1Q) Examine the functions of the foreign exchange market?

The foreign exchange (forex or FX) market is a global decentralized market for trading currencies. Its functions are crucial
for international trade and finance. Here are the primary functions of the foreign exchange market:

1. Facilitating International Trade and Investment

 Currency Conversion: The forex market enables businesses and individuals to convert one currency into another.
This is essential for international trade, as exporters and importers need to be paid in their home currencies.
 Cross-border Investments: Investors use the forex market to exchange currencies when investing in foreign assets,
such as stocks, bonds, or real estate.

2. Providing Hedging Opportunities

 Risk Management: Businesses and investors can hedge against the risk of currency fluctuations. For example, a
U.S. company expecting payment in euros in the future can use forward contracts to lock in an exchange rate,
mitigating the risk of adverse currency movements.
 Forward and Futures Contracts: These financial instruments allow parties to agree on a specific exchange rate for
a future date, providing certainty and protection against volatility.

3. Speculation and Arbitrage

 Profit Opportunities: Traders in the forex market can speculate on the movements of currency prices to make a
profit. Speculators analyze market trends, economic indicators, and geopolitical events to predict future price
movements.
 Arbitrage: Forex traders exploit price discrepancies of the same currency pairs in different markets or time zones to
make risk-free profits.

4. Determining Exchange Rates

 Market Mechanism: The forex market is the primary venue for determining exchange rates through the forces of
supply and demand. Exchange rates fluctuate based on various factors, including economic data, interest rates,
political events, and market sentiment.
 Floating and Fixed Rates: Most major currencies have floating exchange rates, which are determined by the
market. Some countries, however, peg their currencies to another currency or a basket of currencies, leading to a
fixed exchange rate system.

5. Providing Liquidity

 High Liquidity: The forex market is the largest and most liquid financial market in the world, with trillions of
dollars traded daily. This high liquidity ensures that currency transactions can be executed quickly and with minimal
price distortion.
 24/7 Operation: The market operates 24 hours a day, five days a week, allowing participants to trade at any time,
which enhances liquidity and flexibility.

6. Economic Indicator

 Reflecting Economic Health: Exchange rates often reflect the economic health of a country. Strong currencies
typically indicate strong economies, while weak currencies may signal economic problems.
 Impact on Monetary Policy: Central banks monitor and sometimes intervene in the forex market to influence their
currency's value, impacting inflation, trade balances, and overall economic stability.
7. Global Connectivity

 Interconnected Markets: The forex market connects financial markets globally, facilitating smooth and efficient
international financial flows.
 Impact on Global Economy: The market influences global economic conditions by affecting trade balances, capital
flows, and economic policies across countries.

2Q) What are the functions of international stock market?

The functions of international stock markets are crucial for the global economy and include:

1. Capital Raising: Facilitate companies in raising capital by issuing shares to investors worldwide.
2. Liquidity: Provide a platform for buying and selling securities, ensuring liquidity and enabling investors to convert
investments into cash.
3. Price Discovery: Reflect the value of companies through the collective actions of buyers and sellers, aiding in the
determination of fair market prices.
4. Risk Diversification: Allow investors to diversify their portfolios across different markets and geographies,
reducing risk.
5. Information Dissemination: Ensure transparency by providing timely and accurate information about companies,
fostering informed investment decisions.
6. Regulation and Supervision: Enforce rules and regulations to maintain market integrity, protect investors, and
ensure fair trading practices.
7. Economic Indicator: Serve as a barometer of the economic health and performance of countries, sectors, and
industries globally.
8. Wealth Distribution: Enable the equitable distribution of wealth by allowing a broader segment of the population
to invest in successful enterprises.

These functions collectively support economic growth, financial stability, and the efficient allocation of resources globally.

Q3) Define exchange rates. Identify the factors influencing exchange rates?

Definition of Exchange Rates

Exchange Rate: An exchange rate is the price at which one currency can be exchanged for another. It represents the value of
one country's currency in terms of another currency. Exchange rates can be classified into two main types:

1. Floating Exchange Rate: Determined by the free market forces of supply and demand without direct government or
central bank intervention.
2. Fixed or Pegged Exchange Rate: Determined by the government or central bank, where the currency's value is tied
to another major currency like the U.S. dollar or a basket of currencies.

Factors Influencing Exchange Rates

Several factors influence exchange rates, often interacting in complex ways. The primary factors include:

1. Interest Rates:
 o Higher interest rates offer lenders in an economy a higher return relative to other countries. Consequently,
higher interest rates attract foreign capital and cause the exchange rate to rise.
2. Inflation Rates:
o Generally, countries with lower inflation rates exhibit a rising currency value, as the purchasing power
increases relative to other currencies. Conversely, higher inflation typically depreciates a currency's value.
3. Economic Indicators and Performance:
o Strong economic performance typically attracts foreign investors, boosting demand for the currency and
increasing its value. Key indicators include GDP growth rates, employment data, and industrial production.
4. Political Stability and Economic Performance:
o Countries with less risk for political turmoil are more attractive to foreign investors. Stable governance and
consistent economic policies increase currency value.
5. Market Speculation:
o If investors believe a currency will strengthen in the future, they will buy more of that currency now, which
drives up its value. Conversely, if they believe it will weaken, they will sell off their holdings, reducing its
value.
6. Balance of Payments / Trade Balances:
o A country with a surplus in its balance of payments tends to have a stronger currency, as foreign buyers
need to purchase the country's currency to pay for its goods and services. A deficit typically leads to a
weaker currency.
7. Public Debt:
o Countries with large public debts are less attractive to foreign investors due to the risk of inflation and
default. This decreased attractiveness often leads to a depreciation of the currency.
8. Terms of Trade:
o The terms of trade, i.e., the ratio of export prices to import prices, influence exchange rates. Improved
terms of trade mean the country receives more for its exports relative to its imports, increasing demand for
its currency and raising its value.
9. Government Intervention:
o Central banks may intervene in the forex market to stabilize or increase the value of their currency.
Methods include buying or selling currencies and altering interest rates.
10. Global Economic Conditions:
o Global economic events, such as recessions, booms, financial crises, and changes in commodity prices, can
influence exchange rates. For instance, a global demand shift for a country's primary export can
significantly affect its currency value.

Q4) Determine the International Capital Structure and cost of capital.?

International Capital Structure

Capital Structure: The capital structure of a company refers to the mix of debt and equity that a company uses to finance its
operations and growth. For multinational corporations (MNCs), the international capital structure involves not just domestic
financing but also sources from international markets.

Components of International Capital Structure

1. Equity Financing:
o Common Equity: Issuance of common shares in the home country and potentially in foreign markets
through American Depositary Receipts (ADRs) or Global Depositary Receipts (GDRs).
o Retained Earnings: Profits reinvested into the business instead of being paid out as dividends.
2. Debt Financing:
o Domestic Debt: Borrowing in the home country’s currency.
 o Foreign Debt: Borrowing in foreign currencies, often from international banks or through the issuance of
foreign bonds (e.g., Eurobonds).
3. Hybrid Instruments:
o Convertible Bonds: Bonds that can be converted into a specified number of shares.
o Preferred Stock: Equity that has a higher claim on assets and earnings than common stock, often with
fixed dividends.

Determinants of International Capital Structure

1. Exchange Rate Risk: Companies must consider the impact of fluctuating exchange rates on foreign currency-
denominated debt.
2. Interest Rate Differentials: The difference in interest rates between countries can influence borrowing decisions.
3. Tax Considerations: Different tax regimes across countries affect the attractiveness of debt versus equity.
4. Regulatory Environment: Varying regulations in different countries can impact capital structure choices.
5. Access to Capital Markets: The ease of accessing domestic versus international capital markets.
6. Cost of Capital: Companies must evaluate the cost of capital in different countries to minimize overall costs.

Cost of Capital

Cost of Capital: The cost of capital is the required return necessary to make a capital budgeting project worthwhile. It is the
average rate of return a company is expected to pay its security holders to finance its assets.

Components of Cost of Capital

1. Cost of Debt (Kd):

o The effective rate that a company pays on its borrowed funds.
o Calculated after tax since interest payments are tax-deductible: Kd=i(1−T)Kd = i (1 - T)Kd=i(1−T)
 Where iii is the interest rate and TTT is the tax rate.
2. Cost of Equity (Ke):
o The return required by equity investors given the risk of the investment in the company.
o Often calculated using the Capital Asset Pricing Model (CAPM):
 Ke=Rf+β(Rm−Rf)Ke = Rf + \beta (Rm - Rf)Ke=Rf+β(Rm−Rf)
 Where RfRfRf is the risk-free rate, β\betaβ is the beta of the stock, and RmRmRm is the expected
market return.
3. Weighted Average Cost of Capital (WACC):
o The overall cost of capital, combining both debt and equity.
o WACC=(E/V)∗Ke+(D/V)∗Kd∗(1−T)WACC = (E/V) * Ke + (D/V) * Kd * (1 - T)WACC=(E/V)∗Ke+(D/V)∗Kd∗(1−T)
 Where EEE is the market value of equity, DDD is the market value of debt, and VVV is the total
value of capital (E + D).

Factors Influencing International Cost of Capital

1. Country Risk: Includes political risk, economic risk, and exchange rate risk which may increase the required return
on investment.
2. Global Interest Rates: Differences in interest rates across countries impact the cost of debt.
3. Inflation Rates: Higher inflation in a country typically increases the nominal cost of both debt and equity.
4. Currency Risk: Fluctuations in exchange rates can affect the cost of servicing foreign currency debt and the return
required by foreign investors.
5. Market Integration: The extent to which global financial markets are integrated can affect the cost of capital by
providing more financing options and potentially lowering the cost of capital.