Assignment

International Financial Management

International Financial Markets

International financial markets undertake intermediation by transferring purchasing power
from lenders and investors to parties who desire to acquire assets that they expect top yield
future benefits. International financial transactions involve exchange of assets between
residents of different financial centers across national boundaries. International financial
centers are reservoirs of savings and transfer them to their most efficient use irrespective of
where the savings are generated.
There are three important functions of financial markets. First, the interactions of buyers and
sellers in the markets determine the prices of the assets traded which is called the price
discovery process. Secondly, the financial markets ensure liquidity by providing a mechanism
for an investor to sell a financial asset. Finally, the financial markets reduce the cost of
transactions and information.

Money and Capital Market

International financial markets may be divided into money and capital markets. Money
markets deal with assets created or traded with relatively short maturity, say less than a year.
Capital markets deal with instruments whose maturity exceeds one year or which lack definite
maturity.
Domestic markets in the international financial markets also we have primary and secondary
markets dealing with issue of new instruments and trading in existing instruments and trading
in existing instruments and negotiable debt instruments, respectively. In international financial
markets as in the domestic markets there is a symbiotic relationship between primary and
secondary markets.
International financial markets consist of international markets for foreign exchange, Euro
currencies and Euro bonds. In view of the development and rapid growth of swaps and
globalization of equity markets, international financial markets have been categorized into five
markets here: foreign exchange market: lending by financial institutions; issue and trading of
negotiable instruments of debt; issue and trading of equity securities; and lastly internationally
arranged swaps. The rates of foreign exchange as well as interest rates fluctuate and to hedge
against the risk of loss arising out of changes in them derivative instruments are traded in the
organized exchanges as well as in over the counter markets. Most of the derivatives except the
interest rate swaps are short term in nature. Derivatives involve creation of assets that are based
on other financial assets.

International Money Market

A money market is a market for instruments and a means of lending (or investing) and
borrowing funds for relatively short periods, typically regards as from one day to one year.
Such means and instruments include short term bank loans. Treasury bills, bank certificates of
deposit, commercial paper, banker’s acceptances and repurchase agreements and other short
term asset backed claims.
As a key elements of the financial system of a country, the money market plays a crucial
economic role that if reconciling the cash needs of so called deficit units, with the investment
needs of surplus units. Holding or borrowing liquid claims is more productive than holding
cash balances. A smoothly functioning money market can perform these functions very
efficiently if borrowing lending spreads (or bid offers spreads for traded instruments) are small
(operational efficiency), and if funds are lent to those who can make the most productive use
of them (allocation efficiency). Both borrowers and lenders prefer to meet their short term
needs without bearing the liquidity risk or interest rate risk that characterizes longer term
instruments, and money market instruments allow this. In addition money market investors
tend not to want to spend much time analyzing credit risk, so money market instruments are
generally characterized by a high degree of safety of principal. Thus the money market sets a
market interest rate that balances cash management needs, and sets different rates for different
uses that balance their risks and potential for productive use. Unlike stock or futures markets,
the money markets of the major industrial countries have no central location; they operate as
a telephone market that is accessible from all parts of the world.
The international money market can be regarded as the market for short term financing and
investment instruments that are issued or traded internationally. The core of this market is the
Eurocurrency market, where bank deposits are issued and traded outside of the country that
issued the currency

Eurocurrency Time Deposits and Certificates of Deposit

The overwhelming majority of bank deposits in the Eurocurrency market take the forms of
non-negotiable time deposits. An investor puts her money in credit issue. Canceling a time
deposit is awkward and expensive, so the investor sacrifices liquidity. Those who want greater
liquidity invest in shorter maturities. A very high proportion of Eurodollar time deposits,
especially in the interbank market, mature in one week or less.
Alternatively, the invest can buy a negotiable Euro certificate of deposit (Euro CD), which is
simply a time deposit that is transferable and thus has the elements of a security. Some banks
are a little reluctant to issue CDs, because they would prefer not to have their paper traded in
a secondary market, especially at times when the bank might be seeking additional short term
funding. The secondary paper might compete with the primary paper being offered. Other will
issue CDs readily if investors prefer them, perhaps paying ¼ percent or below their equivalent
time deposit rate to reflect the additional liquidity and the somewhat greater documentary
inconvenience of CDs.

Bankers Acceptances and Letters of Credit

Banker’s acceptances are money market instruments arising, typically, from international
trade transactions that are financed by banks. The banker’s acceptance (BA) itself represents
an obligation be a specific bank to pay a certain amount on a certain date in the future. To
simplify a bit, it is a claim the bank that differs little from other short term claims such as CDs.
Indeed Bas, when they are traded in a secondary market, trade at a return that seldom deviates
much from comparable CDs issued by the same bank.
Letters of credit (L/C) are documents issued by banks in which the bank promises to pay a
certain amount on a certain date, if and only if documents are presented to the bank as specified
in the terms of the credit. A letter of credit is generally regarded as a very strong legal
commitment on the part of a bank to pay if the conditions of trade documents are fulfilled.

Euro notes and Euro commercial Paper

These instruments are short term unsecured promissory notes issued by corporations and
banks. Euro notes, the more general term, encompasses note issuance facilities, those that are
underwritten, as well as those that are not underwritten. The term Euro commercial paper is
generally taken to mean notes that are issued without being backed by an underwriting
facilities that is, without out the support of a medium term commitment by a group of banks
to provide funds in the event that the borrower is unable to roll over its Euro notes on
acceptable terms. The Euro notes market takes the form of non-underwritten Euro commercial
paper (ECP), so the actual paper that an investor will find available for investment is likely to
be ECP.

International Financial Market Instruments

Funds are raised from the international financial market also through the sale of securities,
such as international equities or Euro equities, Euro bonds, medium term and short term Euro
notes and Euro commercial papers.
International Equities
International equities or the Euro equities do not represent debt, nor do they represent foreign
direct investment. They are comparatively a new instrument representing foreign portfolio
equity investment. In this case, the investor gets the divided n and not the interest as in case of
debt instruments. On the other hand, it does not have the same pattern of voting right that it
does have in the case of foreign direct investment. In fact, international equities are a
compromise between the debt and the foreign direct investment. They are the instruments that
are presently on the preference list of the investors as well as the issuers.
Benefit to Issuer/ Investor
The issuers issue international equities under certain conditions and with certain objectives.
 First, when the domestic capital market is already flooded with its shares, the issuing
company does not like toad further stress to the domestic stock of shares since such
additions will cause a fall in the share prices. In order to maintain the share prices, the
company issues international equities.
 Secondly, the presence of restriction on the issue of shares in the domestic market
facilitates the issue of Euro equities.
 Thirdly the co company issues international equities also for the sake of gaining
international recognition among the public.
 Fourthly, international equities bring in foreign exchange which is vital for a firm in a
developing country.
 Fifthly, international capital is available at lower cost though the Euro equities.
 Sixthly, funds raised through such an instrument do not add to the foreign exchange
exposure.
From the viewpoint of the investors, international equities bring in diversification benefits and
raise return with a given risk or lower the risk with a given return. If investment is made in
international equalities along with international bonds, diversification benefits are still greater.

International Bonds
International bonds are a debt instrument. They are issued by international agencies,
governments and companies for borrowing foreign currency for a specified period of time. The
issuer pays interest to the creditor and makes repayment of capital. There are different types
of such bonds. The procedure of issue is very specific. All these need some explanation here.
Types of International Bonds
 Foreign Bonds and Euro Bonds:
International bonds are classified as foreign bonds and Euro bonds. There is a difference
between the two, primarily on four counts. First, in the case of foreign bond, the issuer selects
a foreign financial market where the bonds are issued in the currency of that very country.
Secondly, foreign bonds are underwritten normally by the underwriters of the country where
they are issued. But the Euro bonds are underwritten by the underwriters of multi nationality.
Thirdly, the maturity of a foreign bond is determined keeping in mind the investors of a
particular country where it is issued. On the other hand, the Euro bonds are tailored to the
needs of the multinational investors. In the beginning, the Euro bond market was dominated
by individuals who had generally a choice for shorter maturity, but now the institutional
investors dominate the scenes who do not seek Euro bond maturity necessarily to march their
liabilities.
Fourthly, foreign bonds are normally subjected to governmental regulations in the country
where they are issued.

 Global Bonds
It is the World Bank which issued the global bonds for the first time in 1989 and 1990. Since
1992, such bonds are being issued also be companies. Presently, there are seven currencies in
which such bonds are denominated namely, the Australian dollar, Canadian dollar, Japanese
yen, DM, Finnish markka, Swedish krona and Euro. The special features of the global bonds
are:
 They carry high ratings
 They are normally large in size
 They are offered for simultaneous placement in different countries
 They are traded on “home market” basis in different regions.

 Straight Bonds
The straight bonds are the traditional type of bonds. In this case, interest rate is fixed. The
interest rate is known as coupon rate. It is fixed with reference to rates on treasury bonds for
comparable maturity. The credit standing of the borrower is also taken into consideration for
fixing the coupon rate. Straight bonds are of many varieties.
First, there is bullet redemption bond where the repayment of principal is made at the end of
the maturity and not in installments every year.
Second, there is rising coupon bond where coupon rate rises over time. The benefit is that the
borrower has to pay small amount of interest payment during early years of debt.
Third, there are zero coupon bonds. It carries no interest payment. But since there is no interest
payment, it is issued at discount.
Fourth in case of bond with currency options, the investor has the right to receive payments in
a currency other than the currency of the issue.
Fifth, bull and bear bonds are indexed to some specific benchmark and are issued in two
trenches. The bull bonds are those where the amount of redemption rises with a rise in the
indeed. The bear bonds are those where the amount of redemption falls with a fall in the index.
Finally, debt warrant bonds have a call warrant attached with them. (Warrants are zero coupon
bonds.) The creditors have the right to purchase another bond at a given price.

 Floating Rate Notes

Bonds, which do not carry fixed rate of interest, are known as floating rate notes (FRNs). Such
bonds were issued for the first time in Italy during 1970 and they have become common in
recent times. The interest rate is quoted as a premium or discount to a reference rate which is
invariably LIBOR. The interest rate is revised periodically, say, at every three month or every
six month period, depending upon the period to which the interest rate is referenced to. FRNs
are available in different forms. In the case of perpetual FRNs, the principal amount is never
repaid. This means they are like equity shares. They were popular during mid-1980s, but when
the investors began to ask for higher rate of interest, many issuers could not afford paying
higher rates of interest. Such bonds lost their popularity.

 Convertible Bonds
International bonds are also convertible bonds meaning that these variant are convertible into
equity shares. Some of the convertible bonds have detachable warrants involving acquisition
rights. In other cases, there is automatic convertibility into a specified number of shares.
Convertible bonds command a comparatively high market value because of the convertibility
privilege. The value is the sum of the naked value existing in the absence of conversion and
the conversion value. The conversion price per share is computed by dividing the bonds face
value by the conversion factor, where the conversion factor represents the number of shares
into which each bond could be exchanged.

Short – Term and Medium – Term Instruments

 Euro Notes
Euro Notes are like promissory notes issued by companies for obtaining short term funds. They
emerged in early 1980s with growing securitization in the international financial market. They
are denominated in any currency other than the currency of the country where they are issued.
They represent low cost funding route. Documentation facilities are the minimum. They can
be easily tailored to suit the requirements of different kinds of borrowers. Investors too prefer
them in view of short maturity.
When the issuer plans to issue Euro notes, it hires the services of facility agents or the lead
arranger. On the advice of the lead arranger, it issues the notes, gets them underwritten and
sells them through the placement agents. After the selling period is over the underwriter buys
the unsold issues.
The Euro notes carry three main cost components:
1. Underwriting fee;
2. One time management fee for structuring, pricing and documentation; and
3. Margin on the notes themselves. The margin is either in the form of spread above/below
LIBOR or built into the note price itself.
The documentation is standardized. The documents accompanying notes are usually
underwriting agreement, paying agency agreement, and information memorandum showing,
among other things, the financial position of the issuer. The notes are settled either through
physical delivery or through clearing.

 Euro Commercial Papers

Another attractive form of short term debt instrument that emerged during mid – 1980s came
to be known as Euro commercial paper (ECP). It is a promissory note like the short term Euro
notes although it is different from Euro notes in some ways. It is not underwritten, while the
Euro notes are underwritten. The reason is that ECP is issued only by those companies that
possess a high degree of rating. Again, the ECP route for raising funds is normally investor
driven, while the Euro notes is said to be borrower driven.
ECP came up on the pattern of domestic market commercial papers that had a beginning in the
USA and then in Canada as back as in 1950s. The prefix “Euro” means that the ECP is issued
outside the country in the currency in which it is denominated. Most of the ECPs are
denominated in US dollars, but they are different from the US commercial papers on the sense
that the ECPs have longer maturity going up to one year. Moreover, ECPs are structured on
the basis of all in costs, whereas in US commercial papers, various charges, such as front end
fee and commission are collected separately

 Medium- Term Euro Notes

Medium term Euro notes are just an extension of short term Euro notes as they fill the gap
existing in the maturity structure of international financial market instruments. They are a
compromise between short term Euro notes and long term Euro bonds as their maturity ranges
between one year and five to seven years. The short term Euro notes are allowed to roll over
repeatedly over five to seven years. Every three or six months, the short term Euro notes are
redeemed and a fresh issue is made. Alternatively, a medium term Euro note is issued to get
medium term Euro note is issued to get medium term funds in foreign currency without any
need for redemption and fresh issue.
Medium term Euro notes are not underwritten, yet there is provision for underwriting. This is
for ensuring the borrowers that they get the funds even if they lack sufficient creditworthiness.
They are issued broadly on the pattern of US medium term notes that are found there since
early 1970s. Medium term Euro notes carry fixed rate of interest, although floating rates are
also there. In recent years, multicurrency structure has come up. The issuers are mainly banks,
sovereigns and international agencies.

Conclusion
When a multinational enterprise finalizes its foreign investment project, it needs to select a
particular source, or a mix of sources of funds to finance the investment project. Here it may
be noted that a, multinational enterprise position itself on a better footing than a domestic firm
as far as the procurement of funds is concerned. A domestic firm gets funds normally from
domestic sources. It does get funds from the international financial market too but it is not as
easy as in case of a multinationals enterprise. The latter can use the parent companies funds
for its foreign investment project. It can also get funds from the host country financial market,
but more importantly, it tries to get funds from the international financial market. It selects a
particular source or a mix of sources or a particular type or types of funds that suits its corporate
objectives.