International Finance

April 2023 Examination

Answer 1. Introduction:

International Finance is an important component of financial economics.  It

addresses issues related to the monetary interactions of at most two or more
countries. International finance addresses subjects such as foreign exchange
rates, monetary system of the world, and foreign direct investment (FDI). It also
covers other important issues that are part of international financial
management. International Finance exists in the same way as international
trade and commerce. The existence of nations has an effect on the economic
activities and governments of individuals and companies.  It is well known that
countries often borrow or lend from one another.  Many countries will use their
own currencies when they trade with one another.  It is important to know how
different currencies compare.  Also, it is crucial to know how these goods get
paid and what determines the price at which currencies trade.  International
finance plays an essential role in international commerce and inter-economy
transfer of goods or services. It is crucial for many reasons. These are some of
the most important.

International finance is a powerful tool to determine exchange rates, compare

inflation rate, gain an idea about investing international debt securities, assess
the economic status of foreign countries, and judge the foreign market.

International finance has a lot of importance because they help us determine the
relative currencies. These rates can be calculated with international finance.

Making international investment decisions is made easier by various economic

factors. When deciding whether foreign debt securities are safe for investors,
economic factors can help.

IFRS has many benefits for international finance.  The financial statements

produced by countries which have adopted IFRS are comparable.  It's easier for
many countries follow the same reporting systems.

The IFRS is an international finance system that helps save money.

Globalization has led to international finance gaining in importance.  It helps you
understand the basic principles of all international organizations, and it keeps the
balance between them intact.

International finance systems are essential to maintaining peace among

nations. Without a solid financing system, all nations would act in their own best
interests. International finance is essential to keep that problem in check.

International finance organizations such as the IMF, World Bank, and others play
a role in settling international finance disputes.
Concept and application:

There are many ways that ABV Company can expand their business abroad:

Exporting is selling goods directly overseas to customers.  This is the easiest and
quickest way for a company enter international markets.  The pros include low
risk, low cost, ease of setup, and lower barriers to entry.  The cons include
limited control of distribution and marketing, the inability to personalize
products for local markets, as well as dependence on intermediaries.

Licensing - Licensing allows a foreign company to use technology, trademarks,

or other intellectual property, in return for royalty.  It is low-risk and low-cost,
easy to set it up, and can generate significant revenues from royalties.  The cons
include a limited quality control, limited customization options for local
markets, and dependency on intermediaries.

Joint Ventures: This is when a foreign company forms a partnership to jointly

produce and distribute products.  Possibilities include sharing risks and costs,
being able to adapt products for local markets and establishing a local
presence. Pros: Higher risk and higher cost, difficult coordination with partners,
possible loss control over technology, intellectual property, and potential loss.

Direct Investment: This involves setting up a company or subsidiary to sell

products. Pros: Full control over marketing and operations. You can also
customize products for local markets. It is possible to establish a local
presence. The cons: High risk and high cost, difficult coordination with local
partners, potential cultural differences.

International financial markets offer companies access to capital as well as other

financial instruments that can be used to support international expansion.  These
are just a few of the important international financial market players:

Foreign Exchange Markets (Foreign Exchange Markets): Foreign exchange

market allows companies to exchange currencies or manage currency risk.

International Bond Markets (International Bond Markets): International bond

markets enable companies to issue bonds to foreign currencies in order to raise
capital.

International Equity Markets (International Equity Markets): Companies can use

international equity markets to issue shares in foreign currencies for capital
raising.

International Derivatives Markets: These markets offer companies access to

financial instruments, such as options, futures and swaps, to manage currency
risk.

Conclusion
ABV Company has many options to expand their overseas business, including
licensing and joint ventures, exporting and direct investments.  International
financial markets allow companies to access capital and financial instrument to
aid their international expansion efforts.  Each approach has pros and cons. The
company must weigh these carefully and choose the one that meets their
goals. The International Financial Market (IFM) is where financial wealth is
traded among individuals and between nations.  It can be described by a large set
of rules, institutions and rules where assets are traded between agents who have
surplus and those in deficit. The rules are established by institutions.  It is
important to consider policies that have monetary, fiscal, or more structural
implications as well as those that directly affect the governance of the
market. Governance in the Financial Market can be defined as the set of rules
that connect the agents and institutions.  These rules establish the
market. Governance rules can be defined at both the macroeconomic and
microeconomic levels in a financial markets.  Microeconomic rules are not only
for individuals (single or multiple money savers, agents and companies), but also
for the market and its structure.  Macroeconomic governance guidelines deal with
the market in general, but are also closely linked to policies regulating it.

Answer 2:

Introduction

A direct quotation is a quote that offers a foreign exchange rate. It is quoted in

fixed units and variable amounts of the foreign currency.  To put it another way, a
direct quote will ask how much currency the domestic currency needs to buy one
unit (most often the U.S. currency (USD) on forex markets).  Direct quotes refer
to the foreign currency being the base currency while the domestic is the
counter- or quote currency. This contrasts with an indirect quote where the price
for the domestic currency can be expressed in terms of a currency.  Cross
currency quotes refer to a quote which includes two foreign currencies.  There are
two possible ways to present foreign currency conversion rate
information. Indirect quotation: The Foreign Currency amount is fixed. However,
the domestic currency can be variable depending on the geographic
location. Direct method is simpler and easier to understand because it shows the
amount required for the currency conversion.  In other words, if the rate for
conversion is lower it means that the domestic currency is growing in value in
the market. A higher conversion rate means that a domestic currency's market
value is decreasing. Direct quotes are a popular way to communicate or display
the rate for foreign currency changes.  This is used most often when the base
currency has a higher value than the counterpart currency in the marketplace.  In
this instance, the statement will be considered a direct quote because foreign
currency is USD and the domestic currency INR is variable.  In this example, the
base currency (USD) is used, which has more value than the counter currency
(INR). Cross rate refers to a foreign currency transaction that involves two
currencies being exchanged against each other.  The U.S.dollar is often used to
establish the currencies of exchanged pairs in the foreign currency market.
Concept & Application:

You can present the currency exchange rate in two ways.  One is direct and the
other indirect. Although both methods serve the same purpose they have a
different conceptuality.

A rate of foreign currency conversion is considered to be direct if the value or

the price of one unit is in the value/price of the local currency.  However, the rate
of conversion of foreign currency will be considered indirect if one unit's value
or price is expressed in the foreign currency's value or price.

The currency exchange rate quoted depends on the geographic area of the person
involved or the location of any transaction.  If a direct quote is used, it indicates
how many domestic currency units are required to buy one unit of any foreign
currency. In indirect quotations, however, the amount of foreign currencies
required to exchange 1 unit is expressed.

Direct quotation:

If the rate decreases, then the value of the national currency increases.  In
indirect quotation, the rate drops and the value of the currency falls.

a. The trader receives the indirect exchange rate of INR/GBP. This is the
reciprocal exchange rate. In this instance, the indirect exchange rate for
trader is 1/96.15 = 0.0.0104 GBP/INR.

b) A Cross rate is an exchange rate between two currencies that is expressed

as a ratio to two other currencies.  This is how the cross rate method
calculates the bid-ask prices for USD/INR.

INR/USD = 1 INR/GBP * 2 GBP/USD (cross rates formula)

The bid-ask prices for EUR-USD are GBP 1.22100 to 1.31100.

You can calculate the bid-ask rate for INR/USD as follows:

Bid rate = 96.10 * 1.22100/GBP = 11.543 INR/USD

Ask rate: 96.002 INR/USD = 1.3100/GBP

Conclusion: A direct quotation method shows how much domestic currency is

needed to buy one unit foreign currency.  This statement is simple to understand
by the general public.  This allows you to quickly compare the domestic
currency's value with other currencies.  The direct quote also allows the public to
see which currency has more market value than their domestic
currency. According to the direct quotation, the rate is decreasing and the value
of the domestic currency is increasing relative to other currencies. This is a sign
that the country's economy is growing.  The base currency per currency quoted
(i.e., foreign) is calculated using the direct quotation method.  This gives the cost
of one unit of foreign currency to be purchased in local currency.  The transaction
location and the person who is involved determine the nature of the quote.

Answer 3.a Introduction:

There are many strategies that reduce market risk. The effectiveness of each
strategy will depend on the assets or portfolios to be hedged.  The most common
are portfolio construction and options.  Market risk, also called systematic risk,
refers to the possibility that investors will suffer large losses from factors that
impact all financial markets rather than one particular security.  Modern Portfolio
Theory is one way to reduce market risks. It allows investors to use
diversification strategies that limit volatility.  Options, which offer investors
protection against large losses, is another hedge strategy.  Investors have the
option to place trades on market volatility. The VIX is a volatility index
indicator that tracks the market. It's often called the "fear factor" because of its
tendency to spike in periods of higher volatility.

Concept, and its application:

XYZ Ltd can choose from a variety of hedging strategies:

Forward Contract: XYZ Ltd has the option to enter into a forward arrangement
with a bank/financial institution to sell their Euros (Forward Rate) at a later date.
This lock in the currency rate for the raw materials purchase.

Currency Options: XYZ Ltd could use currency options in order to hedge their
foreign risk exposure. A 30-day option on INR EURO allows them to buy Euros
at a pre-agreed price (0.012/Euro) should the exchange rate fall below the strike
rate. Or, they can buy a 30-day Call option (INR EURO) that allows them to
purchase Euros at a pre-agreed price (0.024/Euro) in case the exchange rate falls
below the strike rate.

Money Market Hedge XYZ Ltd also has the option to invest in the foreign money
market in order to earn interest as well as offset the risk of currency
fluctuations. The interest earned on foreign currency investments should equal
the anticipated loss in the local currency from fluctuations in exchange
rate. XYZ Ltd may invest its Euros to the money market to earn 7% interest. This
rate is lower than the 14% rate in INR and will compensate for the foreign
exchange risk.

Conclusion:

You can hedge with options by opening a position, or multiple positions, that
will offset any risk in an existing trade.  This could be an existing option
position, a derivative or investment.  While hedge strategies don't eliminate all
your risk as they are not able to create a net-zero effect that is completely
impossible, they can help reduce your risk to a specified amount.  Hedging is
based on the idea that while one position falls in value, the other position or
positions would make a profit. This creates either a net zero effect (or even a
total profit). You need to be familiar with the details of how options work before
you can hedge. This strategy is extremely popular. Options can be used to hedge
against risks to equity portfolios.  Although investors tend to be more concerned
about shorter-term movements than they are with longer-term ones, hedging
could create additional profit and reduce short-term risks.  Plus, you wouldn't
have to sell any shareholdings. This could lead to lower long-term profits.  Hedge
with derivatives allows you to open a short-term position on the same asset as
you have.

Answer 3.b Introduction:

Money market hedging refers to the use of borrowing and lending transactions
made in foreign currency in order to lock the home currency value of a foreign
transaction. It is also known to be a synthetic forward contracts.  The cover IRP
(the basic principle of a money markets hedge) states that the forward market
price must be equal or greater than the spot exchange rate and the ratio of
riskless returns for both currencies.  A hedge is an investment which protects
your portfolio from adverse market movements.  Put options allow investors to
sell an asset at a given price and within a time limit.  As protection from the
downside, investors may purchase put options.  For the forward rate to be
calculated, multiply the spot interest rate by the ratio and adjust for the
expiration date. So the forward interest rate is equal to the spot rates x (1 +
domestic and 1 + foreign interest rates).

Concept, and its application:

Hedged Cost of XYZ Ltd. These costs can be calculated using different
hedging options:

Forward Market Hedging: The forward rate of Euro 80.79/INR is charged to the
company, which must then pay 14 millions Euros.  Thus, the hedged costs using
the forward-market hedge are 14 million euros * 80.79 INR/Euro = 1127,260,000
INR

Put Option Hedge. The company has a 30-day option for INR EURO at 0.02/Euro
with a premium to 1%. The premium would be 14 Million Euros * 0.12/Euro *1%
= 168,000 INR. The total cost would be 14,000,000 Euros + 0.012/Euro +168,000
INR = 1,684,000 USD + 1,1272,260,000 INR = 1128,944,000 INR.

Money Market Hedge. The company could invest 14,000,000 Euros in the money
markets to earn 7% interest. This will compensate for the potential loss caused
by fluctuation in foreign exchange rates.  The loss expected would be 14,000,000
Euros * (14%-7%) * 30/365 = 9,24,072 INR.

Thus, the total cost of the project is 14 million Euros * 8.49 INR/Euro -
924.072 INR = 1.127.336,480 USD

Conclusion:

Hedging means taking a position in a market that will limit the investor's
downside or protect him from it in another portfolio or position.  Options
contracts like puts and calls give investors the flexibility to create a
hedge. Protective puts provide a floor for downside risk, and selling a call
against an existing contract can produce income while limiting the upside
potential. Options hedges can be costly for investors. Make sure you fully
understand the benefits and risks of each option.  Forward market hedging helps
protect investments, financial assets, instruments, and minimizes potential
losses. Most investors use hedging as a way to prevent future events from putting
their investment at risk. Investors may resort to hedging when there is
uncertainty or volatility in the market.  Hedge funds, mutual fund, brokerage and
investment advisors all promote hedge investing as a strategy.