credit to
overseas buyers to import goods from India.
• Corporate banking – it offers a variety of financing programs to augment the export-
competitiveness of Indian companies.
• Lines of credit – it offers extended a line of credit to Indian exporters to help them expand to
new geographies and uses a line of credit as an effective market-entry tool.
• Overseas investment finance – it offers term loans to Indian companies for equity
investments in their overseas joint ventures or wholly-owned subsidiaries.
• Project exports – encourages project exports from India and helps Indian companies secure
contracts abroad.
Services
• Marketing advisory services – help Indian exporters in their globalization ventures by
assisting in locating overseas distributors/partners, etc. Also, assists in identifying
opportunities abroad for setting up plant projects or acquiring companies.
• Research and analysis – conducts research in the field of international economics, trade and
investment, country profiles to identify risks, etc.
• Export advisory services – it offers information, advisory, and support services enabling
exporters to evaluate international risks, exploit export opportunities and improve
competitiveness.
• Term deposit scheme

When it comes to trading of commercial goods, there is always a certain level of risk and trust
involved. Whether you’re a buyer or seller, you are bound to be exposed to some risk when dealing
with international transactions. In large part, the amount of risk involved highly depends on the
method of payment you use.
There are plenty of international paying methods for importers and exporters across the globe. And
as the world continues to globalize, we’re seeing an increase in international payment modes. But
as with Incoterms, the parties lying at the split ends of the spectrum have clashing agendas and
priorities to fulfill and to look out for.
When it comes to cross-border payments, buyers tend to prioritize the cheapest and most
straightforward payment method. In other words, anything that can help reduces cost. Another
priority is ensuring they receive the goods specified.
While buyers prefer paying as late in the transaction process as possible, sellers will want to be
paid in full, as quickly as possible, and via a secure option. Sellers who offer attractive payment
terms and varying methods will have an advantage over those who limit themselves.
The main international payment methods used around the world today include:
• Cash in Advance
• Letters of Credit
• Documentary Collections
• Open Account
• Consignment
▪ Cash in Advance
Also known as pre-payments, cash in advance is as it sounds. The buyer completes the payment and
pays the seller in full before the merchandise is delivered and shipped off to the buyer.
While there are plenty of cash in advance payment methods available, credit card payment and wire
transfers (electronic payment via banks) are the more commonly used payment modes.
While this is an attractive option for sellers, it’s presents a significantly high risk for buyers as it
produces a disadvantageous cash flow and no definite guarantee of receiving the goods or the
condition in which they arrive.
This is generally a recommended option for sellers who are dealing with new buyers or buyers with
weak credit ratings, and/or for high-valued products.
Other cash in advance methods include:
• Debit card payment
• Telegraphic transfer
• International cheque
• etc.
Pros and Cons of Cash in Advance
Pros Cons
→ Risk of not receiving shipment or receiving damaged

Buyer → Minimal shipment
→ Unfavorable cash flow
→ Secure full payment

before shipment → Risk of losing business to competitors if offering this as the
Seller
→ No risk of non- only accepted international payment method
payment
Letters of Credit
A Letter of Credit is one of the most secure international payment methods for the importer and
exporter as it involves the assistance of established financial institutions such as banks as an
intermediary and a certain level of commitment from both parties.
With a Letter of Credit, payment is made through both the buyer and sellers’ banks. Upon
confirmation of trade terms and conditions, the buyer instructs his bank to pay the agreed-upon
sum by both parties to the seller’s bank. The buyer’s bank then sends a Letter of Credit as proof of
sufficient and legit funds to the seller’s bank. Payment is only remitted after all stated conditions are
met by both parties and shipment has been shipped.
Letters of Credit are also sometimes known as LC, bankers commercial credit or documentary credit.
Pros and Cons of Letters of Credit
Pros Cons
→ Guarantee of cargo being shipped before

payment → Reliance on seller to ship goods
Buyer
→ Obligation by seller to fulfill stated and as specified
negotiated conditions
→ Reliable proof of foreign buyers’ credit prior to

shipment of goods
→ Obligation by buyer to fulfill stated and
Seller negotiated conditions → Minimal
→ Payment by buyer’s bank in the event of a
default
→ Low risk
Documentary Collections
Documentary collections is a process in which both the buyer’s and seller’s banks act as facilitators
of the trade.
The seller submits documents needed by the buyer, such as the Bill of Lading, which is necessary for
the transfer of title to the goods, to its bank. The seller’s bank will then send these documents to
the buyer’s bank along with payment instructions. The documents are only released in exchange for
payment, which is remitted immediately or at a specified date in the future.
With documentary collections, also known as Bills of Exchange, the seller is basically handing over
the responsibility of payment collection to his bank.
Pros and Cons of Documentary Collections
Pros Cons
→ More economical than Letters of → Reliance on seller to ship goods as

Buyer
Credit specified
→ No verification involved
Seller → Minimal → No guarantee of payment from bank
→ No protection against cancellations
Open Account
Under Open Accounts (also known as Accounts Payable), merchandise are shipped and delivered
prior to payment, proving to be an extremely attractive option for buyers especially in terms of cash
flow. On the other end of the spectrum, however, sellers are faced with high risks.
With this payment option, the seller ships the goods to the buyers with a credit period attached.
This is usually in 30-, 60-, or 90-day periods, during which the buyer must carry out full payment.
Open Accounts are usually only recommended for trustworthy and reputable buyers, for buyers and
sellers who have an established and trusting relationship, and/or for exports with relatively lower
value to minimize risk.
Pros and Cons of Open Account
Pros Cons
→ Receives goods before payment is due

Buyer → Minimal
→ Positive cash flow
Seller → Can attract customers in competitive markets → High risk of default
Consignment
The consignment process is similar to that of an open account whereby payment is only completed
after the receipt of merchandise by the buyer.
The difference lies in the point of payment. With consignment, the foreign buyer is only obliged to
fulfill payment after having sold the merchandise to the end consumer. This international payment
method is based on an agreement under which the foreign seller retains ownership of the
merchandise until it has been sold. In exchange, the buyer is responsible for the management and
sale of the merchandise to the end customer.
Consignment is usually only recommended for buyers and sellers with a trusting relationship or
reputable distributors and providers. Given the high risk involved, sellers should make sure they
have adequate insurance coverage that can cover both the goods from transit to final sale and
mitigate any damages caused in the event of non-payment by the buyer.
Pros and Cons of Consignment
Pros Cons
→ Payment is due only after final sale of goods

→ May have large inventory to manage
Buyer to end consumer
→ Minimal
→ Quick receipt of goods
Pros Cons
→ Payment not guaranteed until end

→ Lower storage fees
sale
Seller → Less inventory management
→ Lack of access to and management
→ More competitive
of merchandise

1. Nostro Account
Nostro Account is defined as a bank account that is created by any commercial bank of a given
country in some other foreign country with the currency of a foreign country. It is derived from the
Italian word Nostro account meaning ‘Our.’ Simply, the money that is in your bank is in your
country’s currency. The interest rate is not given to this type of account. If a case arises where there
is an overdrawn amount or there is an insufficient amount of funds in the Nostro account, some fee
is charged from these accounts.
The account of the State bank of India was held with the bank of America in dollars. In simple
words, if there is any bank in India that opens an account to deal with transactions with a foreign
bank, it will be called a Nostro Account. A Nostro account is used as a specialized, additional feature
that is mostly found in the countries with the facility of convertible currencies. Banks usually tie up
with third parties to enable transactions like these. The banks with Nostro facilities are also called
facilitator banks. These banks are not at all similar to deposit accounts, and they demand that the
deposit accounts are kept in the same currency as a bank.
2. Vostro Account
The word Vostro Account has been derived from an Italian word that means ‘yours.’ That is why, in
an actual sense, it means your account, which is held by us. From the domestic bank’s point of view,
a Vostro account is just the same as any other ordinary bank account as it is payable on demand and
is denoted by the same domestic currency of the country. Vostro accounts are maintained in the
domestic country. For example, imagine that a particular USA-based bank wants to open an account
in a particular India-based bank that has the currency of INR (Indian Rupees). Then this type of
account is called a Vostro account.
Unlike Nostro accounts, these types of accounts are not confined or restricted to banks; they can be
used by any other entity if they want to use them. For example, business entities and insurance
companies. The motive that lies behind a Vostro account is the need for the entities and banks to
gain a physical presence in all the countries. For example, a bank that operates in the United
Kingdom or any other country will also want to be able to work in other countries like China, Spain,
Japan, the United Kingdom, and other parts of the world. This kind of relationship makes both of
them correspondent banks, which means that customers of a domestic bank can use services like
money withdrawal, money transfer, or deposit funds in the corresponding bank. Managing or
holding a Vostro account often comes with a fee.
Difference between Nostro and Vostro
Suppose a domestic bank (State Bank of India) opens a foreign account with Citigroup (the USA) in
currency $ USD. For the SBI, this will be a Nostro account, and for Citigroup, it is a Vostro Account.
The bank account that a domestic bank maintains with a foreign bank in a foreign country and in
that foreign country’s currency is Nostro, whereas the same account held by a foreign bank in the
domestic currency is called Vostro
Vostro is a Latin word meaning ‘yours,’ and Nostro is a Latin word meaning ‘ours.’
3. Loro Account
Loro account is derived from the Italian word “Loro,” which means ‘Their,’ which means this
account is a ‘Third Party Account.’ In bilateral correspondence between any two given banks, the
words Vostro (Your) and Nostro (Our) are used, that is, the bank whose book the account is
maintained and the one who is maintaining the account. In such conditions, a third bank’s account,
which is talked about, is called a Loro account.

1] SWIFT
The Society for Worldwide Interbank Financial Telecommunication (Swift) is an international
network that links banks to securely and privately exchange signals regarding actions like money
transfers. Every day, about 11,000 SWIFT members send close to 33.6 million transactions.
▪ How does the SWIFT system work?
Swift payments are transactions carried out across a network. Each bank is given an eight- or
eleven-character-long code by Swift, called the bank identification. It is same as the IFSC code which
is used for domestic interbank transactions whereas the Swift code is used for international
payments. For example, if someone in India wants to send money to a person in the US, they would
need the latter’s bank account number and the Swift code of the destination bank. The Swift code
lets the US bank know of the transfer in real-time and eases its clearing.
a. The Society for Worldwide Interbank Financial Telecommunication (Swift) is a global
network connecting banks to communicate messages about activities like money transfer
in a safe and secure way
b. Swift assigns each bank an eight- or 11-character long code, known as the bank identifier
c. Banks, Securities Dealers, Clearing Houses, Exchanges, and Corporate Business Houses
are some of the users of the SWIFT network.
▪ Example of SWIFT code
To understand the process of assigning code better, let’s take an example of UniCredit Banca, an
Italian bank, headquartered in Milan. Its swift code is UNCRITMM. Let us now understand how the
code is formed.
The first four characters of the code denote the institute code, which is UNCR for UniCredit Banca in
this example.
The next two characters stand for the country code, which is IT for Italy in this case.
The next two characters stand for the location or the city code, which is MM for Milan in this
example.
The last three characters are optional, but some organizations use it for defining individual
branches.
▪ Who uses SWIFT?
SWIFT network has expanded over the years, and presently the following institutions use the
system.
• Banks
• Securities Dealers
• Clearing Houses
• Exchanges
• Corporate Business Houses
• Brokerage Institutes
• Asset Management Companies
• Depositories
• Treasury Market Participants
• Foreign Exchange & Money Brokers
▪ Services offered by SWIFT

SWIFT offers many services to businesses and individuals that facilitate accurate and seamless
business transactions. Some of the services provided by the SWIFT network are:
Applications: SWIFT network offers access to several applications such as real-time instruction tally
for forex and treasury transactions, security market infrastructure, and banking market
infrastructure.
Compliance Services: SWIFT connections also aim to provide services related to financial crime
compliance. It offers Know Your Customer (KYC), Anti-Money Laundering (AML) and Sanctions.
Business Intelligence: Recently, SWIFT has introduced reporting utilities and dashboards, which
help the clients to receive a real-time view of tracking the activities, messages, reporting, and trade
flow.
Messaging and Connectivity: The fundamental business of SWIFT aims at providing a reliable,
secure, and scalable network that enables a seamless movement of messages. It achieves that with
its various network connections, hubs, and software.
2] CHIP
CHIPS stands for Clearing House Interbank Payments System, and it’s the largest private-sector, US
dollar-based, money transfer system in the U.S. It’s a privately operated, and bank owned, system
for electronic payments that are transferred and settled in US dollars.
As a competitor and customer of the Fedwire service of the Federal Reserve, CHIPS allows banks to
make transfers of international payments efficiently, as there’s no need for bank checks.
Understanding CHIPS
The Clearing House Interbank Payments System differs from the Fedwire transaction service in
several respects. First and foremost, it is cheaper than the Fedwire service, albeit not as fast, and
the dollar amounts required to use this service are lower. CHIPS is the main clearing house for large
transactions; the average transaction that uses CHIPS is over $3,000,000.
CHIPS acts as a netting engine, where payments between parties are netted against each other
instead of the full dollar value of both trades being sent. From 9 p.m. to 5 p.m. ET. banks send and
receive payments. During that time, CHIPS nets and releases payments. From 5 p.m. until 5:15 p.m.
the CHIPS system eliminates credit limits, and releases and nets unresolved payments. By 5:15 p.m.,
CHIPS releases any remaining payments and sends payment orders to banks via Fedwire.
3] CHAP
HAPS – also known as Clearing House Automated Payment System – is a type of high-value, bank-to-
bank payment system that provides irrevocable, settlement risk-free, and efficient payments.
Most traditional high-street banks are direct participants in CHAPS, as are a couple of international
and custody banks. For a comprehensive list of CHAPS direct participants, see this list provided by
the Bank of England.
▪ What is the purpose of CHAPS?
CHAPS guarantee same-day payment – as long as payment instructions are received by a specific
time in the working day (the time is determined by your bank) – and there’s no limit to the amount
of money that you can transfer via CHAPS.
4] Telegraphic Transfer (TT)

Telegraphic transfers – which are also referred to as Telex transfers, TT payments, or simply TT – is a
way of transferring funds that’s mostly used when you need to make an overseas transaction. The
term “telegraphic transfer” has its origins in the way that banks used to make international money
transfers. Essentially, transfers would be made with the ‘Telex’ network of teleprinters – electronic
machines that communicated via text-based messages that were used to arrange transfers.
There are now faster ways to complete an international transfer, but the term “telegraphic
transfer” has remained in use, particularly in Australia, New Zealand, and the UK. So, when you hear
the term “telegraphic transfers”, all you need to know is that it refers to international money
transfers made from one account to another. It’s synonymous with terms like bank transfer, wire
transfer, or SWIFT transfer, which are now more commonly used to describe the same process.

Foreign exchange intervention takes several shapes and forms. Here are the most common:
TYPES OF INTERVENTION DIRECT OR INDIRECT

Verbal Intervention Indirect
Operational Intervention Direct
Concerted Intervention Direct and indirect
Sterilized Intervention Direct
1. Verbal Intervention
Also known as “jawboning”. This occurs when officials from the central bank “talk up” (or “talk
down”) a currency. This is either done by threatening to commit real intervention (actual
buying/selling of currency), or simply by indicating that the currency is undervalued or overvalued.
This is the cheapest and simplest form of intervention because it does not involve the use of foreign
currency reserves. Nonetheless, its simplicity doesn’t always imply effectiveness. A nation whose
central bank is known to intervene more frequently and effectively than other nations is usually
more effective in verbal intervention.
2. Operational Intervention
This is the actual buying or selling of a currency by a nation’s central bank.
3. Concerted Intervention
This happens when several nations coordinate in driving up or down a certain currency using their
own foreign currency reserves. Its success is dependent upon its breadth (number of countries
involved) and depth (total amount of the intervention).
Concerted intervention could also be verbal when officials from several nations unite in expressing
their concern over a continuously falling/rising currency.
4. Sterilized Intervention
When a central bank sterilizes its interventions, it offsets these actions through open market
operations. Selling a currency can be sterilized when the central bank sells short-term securities to
drain back the excess funds in circulation as a result of the intervention.
Currency interventions only go unsterilized (or partially sterilized) when action in the currency
market is in line with monetary and foreign exchange policies.
This occurred in the concerted interventions of the “Plaza Accord” in September 1985 when G7
collaborated to stem the excessive rise of the dollar by buying their currencies and selling the
greenback.
The action eventually proved to be successful because it was accompanied by supporting monetary
policies. Japan raised its short-term interest rates by 200 bps after that weekend, and the 3-month
euroyen rate soared to 8.25%, making Japanese deposits more attractive than their US counterpart.
Another example of an unsterilized intervention was in February 1987 at the “Louvre Accord” when
the G7 joined forces to stop the plunge of the U.S. dollar.
On that occasion, the Federal Reserve engaged in a series of monetary tightening, pushing up rates
by 300 bps to as high as 9.25% in September.
4.4 Eurocurrency Market –

Eurocurrency is a currency that is deposited at a foreign bank outside of its home country. Contrary
to its name, the term does not refer to euros that are deposited outside of Europe. It is a general
term that applies to all currencies that are deposited anywhere outside of its local country. For
example, if you deposit Japanese yen at a bank in the United States, it is considered to be
Eurocurrency.

1] Characteristics
1. Transactions in each currency take place outside the country of origin of that currency.
2. Even though the transactions are recorded outside the country of issue, it continues to be held in
the country of issue. This is because a currency cannot be used for settlement of commercial liability
outside its domestic area. (The existence of the foreign exchange market is based on this feature.)
3. Euro-Currency deposits and loans fall outside the regulatory and supervisory control of the
monitoring authority in the country of origin.
4. Euro-Currency market is distinct from the foreign exchange market. It is a market for deposits and
for loans between banks and between banks and their customers. It is a market in which foreign
currencies are lent and borrowed whereas in the foreign exchange market, foreign currencies are
bought and sold. This market therefore converts short term deposit resources into short and
medium term loans for financing projects. While the Euro- Currency market operates on interest
rates, the foreign exchange market operates on exchange rates.
5. Due to absence of regulation, deposits in this market are unsecured. Due to this deposits are
received only on short term basis (max: one year) whereas loans are demanded on medium to long
term basis. This creates an asset-liability mismatch which results in Euro-banks being exposed to
both liquidity and interest rate risks.
6. To eliminate interest rate risk Euro-banks developed the credit roll-over concept which involves
resetting the interest rates on loans at fixed pre-decided intervals. To achieve this loans/credits are
provided on ‘floating rates of interest’. To ensure that the Interest rates are reset on a fair and
equitable basis the concept of reference rates called LIBOR. (LIBOR – London Interbank Offered
Rate) was developed.
7 Each Euro-Currency credit (loan) specifies the periodicity of the roll-over and the LIBOR to which it
is referenced. To provide a uniform profit margin for the lender a ‘MARKUP’ is specified over and
above the LIBOR. The interest cost to the borrower is therefore the applicable LIBOR + Mark-up. The
mark-up normally remains constant through the life-span of the loan.
8. Financial assets and liabilities in a currency by way of deposits, loans and instruments can be
traded only in the domestic market of that currency. Such markets are called the ‘Domestic or
Onshore’ markets. However in the case of freely convertible currencies, it is possible to trade in
assets and liabilities in such currencies outside their home country. Such markets are called “Euro-
Currency or Offshore” markets. Consequently such markets deal only in freely convertible
currencies such as USD, GBP, EUR, JPY, CHF, CAD, AUD etc. The predominant currency is USD.
9. It is essentially a wholesale market dealing only is standardised deposit amounts and large
volume Euro-credits involving substantial credit risk. Lending in this market is therefore done on a
‘Consortium’ basis, i.e. a syndicate of banks collectively finance a project on uniform terms and
conditions thereby distributing the risk among the syndicate members.
10. The Euro-Currency market can be broadly divided into 4 components:
(i) Euro-Currency deposit market involving short term deposits.
(ii) Euro-Currency loan market (Euro-credits) involving syndicated loans.
(iii) Euro-Bond market in which Corporate entities issue debt instruments to raise resources from
investors through banks operating as underwriters.
(iv) Euro-Notes market in which international borrowers raise resources directly from the investors
without using banks as intermediaries or any underwriting support.
2] Instruments
The operational framework of the ECB and euro area national central banks consists of the following
set of instruments:
• Open market operations
• Standing facilities
• Minimum reserve requirements for credit institutions
• Forward guidance
All these instruments are based on the Eurosystem legal framework for monetary policy
instruments, which consists of the “General framework” and the “Temporary framework”. The
Temporary framework complements, amends or overrules the General framework.
Participation
Our monetary policy framework strives to ensure the participation of a broad range of eligible
counterparties. In the case of standing facilities and tender open market operations, only credit
institutions that are subject to minimum reserves and fulfil all the necessary eligibility criteria are
eligible to participate. For outright transactions, there are no a priori restrictions on the range of
counterparties.
Open market operations
Open market operations play an important role in steering interest rates, managing the liquidity
situation in the financial market and signalling the monetary policy stance.
Open market operations are initiated by the ECB, which decides on the instrument and its terms
and conditions. It is possible to execute open market operations on the basis of standard tenders,
quick tenders or bilateral procedures. The Eurosystem may conduct them as reverse transactions,
outright transactions, issuance of debt certificates, foreign exchange swaps or collection of fixed-
term deposits.
Four types of open market operation
Open market operations can differ in terms of aim, regularity and procedure.
• Main refinancing operations are regular reverse transactions that provide liquidity, usually
with a frequency and duration of one week. They are executed in a decentralised manner by
the national central banks on the basis of standard tenders and according to an
indicative calendar published on the ECB’s website.
• Longer-term refinancing operations are reverse transactions that provide liquidity for a
longer duration than the main refinancing operations. Regular longer-term refinancing
operations have a maturity of three months and are conducted monthly by the Eurosystem
on the basis of standard tenders in accordance with the indicative calendar on the ECB’s
website. The Eurosystem may also conduct other longer-term operations, with a maturity of
more than three months. In recent years, such operations have had maturities of up to 48
months (the longest being the targeted longer-term refinancing operations, or TLTROs).
Longer-term refinancing operations are aimed at providing counterparties with additional
longer-term refinancing and can also serve other monetary policy objectives.
• Fine-tuning operations can be executed on an ad hoc basis to manage the liquidity situation
in the market and to steer interest rates. In particular, they are aimed at smoothing the
effects on interest rates caused by unexpected liquidity fluctuations. Fine-tuning operations
are primarily executed as reverse transactions but may also take the form of foreign
exchange swaps or the collection of fixed-term deposits. The instruments and procedures
applied in the conduct of fine-tuning operations are adapted to the types of transaction and
the specific objectives pursued in performing the operations. Fine-tuning operations are
normally executed by the Eurosystem through quick tenders. The Eurosystem may select a
limited number of counterparties to participate in fine-tuning operations.
• Structural operations can be carried out by the Eurosystem through reverse transactions,
outright transactions and the issuance of debt certificates. These operations are executed
whenever the ECB wishes to adjust the structural position of the Eurosystem vis-à-vis the
financial sector (on a regular or non-regular basis). The Eurosystem has conducted asset
purchases to address the risks of a too-prolonged period of low inflation and to help
overcome the limitations caused by the lower bound of interest rates, giving a further boost
to lending, spending and investment in the economy.
Standing facilities
Standing facilities aim to provide and absorb overnight liquidity and to signal the general monetary
policy stance and bound overnight market interest rates. The standing facilities, which are
administered in a decentralised manner by the national central banks, are available to eligible
counterparties on their own initiative.
Marginal lending facility
Counterparties can use the marginal lending facility to obtain overnight liquidity from the national
central banks, against the provision of adequate eligible collateral. The interest rate on the marginal
lending facility normally provides a ceiling for the overnight interbank market interest rate.
Deposit facility
Counterparties can use the deposit facility to place overnight deposits with the national central
banks. The interest rate on the deposit facility normally provides a floor for the overnight interbank
market interest rate and thus anchors short-term wholesale money market rates. To receive the
deposit facility rate, counterparties need to move holdings from their current account to the deposit
facility, unless the deposit facility rate is negative, in which case it also applies to current account
holdings in excess of minimum reserves.
Minimum reserves
The ECB requires credit institutions established in the euro area to hold a certain amount of funds
on their accounts with their respective national central bank. These funds are called “minimum
reserves” or “required reserves”.
The minimum reserve system is meant to stabilise money market interest rates and potentially
create (or enlarge) a structural liquidity shortage.
The ECB does not require credit institutions to hold the total amount of required reserves in their
account at the central bank every day. Rather, they should hold these required reserves on average,
based on their daily holdings, over a maintenance period of about six weeks.
The amount credit institutions should hold is determined by certain elements of their balance sheet,
in particular customer deposits with a maturity of up to two years.
The respective reserve maintenance periods start on the settlement day of the main refinancing
operation (MRO) following each Governing Council monetary policy meeting.
The required reserves are remunerated according to the average interest rate of the main
refinancing operations over the maintenance period.
Excess reserves, i.e. current account holdings in excess of the minimum, are remunerated at the
deposit facility rate or 0%, whichever is lower. The ECB may exempt part of the excess reserves from
the deposit facility rate remuneration. This was the case with the implementation of the two-tier
system for remunerating excess reserves.
What is a Depositary Receipt?
A depositary receipt is a negotiable instrument issued by a bank to represent shares in a
foreign public company, which allows investors to trade in the global markets.
Understanding Depositary Receipts
Depositary receipts allow investors to invest in companies in foreign countries while trading in a
local stock exchange in the investor’s home country. It is advantageous to investors since shares are
not allowed to leave the home country that they trade in.
Depositary receipts were created to minimize the complications of investing in foreign securities.
Previously, if investors wanted to buy shares in a foreign company, they would need to exchange
their money into foreign currency and open a foreign brokerage account. Then, they would be able
to purchase shares through the brokerage account on a foreign stock exchange.
The creation of depositary receipts eliminates the entire process and makes it simpler and more
convenient for investors to invest in international companies.
How are Depositary Receipts Issued?
1. An investor needs to contact a broker in a local bank if he/she is interested in purchasing
depositary receipts. The local bank in the investor’s home country, which is called the
depositary bank, will assess the foreign security before making a decision to purchase
shares.
2. The broker in the depositary bank will purchase the shares either on the local stock
exchange that it trades in or purchase the shares in the foreign stock exchange by using
another broker in a foreign bank, which is also known as the custodian bank.
3. After purchasing the shares, the depositary bank will request the shares to be delivered to
the custodian bank.
4. After the custodian bank receives the shares, they will group the shares into packets, each
consisting of 10 shares. Each packet will be issued to the depositary bank as a depositary
receipt that is traded on the bank’s local stock exchange.
5. When the depositary bank receives the depositary receipts from the custodian bank, it
notifies the broker, who will deliver it to the investor and debits fees from the investor’s
account.
Types of Depositary Receipts
1. American Depositary Receipt (ADR)
It is listed only on American stock exchanges (i.e., NYSE, AMEX, NASDAQ) and can only be traded in
the U.S. They pay investors dividends in U.S. dollars and are issued by a bank in the U.S.
ADRs are categorized into sponsored and unsponsored, which are then grouped into one of three
levels.
2. European Depositary Receipt (EDR)
It is the European equivalent of ADRs. Similarly, EDRs are only listed on European stock exchanges
and can only be traded in Europe. It pays dividends in euros and can be traded like a regular stock.
3. Global Depositary Receipt (GDR)
It is a general term for a depositary receipt that consists of shares from a foreign company.
Therefore, any depositary receipt that did not originate from your home country is called a GDR.
Many other countries around the world, such as India, Russia, the Philippines, and Singapore also
offer depositary receipts.
Advantages of DRs
1. Exposure to international securities
Investors can diversify their investment portfolio by gaining exposure to international securities, in
addition to stocks offered by local companies.
2. Additional sources of capital
Depositary receipts provide international companies a way to raise more capital by tapping into the
global markets and attracting foreign investors around the world.
3. Less international regulation
Since it is traded on a local stock exchange, investors do not need to worry about international
trading policies and global laws.
Although investors will be investing in a company that is in a foreign country, they can still enjoy the
same corporate rights, such as being able to vote for the board of directors.
Disadvantages of DRs
1. Higher administrative and processing fees, and taxes
There may be higher administrative and processing fees because you need to compensate for
custodial services from the custodian bank. There may also be higher taxes.
For example, ADRs receive the same capital gains and dividend taxes as other stocks in the U.S.
However, the investor is subject to the foreign country’s taxes and regulations aside from regular
taxes in the U.S.
2. Greater risk from forex exchange rate fluctuations
There is a higher risk due to volatility in foreign currency exchange rates. For example, if an investor
purchases a depositary receipt that represents shares in a British company, its value will be affected
by the exchange rate between the British pound and the currency in the buyer’s home country.
3. Limited access for most investors
Sometimes, depositary receipts may not be listed on stock exchanges. Therefore, only institutional
investors, which are companies or organizations that execute trades on behalf of clients, can invest
in them.
Unit 5. International Monetary system

he formation of the IMF was initiated in 1944 at the Bretton Woods Conference. IMF came into
operation on 27th December 1945 and is today an international organization that consists of 189
member countries. Headquartered in Washington, D.C., IMF focuses on fostering global monetary
cooperation, securing financial stability, facilitating and promoting international trade, employment,
and economic growth around the world. The IMF is a specialized agency of the United Nations.
Formation of IMF
The breakdown of international monetary cooperation during the Great Depression led to the
development of the IMF, which aimed at improving economic growth and reducing poverty around
the world. The International Monetary Fund (IMF) was initially formed at the Bretton Woods
Conference in 1944. 45 government representatives were present at the Conference to discuss a
framework for postwar international economic cooperation.
The IMF became operational on 27th December 1945 with 29 member countries that agreed to
bound to this treaty. It began its financial operations on 1st March 1947. Currently, the IMF consists
of 189 member countries.
The IMF is regarded as a key organisation in the international economic system which focuses on
rebuilding the international capital along with maximizing the national economic sovereignty and
human welfare.
Organizational Structure of International Monetary Fund (IMF)
The United Nations is the parent organization that handles the proper functioning and
administration of the IMF. The IMF is headed by a Managing Director who is elected by the
Executive Board for a 5-year term of office. The International Monetary Fund (IMF) consists of the
Board of Governors, Ministerial Committees, and the Executive Board.
To know more about the organizational structure of IMF, refer to the table below:
Structure of the International Monetary Fund (IMF)
Governing Bodies of IMF Roles and Responsibilities
Board of Governors • Each governor of the Board of Governors is appointed

by his/her respective member country.
• Elects or appoints executive directors to the Executive
Board.
• Board of Governors is advised by the International
Monetary and Financial Committee (IMFC) and the
Development Committee.
• An annual meet up between the Board of Governors
and the World Bank Group is conducted during the
IMF–World Bank Annual Meetings to discuss the work
of their respective institutions.
Ministerial Committees • It manages the international monetary and financial

system.
1. International Monetary
and Financial • Amendment of the Articles of Agreement.
Committee (IMFC)
• To solve the issues in the developing countries that are
2. Development related to economic development.
Committee
Executive Board • It is a 24-member board that discusses all the aspects

of the Funds.
• The Board normally makes decisions based on
consensus, but sometimes formal votes are taken.
Objectives of the IMF

IMF was developed as an initiative to promote international monetary cooperation, enable
international trade, achieve financial stability, stimulate high employment, diminish poverty in the
world, and sustain economic growth. Initially, there were 29 countries with a goal of redoing the
global payment system. Today, the organization has 189 members. The main objectives of the
International Monetary Fund (IMF) are mentioned below:
1. To improve and promote global monetary cooperation of the world.
2. To secure financial stability by eliminating or minimizing the exchange rate stability.
3. To facilitate a balanced international trade.
4. To promote high employment through economic assistance and sustainable economic
growth.
5. To reduce poverty around the world.
What are the functions of the IMF?
IMF mainly focuses on supervising the international monetary system along with providing credits
to the member countries. The functions of the International Monetary Fund can be categorized into
three types:
1. Regulatory functions: IMF functions as a regulatory body and as per the rules of the Articles
of Agreement, it also focuses on administering a code of conduct for exchange rate policies
and restrictions on payments for current account transactions.
2. Financial functions: IMF provides financial support and resources to the member countries
to meet short term and medium term Balance of Payments (BOP) disequilibrium.
3. Consultative functions: IMF is a centre for international cooperation for the member
countries. It also acts as a source of counsel and technical assistance.
India & IMF

India is a founder member of the IMF. India’s Union Finance Minister is the Ex Officio Governor on
the IMF’s Board of Governors. Each member country also has an alternate governor. The alternate
governor for India is the Governor of the RBI. There is also an Executive Director for India who
represents the country at the IMF.
• India’s quota in the IMF is SDR 13,114.4 million that gives India a shareholding of 2.76%.
Read about the Special Drawing Rights – Created in 1969 by International Monetary Fund
(IMF) at the linked article.
• This makes India the eight largest quota holding country at the organization.
• In 2000, India completed the repayment of all the loans it had taken from the IMF.
• Now, India is a contributor to the IMF.
The emerging economies have gained more influence in the governance architecture of the
International Monetary Fund (IMF).
• The reforms were agreed upon by the then 188 members of the IMF in 2010, in the
aftermath of the global financial meltdown.
• More than six percent of the quota shares will shift to emerging and developing countries
from the U.S. and European countries.
Which countries gained?
• India’s voting rights increased to 2.63 percent from the current 2.3 percent, and China’s to
6.08 percent from 3.8. Russia and Brazil are the other two countries that gain from the
reforms.
Why delay the reforms?
• Among the reasons for the delay has been the time it took the U.S Congress to approve the
changes.
• Though the country holds veto power, Republicans have been agitated over “declining U.S
power.”
Advantages
• For the first time, the Executive Board will consist entirely of elected executive directors,
ending the category of appointed executive directors. Currently, the members with the five
largest quotas appoint an executive director, a position that will cease to exist.
• The significant resource enhancement will fortify the IMF’s ability to respond to crises more
effectively.
• These reforms will reinforce the credibility, effectiveness, and legitimacy of the IMF.

1] Constitution
The International Monetary Fund was founded at an international conference in Bretton Woods,
New Hampshire in July 1944. It was created together with the World Bank as a means to promote
monetary cooperation between countries and achieve a more stable global economy.
The IMF provides policy advice, helps countries design policy programs and issues loans when
"sufficient financing on affordable terms cannot be obtained to meet net international payments."
The loans are funded by quota contributions from member countries.
The IMF states that "Transparency helps economies function better and makes them less vulnerable
to crises," and argues transparency of both member countries and the IMF will lead to better policy-
making and accountability. But the IMF has been criticised for being a secretive organisation, and
though it has reformed its policies on transparency throughout the years, critics say it is still not
letting the light shine through.
The International Monetary Fund has different policies guiding the publication of a list of
documents about its structure and interactions with member countries. They exist under the
umbrella of an principle adopted last year:
"The IMF's approach to transparency is based on the overarching principle that it will strive to
disclose documents and information on a timely basis unless strong and specific reasons argue
against such disclosure."
IMF documents pertaining to member countries are encouraged for disclosure by the Fund but not
mandated [1]. The publication of policy documents is subject to Executive Board approval, and
Board meeting minutes and papers are released three or more years after they are issued internally
[2].
Moreover, the Fund does not recognise the right to information - only the documents it lists can be
accessed. There is no appeal mechanism for requesters who have been denied information [3].
These and other restrictive polices have brought forward a great deal of criticism and demand for
more transparency. In turn, last year, the IMF altered its policy to allow access to more documents
and reduce the lag time for public access to board documents [4].
Member country documents are still not mandated, however, as the information handled is "highly
sensitive and delicate information… whose inappropriate or untimely disclosure could be extremely
damaging to countries, markets and institutions" [5].
But, as the Fund is moving towards disclosing more documents more quickly, it is also permitting
more redaction.
"Deletions are generally considered at the request of the authorities of the country that is the subject
of the report," however, deletions by other members - if they are somehow affected by the report -
are now permitted [2].
Demands for transparency
In December 1994, the Mexican peso was devalued, sending investors scrambling to sell the
Mexican equity and debt securities they had. Some found they could not trade in their pesos, as
foreign currency reserves were not enough.
The United States, Canada, the Bank for International Settlements and the IMF awarded $48.8
billion in bailout money [8]. By then, the crisis had already spread to South America in what became
known as the "Tequila Effect."
During the bailout efforts, attention focused on the IMF: How much did they know about Mexico's
financial situation? What was their plan now? The 1997 Asian economic crisis followed and by then
it had become clear the IMF had not only to demand more data from its member countries, but also
divulge what data they had to the public.
"A natural fallout from the sequence of crisis and response was that reforms that, in another epoch
would have proceeded quietly, without much public fanfare, now required active and constant public
engagement," then IMF Secretary Shailendra J. Anjaria said in a 2002 IMF speech on transparency
[5].
In response, the Fund took measures to increase the amount of information available.
"The IMF used to be accused of lacking transparency and accountability," says a 2001 IMF brief. "But
recent reforms have effectively addressed that issue. A series of initiatives since the mid-1990s have
opened most IMF activities to public scrutiny, including its reports on the economies of a majority of
its member countries, its lending activities, and many of its internal policy deliberations."
One of the main reforms was creating data standards for IMF countries to disseminate their
economic and financial data to the public: the Special Data Dissemination Standard (SDDS), which
guides countries that seek access to international capital markets on sharing data (the SDDS Bulletin
Board on the IMF website shares data from subscribing countries); and the General Data
Dissemination System (GDDS), "which aims to provide a framework for other countries to improve
their data compilation and dissemination" [10].
Policies governing transparency today
In October 2008, a Global Transparency Initiative report showed the IMF lagging significantly behind
best practice in its transparency policy [3]. In January 2010, the IMF announced it would be shifting
its focus from "why publish to why not" and that it would also increase the scope of documents that
could be reviewed and shorten the lag time to obtain them [4]. But for Freedom of Information
advocates, the 2010 reforms did not represent a significant change [11]. Information sharing by
member countries continues to be voluntary and demands for greater transparency continue.
A list of 24 types of documents is covered by the Transparency Decision, which means they are
published "unless strong and specific reasons argue against such disclosure" [2]. These include
Country Reports (the IMF shifted from asking members' consent for publication to publishing unless
it objects); Executive Board meetings minutes (released after five years); and policy documents
(Board papers relating to the IMF's income, financing or budget) [4].
Operation
Because there is no appeals process for requesters, it's difficult to assess the actual operation of the
IMF's disclosure policies.
The IMF has provided figures on the percentage of countries that choose to disclose some of the
information that pertains to them: 98 per cent of member countries agreed to the publication of
Public Information Notices in 2009; 93 per cent published the Article IV staff report [1].
Though after 2010 it has look to publish documents sooner, "some documents may be published
with a delay, for instance, to reduce the market sensitivity of the information, or to avoid
undermining the deliberative process."
It has also begun to allow 'third party deletions,' meaning that, though the document may be
published sooner, it may be heavily redacted [2].
Recent developments
After the resignation of Dominique Strauss-Kahn - who was alleged to have assaulted a
chambermaid - the search for a new Managing Director of the IMF began.
Emerging economies such as China, Brazil and South Africa, and organisations such as the Bretton
Woods Project called for more transparency in the selection process, and for representation based
on merit [12, 13].
The World Bank chief is traditionally American and the IMF chief European - a 'gentleman's
agreement' between the United States and Europe that has existed since the IMF's founding.
China backed French Finance Minister Christine Lagarde rather than her lone competitor, Mexican
central bank governor Agustín Carstens. Lagarde was appointed IMF Managing Director on 28 June
[15] in a process that has been criticised as being highly secretive [16].
2] Role & Responsibility of IMF
Role
The role of the IMF has increased since the onset of the 2008 global financial crisis. In fact, an IMF
surveillance report warned about the economic crisis.8 World leaders soon regretted that they
ignored it.
As a result, the IMF has been called upon more and more to provide global economic surveillance.
It's in the best position to do so because it requires members to subject their economic policies to
IMF scrutiny. They have also committed to policies that keep prices stable. For example, they agree
to avoid manipulating exchange rates for an unfair competitive advantage.9
For example, the 2010 eurozone crisis prompted the IMF to provide short-term loans to bail out
Greece. That was within the IMF's charter because it prevented a global economic crisis.10

Meaning of International Liquidity:
International liquidity is defined as the aggregate stock of internally acceptable assets held by the
central bank to settle a deficit in a country’s balance of payments. In other words, international
liquidity provides a measure of a country’s ability to finance its deficit in balance of payments
without resorting to adjustment measures. Shortage of liquidity hampers the expansion of global
trade and its surplus leads to global inflationary pressures.
International liquidity is generally used as a synonym for international reserves. Such reserves
include a country’s official gold stock holdings, its convertible foreign currencies, SDRs, and its net
reserve position in the IMF. Economists like Heller and McKinnon use a broader definition of
international liquidity to include international borrowings, commercial credit operations, and the
international financial structure in a country’s reserves.
This definition implies international availability of liquidity and the possibility of obtaining credit
from financial institutions operating in international financial markets. Thus, in the broader sense,
international liquidity includes private as well as official holdings of international liquidity assets.
In the literature on international liquidity distinction is made between owned and borrowed
reserves, and between conditional and unconditional reserves. Foreign exchange surplus, after
meeting all current and capital account obligations of the country with the rest of the world, are
“owned” reserves.
Similarly, the official gold stock of a country constitutes its owned reserves. Capital imports in the
form of borrowings from abroad and direct investments by foreign countries constitute borrowed
reserves. Both owned and borrowed reserves are the source of international liquidity.
Unconditional international liquidity consists of a country’s official gold stock, holdings of its foreign
currencies and SDRs, its net position in the IMF, and private holding of international assets. In all
such cases, liquidity assets are available to the country without any conditions or restrictions on
their use. But in the case of borrowed reserves, the lender country may impose conditions or
restrictions on the use of liquid assets by the borrowing country.
Many international financial institutions provide funds on conditional basis for specific projects and
on specified repayment provisions. All these are cases of conditional liquidity. This is done to avoid
the misuse of liquidity by the borrowing country.

Supplementary Foreign Exchange Reserves are defined and maintained by the International
Monetary Fund (IMF) and are known as Special Drawing Rights.
Special Drawing Rights (SDR) – Introduction
1. When there was a shortfall of highly preferred foreign exchange reserve assets such as US
Dollars and Gold, Special Drawing Rights were created in 1969 by the International Monetary
Fund (IMF).
2. XDR is the currency code of Special Drawing Rights.
3. The International Monetary Fund (IMF) allocates Special Drawing Rights (SDR) to different
countries.
4. Private parties cannot hold Special Drawing Rights (SDR). During the 2009 global financial
crisis to give liquidity in the global economic system more than $ 180 billion XDR was
allocated. It is usually held by a few organisations and IMF member countries.
5. The International Monetary Fund reviews a group of key international currencies over a time
period of 5 years and then decides the value of Special Drawing Rights.
6. The latest currency that was added to the basket of currencies by the International
Monetary Fund to determine the value of XDR is the Chinese Yuan in 2016.
7. The other international currencies in the basket of currencies are British Pound, Japanese
Yen, US Dollar, and Euro.
Special Drawing Rights (SDR) Value – Weightage of Basket Currencies
International Monetary Fund (IMF) uses a basket of currencies to determine SDR value; and the
weightage given to those basket of currencies varies as per its prominence in the International trade
and the respective nations foreign exchange reserves. The weightage of currencies are given below.
1. British Pound – 8.09%
2. Japanese Yen – 8.33%
3. Chinese Yuan – Around 11%
4. Euro – Around 31%
5. US Dollar – Around 41.73%
International Treaties – Special Drawing Rights
Special Drawing Rights are used by International treaties like Montreal Convention and many other
treaties. XDR (Unit of Special Drawing Rights) is used to levy penalties, fix prices or charges. One of
the prominent conventions that uses SDR is the Convention on Limitation of Liability for Maritime
Claims. For damages to ships, this Convention caps the personal liability at XDR 330,000.
Special Drawing Rights – Used by International Organizations
Few Major International Organizations use XDR (Currency code of Special Drawing Rights as a unit of
account. Some of the organizations are listed below.
1. International Fund for Agricultural Development
2. Asian Development Bank (ADB)
3. Bank of International Settlements – started using XDR in 2003 by replacing Franc.
4. Islamic Development Bank
5. African Development Bank
6. Japan External Trade Organization (JETRO)
Candidates can refer to the Topic-Wise GS 3 Questions for UPSC Mains, in the linked article.
Reserve Currency
1. As part of foreign exchange reserves, monetary Authorities or Central banks hold foreign
currencies in significant quantities. This foreign currency is known as the Reserve Currency.
2. This foreign currency can be used for many aspects of the global economy like international
investments or international currency.
3. Reserve currency is also known as the anchor currency.
4. In the 1st half of the 20th century Pound Sterling of the United Kingdom was the primary
choice for Reserve Currency.
5. By the end of the 20th century the US Dollar was the primary choice of Reserve Currency as
it was considered as the most dominant currency.
Unit 6. Balance of Payment
6.1. India’s Balance of Payment
6.2. Importance, Functions, Principles & Components of Balance of Payment
6.3. Accounting of Balance of Payment: Deficit & Surplus
6.2. Importance, Functions, Principles & Components of Balance of

Payment
▪ Meaning -
Balance Of Payment (BOP) is a statement that records all the monetary transactions made between
residents of a country and the rest of the world during any given period. This statement includes all
the transactions made by/to individuals, corporates and the government and helps in monitoring
the flow of funds to develop the economy.
▪ Importance –
A balance of payment is an essential document or transaction in the finance department as it gives
the status of a country and its economy. The importance of the balance of payment can be
calculated from the following points:
1. It reveals the economic and financial details of a country.
2. The BOP statement can be an indicator to determine whether the currency of a country is
appreciating or depreciating.
3. BOP helps the government on trade and fiscal policies.
4. It provides important information to understand and analyze the economic dealings of
one country with the other.
5. The government can formulate appropriate policies to divert the funds and technology
imported to the critical sectors of the economy that can drive future growth.
▪ Functions -
A BOP statement of a country indicates whether the country has a surplus or a deficit of funds, i.e.
when a country’s export is more than its import, its BOP is said to be in surplus. On the other hand,
the BOP deficit indicates that its imports are more than its exports.
Tracking the transactions under BOP is similar to the double-entry accounting system. All
transactions will have a debit entry and a corresponding credit entry.
For example:
Funds entering a country from a foreign source are booked as credit and recorded in the BOP.
Outflows from a country are recorded as debits in the BOP. Let’s say Japan exports 100 cars to the
U.S. Japan books the export of the 100 cars as a debit in the BOP, while the U.S. books the imports
as a credit in the BOP.
▪ Principles -
1. Residence principle:
In compiling the BoP account, it is necessary to distinguish residents of an economy from non-
residents. The concept of residence in the system of the balance of payments is not based on the
criteria of national identity or the legal criteria for the determination of residents of a particular
state. The economic entity (individuals or organizations) is said to be the resident of that country if
its center of economic interest falls in the economic territory of that country and has already
engaged in economic activities and transactions on a significant scale in that country for one year or
more or if that economic unit intends to do so.
2. Double-entry bookkeeping Principle:
The balance of payments account of a country is constructed on the principle of double-entry
bookkeeping. Each transaction is entered on the credit and debit side of the balance sheet. Thus,
the total debit and the total credit of the balance of payments are always equal. Hence it is for this
reason that balances of payments for a country must always balance in accounting sense.
3. Principle of the uniform system for valuation of transactions:
The third principle of the balance of payments is the principle of the uniform system for valuation of
transactions, recorded in the balance of payments. The essence is that market prices that are
aligned with economic transactions are used for the evaluation of transactions in real recourses and
financial assets and liabilities. The market price refers only to the price for one specific transaction.
Compliance with the given principle ensures comparability of the balance of payments in different
countries, as well as comparability of accounts of the balance of payments of the particular country.
4. Principle of timing:
The fourth principle of the balance of payments is the principle of timing. Each transaction should
be reflected in the balance of payments on the credit side and on its corresponding debit side at the
same time, and both parties of the transaction should record the operation under the same
number, which corresponds to the date of its execution.
5. Principle of unit of account:
During the compilation of the balance of payments, the unit of account should be clearly defined.
Accordingly, it should be used the same unit of account used during internal payments and
accounting by the country will also be used in the preparation of the balance of payments.
However, it is necessary to note that the balance of payments in most countries is kept in U.S.
dollars.
Component/Types of Balance of Payment –
The balance of payment is divided into three types:
Current account: This account scans all the incoming and outgoing of goods and services between
countries. All the payments made for raw materials and constructed goods are covered under this
account. Few other deliveries that are included in this category are from tourism, engineering,
stocks, business services, transportation, and royalties from licenses and copyrights. All these
combine together to make a BOP of a country.
Capital account: Capital transactions like purchase and sale of assets (non-financial) like lands and
properties are monitored under this account. This account also records the flow of taxes,
acquisition, and sale of fixed assets by immigrants moving into the different country. The shortage
or excess in the current account is governed by the finance from the capital account and vice versa.
Finance account: The funds that flow to and from the other countries through investments like real
estate, foreign direct investments, business enterprises, etc., is recorded in this account. This
account calculates the foreign proprietor of domestic assets and domestic proprietor of foreign
assets, and analyses if it is acquiring or selling more assets like stocks, gold, equity, etc
6.3 Accounting of Balance of Payment: Deficit & Surplus

International payments are similar to that of individuals who spend more than they earn and
finance the gap by borrowing money or selling assets. A country can sell assets or borrow money
from overseas to cover a gap in its current account (spending more than it brings in from sales to
the outside world). Therefore, any current account shortfall must be covered by a capital account
surplus or net inflow of capital into the country.
▪ Balance of Payments: Surplus
It is a favourable situation when the country’s export is more than its import. The country can
create more capital to pay for its domestic productions. An increase in the level of production will
ultimately help in the short-term growth of a country. Under this:
a. Payment made by the country is certainly less than the receipts received by the country.
b. This means that a country’s foreign currency inflows exceed its outflows within a specific
period.
c. In simple words, Credit Side > Debit Side
▪ Balance is in surplus when:
(Current Account + Capital Account Total Receipts) > (Current Account + Capital Account Total
Payments)
For example, If Export = ₹500 lakh and Import= ₹250 lakh, then there is a trade surplus of ₹ 250
lakh.
Balance of Payments: Deficit
It is an unfavourable situation when the country’s import is more than its export of goods and
services. It means that a country is spending money more than it earns. In this case, it has to borrow
to pay for its imports. Thus, it creates a problem for the economy. Under this:
• Payment made by the country is certainly more than the receipts received by the country.
• This means that a country’s foreign currency outflows exceed its inflows within a specific
period.
• In simple words, Credit Side < Debit Side
Balance is in deficit when:
(Current Account + Capital Account Total Receipts) < (Current Account + Capital Account Total
Payments)
For example, If Export= ₹150 lakh and Import= ₹ 250 lakh, then there is a trade deficit of ₹ 100 lakh.

1. The Elasticity Approach:
Marshall-Lerner Condition:
The elasticity approach to BOP is associated with the Marshall-Lerner condition which was worked
out independently by these two economists. It studies the conditions under which exchange rate
changes restore equilibrium in BOP by devaluing a country’s currency. This approach is related to
the price effect of devaluation.
Assumptions:
This analysis is based on the following assumptions:
1. Supplies of exports are perfectly elastic.
2. Product prices are fixed in domestic currency.
3. Income levels are fixed in the devaluing country.
4. The supply of imparts are large.
ADVERTISEMENTS:
5. The price elasticities of demand for exports and imports are arc elasticities.
6. Price elasticities refer to absolute values.
7. The country’s current account balance equals its trade balance.
Its Criticisms:
The elasticity approach based on the Marshall-Lerner condition has the following defects:
1. Misleading:
The elasticity approach which applies the Marshallian concept of elasticity to solve BOP deficit is
misleading. This is because it has relevance only to incremental change along a demand or supply
curve and to problems dealing with shifts in these curves. Moreover, it assumes constant
purchasing power of money which is not relevant to devaluation of the country’s currency.
2. Partial Elasticities:
The elasticity approach has been criticised by Alexander because it uses partial elasticities which
exclude all factors except relative prices and quantities of exports and imports. This is applicable
only to single-commodity trade rather than to a multi-commodity trade. It makes this approach
unrealistic.
3. Supplies not Perfectly Elastic:
The Marshall-Lerner condition assumes perfectly elastic supplies of exports and imports. But this
assumption is unrealistic because the country may not be in a position to increase the supply of its
exports when they become cheap with devaluation of its currency.
4. Partial Equilibrium Analysis:
The elasticity approach assumes domestic price and income levels to be stable within the devaluing
country. It, further, assumes that there are no restrictions in using additional resources into
production for exports. These assumptions show that this analysis is based on the partial
equilibrium analysis.
It, therefore, ignores the feedback effects of a price change in one product on incomes, and
consequently on the demand for goods. This is a serious defect of the elasticity approach because
the effects of devaluation always spread to the entire economy.
5. Inflationary:
Devaluation can lead to inflation in the economy. Even if it succeeds in improving the balance of
payments, it is likely to increase domestic incomes in export and import-competing industries. But
these increased incomes will affect the BOP directly by increasing the demand for imports, and
indirectly by increasing the overall demand and thus raising the prices within the country.
2. The Absorption Approach:

The absorption approach to balance of payments is general equilibrium in nature and is based on
the Keynesian national income relationships. It is, therefore, also known as the Keynesian approach.
It runs through the income effect of devaluation as against the price effect to the elasticity
approach.
Its Criticisms:
The absorption approach to BOP deficit has been criticised on the following grounds:
1. Neglects Price Effects:
This approach neglects the price effects of devaluation which are very important.
2. Calculation Difficult:
Analytically, it appears to be superior to the elasticity approach but propensities to consume, save
and invest cannot be accurately calculated.
3. Ignores Effects on Other Countries:
The absorption approach is weak in that it relies too much on policies designed to influence
domestic absorption. It does not study the effects of a devaluation on the absorption of other
countries.
4. Not Operative in a Fixed Exchange Rate System:
The absorption approach fails as a corrective measure of BOP deficit under a fixed exchange rate
system. When prices rise with devaluation, people reduce their consumption expenditure. With
money supply remaining constant, interest rate rises which brings a fall in output along with
absorption. Thus devaluation will have little effect on BOP deficit.
5. More Emphasis on Consumption:
This approach places more emphasis on the level of domestic consumption than on relative prices.
A mere reduction in the level of domestic consumption for reducing absorption does not mean that
resources so released will be redirected for improving BOP deficit.

General equilibrium in economics is a perfect state when demand and supply are equal to each
other. In other words, supply and demand are in balance, i.e., in perfect harmony. We also use the
term Walrasian general equilibrium.
The term economic equilibrium means the same as general equilibrium. Walras developed the
theory to solve a controversy among economists. Most economic analyses had demonstrated only
partial equilibrium in individual markets.
General equilibrium definition refers to a theory explaining how demand and supply become equal
in an economy with various markets working simultaneously. It tries to explain how price, demand,
and supply work in an economy, not in a particular or single market.
Assumptions
The assumptions of general equilibrium are as follows:
• Consumers’ habits and tastes remain constant.
• There is no change in production techniques.
• All firms carry out business-related operations under exactly the same conditions.
• The returns to scale remain constant.exists full employment of resources, including labor.
• Consumers’ income remains constant.
• Factors of production (land, labor, capital, and entrepreneurship) remain perfectly mobile
between various places and occupations.
• Every unit of a product service is the same.
• Perfect competition exists in services, goods, and factor markets.
Diagram –
Let us look at a diagrammatic representation of general equilibrium.
As one can observe from the above figure, at price and output levels P1 and Q1, demand and
supply balance each other, and general equilibrium exists.

1] Balance of payment (BOP)
The balance of payment is the statement that files all the transactions between the entities,
government anatomies, or individuals of one country to another for a given period of time. All the
transaction details are mentioned in the statement, giving the authority a clear vision of the flow of
funds.
After all, if the items are included in the statement, then the inflow and the outflow of the fund
should match. For a country, the balance of payment specifies whether the country has an excess or
shortage of funds. It gives an indication of whether the country’s export is more than its import or
vice versa.
Types of Balance of Payment
The balance of payment is divided into three types:
Current account: This account scans all the incoming and outgoing of goods and services between
countries. All the payments made for raw materials and constructed goods are covered under this
account. Few other deliveries that are included in this category are from tourism, engineering,
stocks, business services, transportation, and royalties from licenses and copyrights. All these
combine together to make a BOP of a country.
Capital account: Capital transactions like purchase and sale of assets (non-financial) like lands and
properties are monitored under this account. This account also records the flow of taxes,
acquisition, and sale of fixed assets by immigrants moving into the different country. The shortage
or excess in the current account is governed by the finance from the capital account and vice versa.
Finance account: The funds that flow to and from the other countries through investments like real
estate, foreign direct investments, business enterprises, etc., is recorded in this account. This
account calculates the foreign proprietor of domestic assets and domestic proprietor of foreign
assets, and analyses if it is acquiring or selling more assets like stocks, gold, equity, etc.
Importance of Balance of Payment
A balance of payment is an essential document or transaction in the finance department as it gives
the status of a country and its economy. The importance of the balance of payment can be
calculated from the following points:
• It examines the transaction of all the exports and imports of goods and services for a given
period.
• It helps the government to analyse the potential of a particular industry export growth
and formulate policy to support that growth.
• It gives the government a broad perspective on a different range of import and export
tariffs. The government then takes measures to increase and decrease the tax to discourage
import and encourage export, respectively, and be self-sufficient.
• If the economy urges support in the mode of import, the government plans according to
the BOP, and divert the cash flow and technology to the unfavourable sector of the
economy, and seek future growth.
• The balance of payment also indicates the government to detect the state of the
economy, and plan expansion. Monetary and fiscal policy are established on the basis of
balance of payment status of the country.
2] Exchange rate
Foreign Exchange Rate is defined as the price of the domestic currency with respect to another
currency. The purpose of foreign exchange is to compare one currency with another for showing
their relative values.
Foreign exchange rate can also be said to be the rate at which one currency is exchanged with
another or it can be said as the price of one currency that is stated in terms of another currency.
Exchange rates of a currency can be either fixed or floating. Fixed exchange rate is determined by
the central bank of the country while the floating rate is determined by the dynamics of market
demand and supply.
▪ Factors Affecting the Exchange Rate
Exchange rate is impacted by some factors which can be economic, political or psychological as well.
The economic factors that are known to cause variation in foreign exchange rates are inflation,
trade balances, government policies.
Political factors that can cause a change in the foreign exchange rate are political unrest or
instability in the country and any kind of political conflict.
Psychological factors that impact the forex rate is the psychology of the participants involved in
foreign exchange.
Types of Exchange Rate Systems
There are three types of exchange rate systems that are in effect in the foreign exchange market
and these are as follows:
1. Fixed exchange rate System or Pegged exchange rate system: The pegged exchange rate or the
fixed exchange rate system is referred to as the system where the weaker currency of the two
currencies in question is pegged or tied to the stronger currency.
Fixed exchange rate is determined by the government of the country or central bank and is not
dependent on market forces.
To maintain the stability in the currency rate, there is purchasing of foreign exchange by the central
bank or government when the rate of foreign currency increases and selling foreign currency when
the rates fall.
This process is known as pegging and that’s why the fixed exchange rate system is also referred to
as the pegged exchange rate system.
▪ Advantages of Fixed Exchange Rate System
Following are some of the advantages of fixed exchange rate system
1. It ensures stability in foreign exchange that encourages foreign trade.
2. There is a stability in the value of currency which protects it from market fluctuations.
3. It promotes foreign investment for the country.
4. It helps in maintaining stable inflation rates in an economy.
▪ Disadvantages of Fixed Exchange Rate System

Following are some of the disadvantages of the fixed exchange rate system
1. There is a constant need for maintaining foreign reserves in order to stabilise the economy.
2. The government may lack the flexibility that is required to bounce back in case an economic
shock engulfs the economy.
2. Flexible Exchange Rate System: Flexible exchange rate system is also known as the floating
exchange rate system as it is dependent on the market forces of supply and demand.There is no
intervention of the central banks or the government in the floating exchange rate system.
Advantages of Floating Exchange Rate System
Following are the advantages of the floating exchange rate system
1. There is no need to maintain foreign reserves in this exchange system.
2. Any deficiencies or surplus in Balance of Payment is automatically corrected in this system.
Disadvantages of Floating Exchange Rate System
Following are some of the disadvantages of the floating exchange rate system
1. It encourages speculation that may lead to fluctuations in the exchange rate of currencies in the
market.
2. If the fluctuations in exchange rates are too much it can cause issues with movement of capital
between countries and also impact foreign trade.
3. It will discourage any type of international trade and foreign investment.
3. Managed floating exchange rate system: Managed floating exchange rate system is the
combination of the fixed (managed) and floating exchange rate systems. Under this system the
central banks intervene or participate in the purchase or selling of the foreign currencies.
❖ Balance of Trade and Balance of Payments: Differences

Balance of trade
The balance of trade is the distinction between the value of a nation’s imports and exports for a
given time frame. The BoT is the largest constituent of a nation’s balance of payments. Economists
utilise the BoT to compute the associative potency of a nation’s economy. The BoT is also known as
the trade balance or the international trade balance.
Balance of payment
The balance of payment is a statement of all the transactions that are made between entities in one
nation and the rest of the world over a particular time frame, such as a quarter or a year. To put it in
other words, the BoP is a set of accounts that identifies all the commercial transactions operated by
the nation in a specific period with the remaining nations of the world. It documents a record of all
the monetary transactions performed globally by the nation on goods, services, and income during
the year.
This article is a ready reckoner guide for the students to learn the difference between the balance of
trade and balance of payments.
Balance of trade Balance of payments
Definition
Balance of trade or BoT is a financial statement Balance of payment or BoP is a financial

that captures the nation’s import and export of statement that keeps track of all the
commodities with the rest of the world. economic transactions by the nation with the
rest of the world.
What does it deal with?
It deals with the net profit or loss that a country It deals with the proper accounting of the
incurs from the import and export of goods. transactions conducted by the nation.
Fundamental Difference
Balance of trade (BoT) is the difference that is Balance of payments (BoP) is the difference
obtained from the export and import of goods. between the inflow and outflow of foreign
exchange.
Type of transactions included
Transactions related to goods are included in Transactions related to transfers, goods, and
BoT. services are included in BoP.
Are capital transfers included?
No Yes
What is its net effect?
The net effect of BoT can be either positive, The net effect of BoP is always zero.
negative, or zero.
Money is the most liquid asset of all. It represents the prime form of a capital asset. Money is
accepted as a means of exchange or as a measurement of the value of goods. It is fascinating to
imagine a world where the money wouldn't exist.
The supply of money, on the other hand, is a different concept. It is a concept of stocks and shares
and is usually perceived in terms of the cumulative effect of the amount of currency that the
citizens have and the demand deposits available with the banks of a country.
Understanding the fundamentals of money supply and money demand helps get an idea regarding
the country's financial status and the fluidity of the country's currency. In this section, we shall talk
about the supply of money, its meaning, components, and the various methods that are involved in
the money supply.
Money Supply:
▪ Definition
The concept of money supply can be defined as the total quantity of currency that can be included
in a nation's economy. Money supply includes the total money both in the form of cash as well as
deposits that can be used as cash easily.
The money supply economics is associated with the government's direct power as it is the
government that issues currency either in paper form or in the form of a coin as a combination of
treasuries bills and demand drafts of banks. Similarly, the banks also have control over the money
supply, and they exert such influence through reserves and credit controls.
Money supply has a major impact on the economy of a country. The inflation of prices of
commodities, their demand, and supply change the supply of money. In economics, money supply
plays a role in the interest rates and cash flow prevalent throughout the country.
It is important to note here that the money supply does not include the stock of money held by the
government or the money under the possession of the banks. These institutions serve as the
suppliers of money or are involved in the production of money rather than being a part of the
money supply. The term money supply refers only to that share of capital or cash that is governed
by the people of the country.
▪ Effect of Money Supply on the Economy
The money supply, meaning the total cash present under a nation's economy, is bound to influence
the economics of the market. Therefore, any change in the demand and supply of money will result
in a consequent change in the market.
A rise in the money supply will reveal its effect by decreased interest rates and price values of
commodities and services. Whereas a decrease in money supply will result in increased interest
rates, price values with a coupled increase in banks' reserves.
An effect similar to this occurs on the business as well. As the price levels lower due to increased
money supply, the production in business will increase to accommodate people's increased
spending. Thus, the money supply and money demand directly impact the macroeconomics of a
nation's market.
Components of the Money Supply
Two components of the money supply regulate its structure and flow. These are:
1. Currency
Currency forms a major part of the money supply of a nation. As discussed before, the government
produces currency in two forms, i.e., coins and paper currency. Thus, money supply through
currency can also be divided into:
• Paper Currency/ Notes: The production of currency notes is under the control of the
government as well as the reserve bank of India. In the country, only one-rupee paper
currency is produced by the government, while RBI produces all the other currency notes.
• Coins: The second form of currency in India, the coins, are produced in two variants viz
token coins and the standard coins characterized as full-bodied coins. The full-bodied
currency coins are of little value today under the current currency system. The token coins
represent the value of 50 paise and 25 paise.
2. Demand Deposits
The demand deposits are a part of commercial banks and are used as a non-confidential fund. These
accounts are considered money when included in the economy of a country. Such deposits' working
mechanism is similar to that of a checking account where withdrawals from the fund can be made
without notice.
▪ Different Measures of Money Supply
After getting an idea about the concept of money supply, we shall now understand the different
methods used to measure India's supply of money.
As mentioned before, money production is largely governed by the Reserve Bank of India or RBI.
Therefore, it is the RBI that is responsible for the measures of the money supply.
There are four types of methods used by the RBI to measure the supply of money in India. Let's take
them one by one:
• The first measure is denoted as M1, and it is represented as the formula.
M1 = C + DD + OD
Where C represents the currency, including both paper currency and coins.
DD represents the demand deposits made in the banks.
OD represents the other types of deposits made in RBI, like deposits from public sector financing,
foreign banks, or international institutions such as the IMF.
• The next measure under the RBI approach to the money supply is denoted as M 2. Under the
first approach, the deposits made in a savings account are not included as money supply.
The second method compensates for this by adding the savings account. Thus,
M2 = M1 + deposits made as savings deposits in Post office savings banks.
• The third method under the RBI approach of money supply includes the net deposits made
under a specified period with the banks. It includes the normal money supply and net
deposits.
M3 = M1 + Net Time-deposits included in banks.
• The final measure of money supply included under RBI guidelines accumulates Post office
savings banks' deposits and the total deposits except those from National Saving Certificate.
Thus,
M4 = M3 + Deposits made with Post-office savings institute.
The concept of money supply still has certain elements that need to be explored. This mainly
includes figuring out what can be treated as 'money' and what can't. For example, commercial
banks' fixed deposits are not treated as 'money' under money supply. In contrast, the savings
deposits made under the Post office savings bank cannot be counted as money because they lack
exchange via cheque and face no liquidity.
Thus, M1 is the most liquid measure of the money supply, as it only includes currency and demand
deposits. The M1 and M2 are considered narrow money supply measures, and M3 and M4 measure
the broad money by including other forms of savings.
Money Supply—Its Main Components

Coins (standard money): paper currency and demand deposits or credit money issued by
commercial banks are the key components of the supply of money:
The word "Monetary Standard" refers to the sort of standard money that is utilized in a monetary
system. In reality, a country's monetary system is often characterized in terms of its standard
money. As a result, the monetary standard is associated with standard money. (A monetary system
includes its standard money as well as all paper and credit substitutes that are linked to and
convertible into standard money.) A country is considered to have a gold standard system if the
standard monetary unit is defined in terms of both gold and silver; a system is said to be bimetallic if
the standard monetary unit is defined in terms of both gold and silver.
However, a country's currency is said to have an inconvertible paper money standard if it is not
convertible in gold or silver. Thus, it is conventional to describe a country's monetary system in
terms of its standard money, which serves as the primary source of supply. It should be mentioned
that the adoption of a specific monetary standard in a country at a given moment is determined by
the country's economic conditions. However, the monetary standard, which therefore becomes a
key component of the monetary system, must be such that it facilitates elastic money supply,
economic progress, and promotes people's wellbeing.
A suitable monetary system is one that satisfies both domestic and international trade
requirements. In general, the monetary system and hence the monetary standards are directed by
the domestic demands of a certain country, while the international aspects of currency
management are important.

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Paper: 406 A – International Financial Management

1. International Financial Environment (06)

2. Foreign Exchange Market and Exchange Rate (12)

3. International Accounting (06)

4. Financing Foreign Operations (10)

5. International Monetary system (6)

6. Balance of Payment (8)

1.1 International Financial Management: Evolution

4) Present International Monetary System

India’s Monetary Policy system

1.2. International Financial Management- Goals, Features & scope

d) Functions of Financial Management

• Risk and Returns Evaluation

• Capital Requirement Estimation

• Improve Company’s Stock / Shareholder Value

➢ Few Additional Nature and Scope of Financial Management

1.3. Domestic V/s International Financial Management

➢ Difference Between IFM & DFM

1.4. Role of Financial Manager in International Environment

2.1 Wholesale & Retail Market

➢ Retail Marketing Mix: The 6 Ps

➢ Non-store-based retail marketing

Digital retail marketing

2.2 Participants in the Foreign Exchange Market

Characteristics of the Forex Market

The Three Key Essentials of the Forex Market

➢ Instruments of Forex Market

➢ What is a Bid Rate?

➢ Cross Rates of Exchange

2.4 Factors affecting Exchange Rate

➢ Common Factors Affecting Exchange Rates

2.5 Exchange Rate Determination

2.5.1 Purchasing Power Parity Theory

2.5.2 Interest Rate Parity

How interest parity helps in currency trading

2.5.3 International Fischer Effect

2.6 Spot Market and the Forward Market

➢ Advantages of Spot Markets

How Does It Work?

❖ Types of Derivative Contracts

▪ Criticisms of the Derivatives Market

2] Foreign Currency Futures

3] Option & Swap

Sr.No Options contract Swap contract

1 It’s a right to buy or sell financial It’s an agreement between parties to

2 Bought or sold through It’s over the counter financial products.

3 Premium payment is paid. No premium payments are required.

2.8 Arbitrage – Two Point and Triangular Arbitrage

2.9 Functions of Foreign Exchange Market

2.10 Foreign Exchange Risk Exposure –

3.1. Convergence to International Financial Reporting Standards

3.1.2. Comparison of IFRS and Ind –AS

Topic IFRS IND AS

IFRS stands for international IND AS stands for Indian

International accounting Ministry of corporate affairs

Followed by 144 countries across the world Followed only in India

Companies acting in accordance Such disclosure is not mandatory

Companies acting in accordance Companies complying with IND