1.

Rating Methodology
Rating methodology used by the major Indian credit rating agencies is more or less the same. The rating methodology involves an assessment of all the aspects influencing the creditworthiness of an issuer company e.g. business, financial and industry features, operational competence, the ability to manage, competitive position of the issuer and dedication to new ventures among others. A thorough analysis of the past financial statements is made to evaluate the performance and to anticipate the future earnings. The ability of the company to fulfill the debt obligations over the term of the instrument being rated is also assessed. As a matter of fact, it is the capability of the issuer to fulfil obligations that determine the rating. While assessing the instrument, the following are the main factors that are analysed in detail by the credit rating agencies: (i) Business risk analysis (ii) Financial analysis (iii) Management evaluation (iv) Geographical analysis (v) Regulatory and competitive environment (vi) Fundamental analysis These are explained as follows: (i) Business risk analysis Business risk analysis focuses on analysing the industry hazards, market position of the company, operating competence and legal position of the company. The industry risk by taking into consideration various factors like strength of the industry prospect, nature and basis of competition, demand and supply position, structure of industry, pattern of business cycle etc. How the industry players are competing with each other on the basis of price, product quality, distribution capabilities etc are also analysed. Industries with stable growth in demand and flexibility in the timing of capital outlays are in a stronger position and, therefore, enjoy better credit rating. For example, a seasonal business like hiring of vacation cottages or firms making winter clothesline. (ii) Financial analysis Financial analysis aims at determining the financial strength of the issuer company through ratio analysis, cash flow analysis and study of the existing capital structure. The analytical framework involves the analysis of business risk, technology risk, operational risk, industry risk, market risk, financial risk and management risk. Business risk analysis covers industry analysis, operating efficiency, market position of the company whereas financial risk covers accounting quality, existing financial position, cash flows and financial flexibility. Under management risk analysis, an assessment is made of the competence and risk appetite of the management. The CRA might also look at the sufficiency of other means of servicing debt in case the primary cash flows are insufficient: for instance, in a securitized instrument, the credit enhancement and structure will be examined, while in case of a guaranteed bond the credit strength of the guarantor could drive the rating. (iii) Management evaluation A companys performance is largely influenced by the aims and objectives

of the management, its plans and policies, ability to prevail over adverse conditions, employees experience and skills, planning and control system among others. The managements strong points and weak points are evaluated for rating a debt instrument. For example, if the vision of the management is not clear about the big picture of the firm at least five to fifteen years down the line, then the companys focus may not be in proper place and the performance will not be as per the expected level. Any companys performance is significantly affected by the management goals, plans and strategies, capacity to overcome unfavourable conditions, staffs own experience and skills, planning and control system etc. Rating exercise requires evaluation of the management strengths and weaknesses. (iv) Geographical analysis Geographical analysis facilitates in ascertaining the locational advantages enjoyed by the issuer company. An issuer company whose business covers a large geographical region avail the advantage of diversification and as a result, gets an improved credit rating. A company located in a backward area may avail subsidies from the government and, hence have the advantage of lower cost of operation. Smaller companies operations are limited in terms of product, geographical area and the number of customers. However, large companies enjoy the benefits of diversification owing to wide range of products and customers spread over larger geographical area. For example, a local shoe manufacturer has an exposure to a smaller market whereas a national level shoemaker has a wider reach to customer with better distribution system in place. (v) Regulatory and competitive environment Credit rating agencies assess the composition and regulatory structure of the financial system in which it operates. CRAs have to assess the bearing of regulation/ deregulation on the issuer company, while allotting rating symbols. (vi) Fundamental analysis Fundamental analysis includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company. This includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company. Fundamental analysis is undertaken for rating debt instruments of financial institutions, banks and non-banking finance companies. 2. Concept of Venture Capital Funds Venture capital is the money provided by investors to start firms and small businesses with long-term growth potential. This is a very important source of funding for start-ups that do not have access to capital markets. It typically entails high risk for the investor, but it has the potential for above-average returns. Venture capital can be defined as investment (long term) which is made in: Ventures that are promoted by persons who though they are qualified and technically sound but do not have any entrepreneurial experience. Projects which involves high degree of risk. The concept of venture capital financing is very old but todays changing business environment makes it more tempting for businesses. The reason being, venture capital companies give risky capital to the entrepreneur so that they can

meet the minimum requirements of the promoters contribution. Venture capitalists not only provide the finance for risky business but also provide valueadded services and business and managerial support. In situations where firms are not able to raise finance by conventional means, like public issue, etc., the importance of venture capital is greater. Thus, we can say that venture capital institutions are financial intermediaries between the entrepreneurs who need institutional capital (as they are not ready for public finance) and investors who are looking for higher returns.

Features of a Venture Capital Fund

As venture capital is provided for businesses which involve higher risk and also a higher rate of return, it has some specific features. These are: (i) Long-term investment: Venture capital is provided for the long term. This is generally provided to high-risk businesses (small and medium enterprises) who cannot arrange funds from other sources of finance. Venture capital is for that project which starts earning returns after some time. Due to all these reasons, venture capital is provided for the long term. (ii) Participation in equity capital: Venture capital is always invested in equity capital (actual or potential). The reason for this is that the venture capitalist can sell his part of equity when they start earning profit from their equity holding. In the beginning, the equity capital of new ventures is risky but when they start earning profits and the market gains confidence in them, the venture capitalist can sell his portion of equity capital at a profit. (iii) High risk: Venture capital signifies equity investment (ownership participation) in highly risky projects which have growth prospective and a projected high rate of return. Projects, in which markets have no earlier experience of earning profits, are the target of the venture capitalists. (iv) Management participation: Venture capital funds not only provide equity capital to the firms or businesses but also provide them with various kinds of services like participation in management of the assisted business. Due to this reason they are different from bankers. They are not like other stock market investors who do not participate in the management of companies but invest and trade in shares in the stock market. In this way, venture capital is different from investors (equity) also. Moreover, it is the combination of bankers, stock market investors and entrepreneurs. (v) Liquid investment: Investment made by venture capital fund is in equity portion of the company which makes it less liquid. Funds cannot demand its money back anytime during the life of the assisted business. They get their money back when the assisted business goes into liquidation. (vi) Fulfils its social objectives: Unlike several state and central-level government organizations, venture capitalists provide finance with profit as their main objective. But venture capital funds help in generating new employment opportunities and also help in the balanced growth of the economy by the development of new and innovative business. (vii) Large scope of venture capital activities: Venture capital is not merely a means for financing technology. It is beyond financing new technologyoriented companies and businesses. It extends to involve the financing of small and medium enterprises at their early stages of business and helps them establish in the market. So, it can be said that the scope of venture

capital activities is big. 3. Concept of Hire Purchase In a hire purchase system, the buyer acquires the property by promising to pay in monthly, quarterly and half-yearly installments. The period of payment has to be fixed while signing the hire sale agreement. Though the buyer acquires the asset after signing the agreement, the title of ownership remains with the vendor until the buyer pays the entire liability. When the buyer pays the entire installment and any other obligation according to hire purchase agreement, only then the title of ownership of goods would be transferred to the hirer. If the hirer makes any default in the payment of any installment, the hire vendor has the right to reposses the goods. In this case, the amount that is already paid so far by the hirer will be forfeited. The hire purchase price of goods is normally higher than the cash price of the good, because it includes interest on the balance payable amount charged by the vendor as well as the cash price. Under this system, the vendor is responsible to repair the goods which are in possession of buyer provided that the buyer takes the utmost proper care of the goods acquired. The risk is also borne by the vendor until the payment of last installment. The buyer has the right to return the goods to the vendor, if they are not according to the terms and condition of the hire purchase agreement. Generally, a higher purchase agreement has the following features: 1. The buyer (hirer) buys some goods from the hiree and the possession of the goods is immediately given to the buyer while the ownership rests with the merchant (vendor). 2. This payment for goods is made in installments and this must be completed in a specific period of time. In other words, we can say that hire purchase agreement is for a specific period of time. 3. The ownership of the asset transfer to the buyer when he pays the last instalment for it; till then ownership lies with the merchant or vendor. 4. In this agreement hiree charges interest on flat rate. 5. The hiree or vender has the right to repossess the asset in case there is default in the payment of installments from buyer side. 6. Each instalment paid by buyer includes the amount of interest as well as the repayment of the loan amount or principal amount. 7. The hire purchaser generally makes a down payment (initial payment) in signing the agreement and the balance of the amount along with the interest is paid in the installments at regular intervals. 8. The hire purchaser has the right to terminate the agreement at any time before the property so passes. The preceding discussion makes it clear that in the case of hire purchase, goods are immediately given to the buyer on the promise that he pays the cost of the goods (with interest) in instalments and he gets the ownership of the goods after the last payment of installment till then ownership lies with vendor. In hire purchase arrangement there are two parties: the buyer (hirer) and the vendor (hiree).

Difference between Hire Purchase and Leasing

1. Ownership In leasing ownership is never transfer to the lessee even after the payment of last lease rentals. But in hire purchase, after the payment of last installment

ownership is transferred to the buyer of the goods. 2. Repayment amount Generally in lease, repayment is called lease rentals and that in case of hire purchase is called installments. 3. Advantage of tax deductibility In lease financing lease rentals are tax deductible expenses. However, in hire purchase arrangement only the amount of interest is tax deductible not the full installment. 4. Depreciation Lessee cannot claim depreciation as he is not the owner of the asset. In hire purchase the buyer can have the claim of depreciation with other expenses. 5. Realization of salvage value Lessee cannot realize salvage value of the leased asset after the end of the lease contract. The hirer can claim salvage value. 6. Magnitude of funds involved In leasing, magnitude of funds involved is very large because these contracts are generally for capital goods such as plant and machinery, ships, among others. In the case of hire purchase, the magnitude of funds involved is low. Generally, these contracts are for the purchase of office equipments, automobiles, furniture among others. 7. Nature of Expenditure In lease, rentals paid by the lessee are entirely revenue expenditure of the lessee. But, only interest element included in the HP installment is revenue expenditure. 8. Components Lease rental comprises two elements: (1) finance charge and (2) capital recovery. In case of Hire Purchase, HP installments comprise three elements (1) normal trading profit (2) finance charge and (3) recovery of cost goods/assets.

4. introduction of swap

A swap is an agreement between two parties to exchange sequences of cash flows for a set period of time. Usually, at the time the contract is initiated, at least one of these series of cash flows is determined by a random or uncertain variable, such as an interest rate, foreign exchange rate, equity price or commodity price. Conceptually, one may view a swap as either a portfolio of forward contracts, or as a long position in one bond coupled with a short position in another bond. This article will discuss the two most common and most basic types of swaps: the plain vanilla interest rate and currency swaps.

Swaps are private over the counter agreements that are largely unregulated; swaps can be highly customized to meet the needs of the counterparties. A swap is a mutually agreed exchange of cash flows. A swap has an initial value of zero; with the passage of time and change of market conditions, the swap may have negative value for one party and positive value for the other party. The party with positive value is exposed to default risk by the party with negative value. No money is exchanged at swap initiation, with the exception of currency swaps. Swaps can be categorized as: currency, interest rate, equity (including equity index), and commodity & other swaps. Featuers of swap

Characteristics of Swaps
Non-standardized contracts that are traded over the counter (OTC), allow to deal with much longer horizons than exchange-tradedinstruments, but subject to credit risk give greater privacy & escape regulation. Swaps are contracts that exchange assets, liabilities, currencies, securities, equity participations and commodities. Generally used for risk management by institutions Most involve multiple payments as a series of forward contracts, although one-payment contracts are possible When initiated, neither party exchanges any cash, a swap has zero value at the beginning.

Swap Characteristics

Most involve multiple payments, although one-payment contracts are possible A series of forward contracts. When initiated, neither party exchanges any cash; a swap has zero value at the beginning. One party tends to pay a fixed rate while the other pays on the movement of the underlying asset. However, a swap can be structured so that both parties pay each other on the movement of an underlying asset. Parties make payments to each other on a settlement date. Parties may decide to agree to just exchange the difference that is due to each other. This is called netting.

Final payment is made on the termination date. Usually traded in the over-the-counter market. This means they are subject credit risk.

Interest rate swaps

The most common type of swap is a plain Vanilla interest rate swap. It is the exchange of a fixed rate loan to a floating rate loan. The life of the swap can range from 2 years to over 15 years. The reason for this exchange is to take benefit fromcomparative advantage. Some companies may have comparative advantage in fixed rate markets, while other companies have a comparative advantage in floating rate markets. When companies want to borrow, they look for cheap borrowing, i.e. from the market where they have comparative advantage. However, this may lead to a company borrowing fixed when it wants floating or borrowing floating when it wants fixed. This is where a swap comes in. A swap has the effect of transforming a fixed rate loan into a floating rate loan or vice versa. For example, party B makes periodic interest payments to party A based on a variable interest rate of LIBOR +70basis points. Party A in return makes periodic interest payments based on a fixed rate of 8.65%. The payments are calculated over the notional amount. The first rate is called variable because it is reset at the beginning of each interest calculation period to the then current reference rate, such as LIBOR. In reality, the actual rate received by A and B is slightly lower due to a bank taking a spread.

Fixed-for-floating rate swap, different currencies[edit]

Party P pays/receives fixed interest in currency A to receive/pay floating rate in currency B indexed to X on a notional N at an initial exchange rate of FX for a tenure of T years. For example, you pay fixed 5.32% on the USD notional 10 million quarterly to receive JPY 3M (TIBOR) monthly on a JPY notional 1.2 billion (at an initial exchange rate of USD/JPY 120) for 3 years. For nondeliverable swaps, the USD equivalent of JPY interest will be paid/received (according to the FX rate on the FX fixing date for the interest payment day). No initial exchange of the notional amount occurs unless the Fx fixing date and the swap start date fall in the future. Fixed-for-floating swaps in different currencies are used to convert a fixed rate asset/liability in one currency to a floating rate asset/liability in a different currency, or vice versa. For example, if a company has a fixed rate USD 10 million loan at 5.3% paid monthly and a floating rate investment of JPY 1.2 billion that returns JPY 1M Libor +50bps monthly, and wants to lock in the profit in USD as they expect the JPY 1M Libor to go down or USDJPY to go up (JPY depreciate against USD), then they may enter into a Fixed-Floating swap in different currency where the company pays floating JPY 1M Libor+50bps and receives 5.6% fixed rate, locking in 30bps profit against the interest rate and the fx exposure.

Floating-for-floating rate swap, same currency[edit]

Party P pays/receives floating interest in currency A Indexed to X to receive/pay floating rate in currency A indexed to Y on a notional N for a tenure of T years. For example, you pay JPY 1M LIBOR monthly to receive JPY 1M TIBOR monthly on a notional JPY 1 billion for 3 years or you pay EUR 3M EURIBOR quarterly to receive EUR 6M EURIBOR semi-annually. The second type of example, where the indexes are of the same type but with different tenors, are the most liquid and most traded same currency floating-for-floating swaps.

Floating-for-floating rate swaps are used to hedge against or speculate on the spread between the two indexes widening or narrowing. For example, if a company has a floating rate loan at JPY 1M LIBOR and the company has an investment that returns JPY 1M TIBOR + 30bps and currently the JPY 1M TIBOR = JPY 1M LIBOR + 10bps. At the moment, this company has a net profit of 40bps. If the company thinks JPY 1M TIBOR is going to come down (relative to the LIBOR) or JPY 1M LIBOR is going to increase in the future (relative to the TIBOR) and wants to insulate from this risk, they can enter into a float-float swap in same currency where they pay, say, JPY TIBOR + 30bps and receive JPY LIBOR + 35bps. With this, they have effectively locked in a 35bps profit instead of running with a current 40bps gain and index risk. The 5bps difference (w.r.t. the current rate difference) comes from the swap cost which includes the market expectations of the future rate difference between these two indices and the bid/offer spread which is the swap commission for the swap dealer. Floating-for-floating rate swaps are also seen where both sides reference the same index, but on different payment dates, or use different business day conventions. This can be vital for asset-liability management. An example would be swapping 3M LIBOR being paid with prior non-business day convention, quarterly on JAJO (i.e. Jan, Apr, Jul, Oct) 30, into FMAN (i.e. Feb, May, Aug, Nov) 28 modified following

Floating-for-floating rate swap, different currencies[edit]

Party P pays/receives floating interest in currency A indexed to X to receive/pay floating rate in currency B indexed to Y on a notional N at an initial exchange rate of FX for a tenure of T years. The notional is usually exchanged at the start and at the end of the swap. This is the most liquid type of swap with different currencies. For example, you pay floating USD 3M LIBOR on the USD notional 10 million quarterly to receive JPY 3M TIBOR quarterly on a JPY notional 1.2 billion (at an initial exchange rate of USDJPY 120) for 4 years; at the start you receive the notional in USD and pay the notional in JPY and at the end you pay back the same USD notional (10 million) and receive back the same JPY notional (1.2 billion). To explain the use of this type of swap, consider a US company operating in Japan. To fund their Japanese growth, they need JPY 10 billion. The easiest option for the company is to issue debt in Japan. As the company might be new in the Japanese market without a well known reputation among the Japanese investors, this can be an expensive option. Added on top of this, the company might not have appropriate debt issuance program in Japan and they might lack sophisticated treasury operation in Japan. To overcome the above problems, it can issue USD debt and convert to JPY in the FX market. Although this option solves the first problem, it introduces two new risks to the company: FX risk. If this USDJPY spot goes up at the maturity of the debt, then when the company converts the JPY to USD to pay back its matured debt, it receives less USD and suffers a loss. USD and JPY interest rate risk. If the JPY rates come down, the return on the investment in Japan might go down and this introduces an interest rate risk component.

The first exposure in the above can be hedged using long dated FX forward contracts but this introduces a new risk where the implied rate from the FX spot and the FX forward is a fixed rate but the JPY investment returns a floating rate. Although there are several alternatives to hedge both the exposures effectively without introducing new risks, the easiest and the most cost effective alternative would be to use a floating-for-floating swap in different currencies. In this,

Fixed-for-fixed rate swap, different currencies[edit]

Party P pays/receives fixed interest in currency A to receive/pay fixed rate in currency B for a term of T years. For example, you pay JPY 1.6% on a JPY notional of 1.2 billion and receive USD 5.36% on the USD equivalent notional of 10 million at an initial exchange rate of USDJPY 120.

Other variations[edit]
A number of other variations are possible, although far less common. Mostly tweaks are made to ensure that a bond is hedged "perfectly", so that all the interest payments received are exactly offset by the swap. This can lead to swaps where principal is paid on one or more legs, rather than just interest (for example to hedge a coupon strip), or where the balance of the swap is automatically adjusted to match that of a prepaying bond (such as RMBS Residential mortgage-backed security)

5. 6. Political Stability and Economic Performance Foreign investors inevitably seek out stable countries with strong economic performance in which to invest their capital. A country with such positive attributes will draw investment funds away from other countries perceived to have more political and economic risk. Political turmoil, for example, can cause a loss of confidence in a currency and a movement of capital to the currencies of more stable countries.
Lesson 6 Key Factors Affecting Exchange Rate
All forex trading involves the exchange of one currency with another. At any one time, the actual exchange rate is determined by the supply and demand of the corresponding currencies. Keep in mind that the demand of a certain currency is directly linked to the supply of another. Likewise, when you supply a certain currency, it would mean that you have the demand for another currency. The following factors affect the supply and demand of currencies and would therefore influence their exchange rates. 1. Monetary Policy When a central bank believes that intervention in the forex market is effective and the results would be consistent with the governments monetary policy, it will participate in forex trading and influence the exchange rates. A central bank generally participates by buying or selling the domestic currency so as to stabilize it at a level that it deems realistic and ideal. Judgment on the possible impact of governments monetary policy and prediction on future policy by other market players will affect the exchange rates as well. 2. Political Situation Growing global tension will result in instability in the forex market. Irregular inflow or outflow of currencies may result in significant fluctuations in exchange rates. The stability of a foreign currency is closely related to the political situation of that place. In general, the more stable the country is, the more stable its currency will be. We will illustrate how political factors influence exchange rates with some actual examples. At the end of 1987, the US Dollar was suffering from continuous depreciation. In order to stabilize the US Dollar, the G7 Finance Ministers and central bank governors released a joint statement on 23 December 1987 announcing plans for a large-scale intervention in the forex market. On 4 January 1988, the group started to dump Japanese Yen and Deutsche Mark in huge volumes while buying US Dollars. This resulted in a rebound of the US Dollar and maintained its exchange rate at a stable level. For our second example, if you have been observing the Euro, you would have noticed that for three consecutive months during the Kosovo War, the Euro fell by about 10% against the US Dollar. One of the reasons was the downward pressure on the Euro caused by the Kosovo War. 3. Balance of Payments

Balance of payments of a country will cause the exchange rate of its domestic currency to fluctuate. The balance of payments is a summary of all economic and financial transactions between the country and the rest of the world. It reflects the countrys international economic standing and influences its macroeconomic and microeconomic operations. The balance of payments can affect the supply and demand for foreign currencies as well as their exchange rates. An economic transaction, such as export, or capital transaction, such as inflow of foreign investment, will result in foreign revenue. Since foreign currencies are normally not allowed to circulate in the domestic market, there is a need to exchange these currencies into the domestic currency before circulation. This in turn creates a supply of foreign currencies in the forex market. On the other hand, an economic transaction, such as import, or capital transaction, such as outflow of investment to a foreign country, will result in foreign payments. In order to meet a countrys economic needs, it is necessary to convert t he domestic currency into foreign currencies. This creates a demand for foreign currencies in the forex market. When all these transactions are consolidated into a table of international balance of payments, this would become the countrys foreign exchange balance of payments. If the foreign revenue is larger than payment, there will be a larger supply of foreign currencies. If the foreign payment is larger than revenue, then the demand for foreign currencies will be higher. When the supply of a foreign currency increases but its demand remains constant, it will directly drive the price of that foreign currency down and increase the value of the domestic currency. On the other hand, when the demand for a foreign currency increases but its supply remains constant, it will drive the price of the foreign currency up and decrease the value of the domestic currency. 4. Interest Rates When a countrys key interest rate rises higher or falls lower than that of another country, the currency of the nation with lower interest rate will be sold and the other currency will be bought so as to achieve higher returns. Given this increase in demand for the currency with higher interest rate, the value of that currency will rise against other currencies. Let us use an example to illustrate how interest rates affect exchange rates. Assume there are two countries, A and B. Both countries do not exercise foreign exchange control and capital funds can flow freely between them. As part of its monetary policy, Country A raises its interest rate by 1% while the interest rate of Country B remains unchanged. There is a huge volume of liquid capital in the market that flows freely between these two countries, seeking out the best possible interest rate. With all other conditions remaining unchanged, as Country As key interest rate rises, a large portion of the liquid capital will flow into Country A. When the liquid capital flows out from Country B to Country A, a large amount of Country Bs currency will be sold in exchange for Country As currency. In this way, the demand for Country As currency will increase, strengthening it against Country Bs currency. In fact, in todays globalized market, this scenario applies to the whole world. Over the years, the market trend has been shifting towards free capital mobility and elimination of foreign exchange restrictions. This enables liquid capitals(also known as hot money) to flow freely in the international market. A point to note though is that such capital will only be moved to a region or country with higher interest rate if their investors believe that the change in exchange rate will not nullify the returns gained with higher interest rate. 5. Market Judgment The forex market does not always follow a logical pattern of change. Exchange rates are also influenced by intangible factors such as emotions, judgments as well as analysis and comprehension of political and economic events. Market operators must be able to interpret reports and data such as balance of payments, inflation indicators and economic growth rates accurately. In reality, before these reports and data become available to the public, the market would have already made its own predictions and judgments, and these will be reflected in the prices. In the event that the actual reports and data deviate too much from the predictions and judgments of the market, huge fluctuations in exchange rates will occur. Accurate interpretation of reports and data alone is not adequate, a good forex trader must also be able to determine market reactions before the information becomes publicly available. 6. Speculation Speculation by major market operators is another crucial factor that influences exchange rates. In the forex market, the proportion of transactions that are directly related to international trade activities is relatively low. Most of the transactions are actually speculative tradings which cause currency movement and influence exchange rates. When the market predicts that a certain currency will rise in value, it may spark a buying frenzy that pushes the currency up and fulfill the predicti on. Conversely, if the market expects a drop in value of a certain currency, people will start selling it away and the currency will depreciate.

1. Interest Rates
"Benchmark" interest rates from central banks influence the retail rates financial institutions charge customers to borrow money. For instance, if the economy is under-performing, central banks may lower interest rates to make it cheaper to borrow; this often boosts consumer spending, which may help expand the economy. To slow the rate of inflation in an overheated economy, central banks raise the benchmark so borrowing is more expensive. Interest rates are of particular concern to investors seeking a balance between yield returns and safety of funds. When interest rates go up, so do yields for assets denominated in that currency; this leads to increased demand by investors and causes an increase in the value of the currency in question. If interest rates go down, this may lead to a flight from that currency to another.

6. 1. Monetary Policy When a central bank believes that intervention in the forex market is effective and the results would be consistent with the governments monetary policy, it will participate in forex trading and influence the exchange rates. A central bank generally participates by buying or selling the domestic currency so as to stabilize it at a level that it deems realistic and ideal. Judgment on the possible impact of governments monetary policy and prediction on future policy by other market players will affect the exchange rates as well. 2. Political Situation Growing global tension will result in instability in the forex market. Irregular inflow or outflow of currencies may result in significant fluctuations in exchange rates. The stability of a foreign currency is closely related to the political situation of that place. In general, the more stable the country is, the more stable its currency will be. We will illustrate how political factors influence exchange rates with some actual examples. At the end of 1987, the US Dollar was suffering from continuous depreciation. In order to stabilize the US Dollar, the G7 Finance Ministers and central bank governors released a joint statement on 23 December 1987 announcing plans for a large-scale intervention in the forex market. On 4 January 1988, the group started to dump Japanese Yen and Deutsche Mark in huge volumes while buying US Dollars. This resulted in a rebound of the US Dollar and maintained its exchange rate at a stable level. For our second example, if you have been observing the Euro, you would have noticed that for three consecutive months during the Kosovo War, the Euro fell by about 10% against the US Dollar. One of the reasons was the downward pressure on the Euro caused by the Kosovo War. 3. Balance of Payments

Balance of payments of a country will cause the exchange rate of its domestic currency to fluctuate. The balance of payments is a summary of all economic and financial transactions between the country and the rest of the world. It reflects the countrys international economic standing and influences its macroeconomic and microeconomic operations. The balance of payments can affect the supply and demand for foreign currencies as well as their exchange rates. An economic transaction, such as export, or capital transaction, such as inflow of foreign investment, will result in foreign revenue. Since foreign currencies are normally not allowed to circulate in the domestic market, there is a need to exchange these currencies into the domestic currency before circulation. This in turn creates a supply of foreign currencies in the forex market. On the other hand, an economic transaction, such as import, or capital transaction, such as outflow of investment to a foreign country, will result in foreign payments. In order to meet a countrys economic needs, it is necessary to convert the domestic currency into foreign currencies. This creates a demand for foreign currencies in the forex market. When all these transactions are consolidated into a table of international balance of payments, this would become the countrys foreign exchange balance of payments. If the foreign revenue is larger than payment, there will be a larger supply of foreign currencies. If the foreign payment is larger than revenue, then the demand for foreign currencies will be higher. When the supply of a foreign currency increases but its demand remains constant, it will directly drive the price of that foreign currency down and increase the value of the domestic currency. On the other hand, when the demand for a foreign currency increases but its supply remains constant, it will drive the price of the foreign currency up and decrease the value of the domestic currency. 4. Interest Rates When a countrys key interest rate rises higher or falls lower than that of another country, the currency of the nation with lower interest rate will be sold and the other currency will be bought so as to achieve higher returns. Given this increase in demand for the currency with higher interest rate, the value of that currency will rise against other currencies. Let us use an example to illustrate how interest rates affect exchange rates. Assume there are two countries, A and B. Both countries do not exercise foreign exchange control and capital funds can flow freely between them. As part of its monetary policy, Country A raises its interest rate by 1% while the interest rate of Country B remains unchanged. There is a huge volume of liquid capital in the market that flows freely between these two countries, seeking out the best possible interest rate. With all other conditions remaining unchanged, as Country As key interest rate rises, a large portion of the liquid capital will flow into Country A. When the liquid capital flows out from Country B to Country A, a large amount of Country Bs currency will be sold in exchange for Country As currency. In this way, the demand for Country As currency will increase, strengthening it against Country Bs currency. In fact, in todays globalized market, this scenario applies to the whole world. Over the years, the market trend has been shifting towards free capital mobility and elimination of foreign exchange restrictions.

This enables liquid capitals(also known as hot money) to flow freely in the international market. A point to note though is that such capital will only be moved to a region or country with higher interest rate if their investors believe that the change in exchange rate will not nullify the returns gained with higher interest rate. 5. Market Judgment The forex market does not always follow a logical pattern of change. Exchange rates are also influenced by intangible factors such as emotions, judgments as well as analysis and comprehension of political and economic events. Market operators must be able to interpret reports and data such as balance of payments, inflation indicators and economic growth rates accurately. In reality, before these reports and data become available to the public, the market would have already made its own predictions and judgments, and these will be reflected in the prices. In the event that the actual reports and data deviate too much from the predictions and judgments of the market, huge fluctuations in exchange rates will occur. Accurate interpretation of reports and data alone is not adequate, a good forex trader must also be able to determine market reactions before the information becomes publicly available. 6. Speculation Speculation by major market operators is another crucial factor that influences exchange rates. In the forex market, the proportion of transactions that are directly related to international trade activities is relatively low. Most of the transactions are actually speculative tradings which cause currency movement and influence exchange rates. When the market predicts that a certain currency will rise in value, it may spark a buying frenzy that pushes the currency up and fulfill the prediction. Conversely, if the market expects a drop in value of a certain currency, people will start selling it away and the currency will depreciate.

one of the forms of the movement of monetary and material means in international economic relations. It is based on the temporary provision of financial and commodity resources by a creditor to a borrower on condition of repayment at a set time and with interest. International credit is closely linked to the formation and development of the world capitalist and world socialist economic systems. The essence, forms, and functions of international credit are determined by the socioeconomic conditions under which it is applied. Capitalist countries. Capitalist international credit is a form for the movement of loan capital between countries with the aim of obtaining the highest possible rate of profit and gaining political advantages. This form of credit was one of the levers for the initial accumulation of capital. During the period of industrial capitalism, it helped to industrialize production and exchange and to form the world market. In the era of imperialism, international credit has been turned into one of the main forms of exporting capital and into an implement for the struggle of the imperialist states for markets and for the most profitable spheres of capital investment. With the development of state-monopoly capitalism, international credit in the hands of the imperialist states became a means of political and economic expansion. The imperialist states use international credit, a form of financing international trade, to preserve an export structure advantageous to themselves in the developing countries. Since World War II, international credit has

been widely used to mitigate the chronic instability of the capitalist monetary system and to support the leading capitalist currencies, above all the US dollar. Several basic types of international credits are used, including corporate, bank, and intergovernmental credits and credits of international monetary and financial organizations. Credits may take a commodity or a monetary form. International credits can be short-term (up to one year), medium-term (from one to 5-7 years), and long-term (more than 5-7 years). Corporate credits are usually extended in a commodity form by capitalist companies, with deliveries of strictly determined types of goods by the exporter firms; the credits are most often granted within the limits of the value of the firm s commodity exports. The credits are basically short -term and medium-term. Bank credits take such monetary forms as discounts of bills of exchange, commodity and other loans, contra account credits, and bank acceptances. In the 1960s, medium -term bank credits for specific purposes became common; these were granted by the major commercial banks or consortiums of banks for financing specific projects and for purchasing large batches of equipment in the creditor states. In particular, the exports of machiner y and equipment from the United States to Japan in the 1960s were financed to a significant degree through credits and loans of private commercial banks. Bank crediting has also been widely used in financing US exports to such Western European coun-tries as Norway, Denmark, Sweden, Greece, and Spain. With the strengthening of the state-monopoly trends in the sphere of international credit, intergovernmental credits have been widely developed. From 1948 to 1951, through a system of governmental subsidies and loans under the Marshall Plan, the United States gave $12.3 billion of assistance to the states of Western Europe, a program that served as a basis for a full -scale offensive by American monopolies in Western European markets. Intergovernmental credits have been widely used by the imperialist states as an implement of neocolonial policy vis--vis the developing countries. The credits are earmarked for strictly defined sectors of production whose development does not encroach on the interests of the monopolies in the creditor coun-tries. They are also designated for development of the infrastructure (education, communications and transport, and the other underlying economic sectors of society); the development of this sector is a necessary condition for the influx of private investments from the developed capitalist countries. The granting of credits is frequently linked with demands for commercial and monetary advantages to the foreign companies and for the participation of the developing countries in economic groupings and military-political alliances. Much of this credit is blocked; that is, it is granted for acquiring necessary commodities only from the creditor states. Thus, in 1967, 93.7 per-cent of the state credit going to the developing countries was blocked: 96.5 percent of the total volume of US state credits was blocked, 86.6 percent of Japans, 72.6 percent of Italys, 61.8 percent of Frances, and 57.1 percent of Great Britains. The monopolies of the imperialist states substantially inflated the prices for the goods to be sold on credit, which led to the worsening of the monetary position of the developing countries; at the end of the 1960s they were losing more than $1 billion annually as a result of this price inflation. Short-term credits of the swap type (the exchange of currencies between countries) are a variety of intergovernmental credits of the capitalist states and are a means of evading the chronic deficits of the balance of payments and the instability of the currencies of the leading capitalist states. Swap credits have been provided since 1962 by the central banks of the countries on the basis of bilateral international agreements. They have been widely used by the United States since 1962, by Great Britain since 1966, and by France since 1968. A specific form of inter-governmental credit is the credit granted by the capitalist coun-tries to one another within the system of special drawing rights, introduced on Jan. 1, 1970. The postwar years have seen a sharp increase in the role of the credits of monetary and financial organizations, including the International Monetary Fund and the International Bank for Reconstruction and Development, with its affiliates the Inter-American Development Bank and the Asian Development

Bank. These credits are used by the imperialist states as one of the means of an expansionist foreign policy. With the constant exacerbations of the crisis in the 1960s of the capitalist monetary system, the International Monetary Fund began to provide the central banks of the capitalist coun-tries with currency credits on the basis of bilateral agreements of support (reserve credits). Socialist countries. The international credit of the socialist countries is a form of the planned mobilization and investment of the financial and commodity resources of the socialist states in the process of implementing their intergovernmental economic relations. It acts as a means for assimilating achievements of scientific and technical progress and on this basis raising the effectiveness of the international socialist division of labor. The international credit of the socialist countries is carried out in two basic forms: intergovernmental credits on a bilateral basis and multilateral credits of the intergovernmental monetary and financial organizations of the socialist nations, the International Bank for Economic Cooperation (IBEC) and the International Investment Bank (IIB). Bilateral credits are provided by socialist states to each other on a long-term basis in the form of commodities, products, or money. The Soviet Union is the largest creditor among the socialist states. By the start of the 1970s the total of long-term credits and aid to the socialist states from the USSR was more than 8 billion rubles. Hundreds of industrial enterprises and other economic projects have been built with these funds. Czechoslovakia and the German Democratic Republic (GDR) have also played an important role in providing interstate credits to other socialist countries.