Tag: International Finance Mumbai University BMS Notes

FASB Statement No. 95, “Statement of Cash Flows,” mandates that companies include a state­ment of cash flows among their financial statements. The consolidated statement of cash flows is not prepared from the individual cash flow statements of the separate companies. Instead, the income statements and balance sheets are first brought together on the worksheet. The cash flows statement is then based on the resulting consolidated figures.

Thus, this statement is not actually produced by consolidation but is created from numbers generated by that process. However, preparing a consolidated statement of cash flows does introduce several accounting issues. Its preparation involves properly handling of any excess amortizations, intercompany transactions, subsidiary dividends, and several other acquisition-year cash flows.

Amortizations:

A worksheet adjustment (Entry E) includes in the consolidation process the amortizations of acquisition-date excess fair-value allocations. These expenses do not appear on either set of individual records but in the consolidated income statement. As a noncash decrease in income, this expense, under the indirect approach, is added back to consolidated net income to arrive at cash flows from operations. If the business combination uses the direct approach, it omits the balance because this expense does not affect the amount of cash.

Intercompany Transactions:

As this text previously discussed, a significant volume of transfers between the related compa­nies composing a business combination often occurs. The resulting effects of this intercompany activity is eliminated on the worksheet so that the consolidated statements reflect only transac­tions with outside parties. Likewise, the consolidated statement of cash flows does not include the impact of these transfers.

Intercompany sales and purchases do not change the amount of cash held by the business combination when viewed as a whole. Because the statement of cash flows is derived from the consolidated balance sheet and income statement, the impact of all transfers is already removed. Therefore, no special adjustments are needed to properly present cash flows. The worksheet entries produce correct balances for the consolidated statement of cash flows.

Subsidiary Dividends Paid:

The cash outflow from dividends paid by a subsidiary only leaves the consolidated entity when paid to the non-controlling interest. Thus dividends paid by a subsidiary to its parent do not appear as financing outflows. However, subsidiary dividends paid to the non-controlling inter­est are a component of cash outflows from financing activities.

Acquisition Year Cash Flow Adjustments:

In the year of a business acquisition, the consolidated cash flow statement must properly reflect several additional considerations.

For many business combinations, the following issues frequently are present:

1. Cash purchases of businesses are an investing activity. The net cash outflow (cash paid less subsidiary cash acquired) is reported as the amount paid in a business acquisition.
2. For intraperiod acquisitions, SFAS No. 95 requires that any adjustments from changes in oper­ating balance sheet accounts (Accounts Receivable, Inventory, Accounts Payable, etc.) reflect the amounts acquired in the combination. Therefore, any changes in operating assets and lia­bilities are reported net of effects of acquired businesses in computing the adjustments to con­vert consolidated net income to operating cash flows. Use of the direct approach of presenting operating cash flows also reports the separate computations of cash collected from customers and cash paid for inventory net of effects of any acquired businesses.

• Any adjustments arising from the subsidiary’s revenues or expenses (e.g., depreciation, amortization) must reflect only post-acquisition amounts. Closing the subsidiary’s books at the date of acquisition facilitates the determination of the appropriate post-acquisition sub­sidiary effects on the consolidated entity’s cash flows.

Depreciation and Amortization:

These expenses do not represent current operating cash out­flows and thus are added back to convert accrual basis income to cash provided by operating activities.

Increase in Accounts Receivable, Inventory, and Accounts Payable (Net of Acquisition):

SFAS No. 95 requires that changes in balance sheet accounts affecting operating cash flows reflect amounts acquired in business acquisitions.

Acquisition of Salida Company:

The Investing Activities section of the cash flow statement shows increases and decreases in assets purchased or sold involving cash.

Consolidation Includes

Adjustments to offset the net effect of intercompany sales and transfers are required, because consolidation rolls all results into one and no accounting rule allows a company to sell or transfer goods or services to itself. For consolidation rules to apply, your company must own the majority of the outstanding stock, membership interests or limited partner interests in a business. If your company has voting control but not ownership control, meaning your company directs what another business does but does not own 50.1 percent or more, then you exclude that business from the consolidation.

Equity financing is the process of raising capital through the sale of shares. Companies raise money because they might have a short-term need to pay bills or have a long-term goal and require funds to invest in their growth. By selling shares, a company is effectively selling ownership in their company in return for cash.

Equity financing comes from many sources: for example, an entrepreneur’s friends and family, investors, or an initial public offering (IPO). An IPO is a process that private companies undergo to offer shares of their business to the public in a new stock issuance. Public share issuance allows a company to raise capital from public investors. Industry giants, such as Google and Meta (formerly Facebook), raised billions in capital through IPOs.

While the term equity financing refers to the financing of public companies listed on an exchange, the term also applies to private company financing.

International finance analyzes the following specific areas of study:

• International Fisher Effect is an international finance theory that assumes nominal interest rates mirror fluctuations in the spot exchange rate between nations.
• The Mundell-Fleming Model, which studies the interaction between the goods market and the money market, is based on the assumption that price levels of said goods are fixed.
• The optimum currency area theory states that certain geographical regions would maximize economic efficiency if the entire area adopted a single currency.
• Interest rate parity describes an equilibrium state in which investors are indifferent to interest rates attached to bank deposits in two separate countries.
• Purchasing power parity is the measurement of prices in different areas using a specific good or a specific set of goods to compare the absolute purchasing power between different currencies.

Sources of International Finance

The sources of international finance can be excavated deep in the international economy and international market. The various sources for International Finance are as follows:

Commercial Banks

Global Commercial Banks all over the international market provide loans in the foreign currency to the companies. These banks are very crucial in financing the non-trade international operations. They facilitate international trading to occur smoothly.

International Agencies and Development Banks

The developmental banks and other international agencies have come forth over the years for the purpose of financing in the international sector. The agencies are set up by the government of the developed countries of the world. The highly industrious agencies among this sector are – International Finance Corporation, EXIM Bank and Asian Development Bank. 

International Capital Markets

The budding organizations which include the multinational companies depend upon the fairly large amount of loans known as the foreign currency. The financial instruments which are used by these organizations include; American Depository Receipts, Global Depository Receipts, and Foreign Currency Convertible Bonds.

Depository Receipts; ADR, GDR, IDR

A depositary receipt (DR) is a negotiable financial instrument issued by a bank to represent a foreign company’s publicly traded securities. The depositary receipt trades on a local stock exchange. Depositary receipts facilitates buying shares in foreign companies, because the shares do not have to leave the home country.

Depositary receipts that are listed and traded in the United States are American depositary receipts (ADRs). European banks issue European depositary receipts (EDRs), and other banks issue global depository receipts (GDRs).

An investor needs to contact a broker in a local bank if he/she is interested in purchasing depositary receipts. The local bank in the investor’s home country, which is called the depositary bank, will assess the foreign security before making a decision to purchase shares.

The broker in the depositary bank will purchase the shares either on the local stock exchange that it trades in or purchase the shares in the foreign stock exchange by using another broker in a foreign bank, which is also known as the custodian bank.

After purchasing the shares, the depositary bank will request the shares to be delivered to the custodian bank.

After the custodian bank receives the shares, they will group the shares into packets, each consisting of 10 shares. Each packet will be issued to the depositary bank as a depositary receipt that is traded on the bank’s local stock exchange.

When the depositary bank receives the depositary receipts from the custodian bank, it notifies the broker, who will deliver it to the investor and debits fees from the investor’s account.

Types of Depositary Receipts

1. American Depositary Receipt (ADR)

It is listed only on American stock exchanges (i.e., NYSE, AMEX, NASDAQ) and can only be traded in the U.S. They pay investors dividends in U.S. dollars and are issued by a bank in the U.S.

ADRs are categorized into sponsored and unsponsored, which are then grouped into one of three levels.

2. European Depositary Receipt (EDR)

It is the European equivalent of ADRs. Similarly, EDRs are only listed on European stock exchanges and can only be traded in Europe. It pays dividends in euros and can be traded like a regular stock.

3. Global Depositary Receipt (GDR)

It is a general term for a depositary receipt that consists of shares from a foreign company. Therefore, any depositary receipt that did not originate from your home country is called a GDR.

Many other countries around the world, such as India, Russia, the Philippines, and Singapore also offer depositary receipts.

4. Indian Depository Receipt (IDR)

Indian Depository Receipt (IDR) is a financial instrument denominated in Indian Rupees in the form of a depository receipt. The IDR is a specific Indian version of the similar global depository receipts.

It is created by a Domestic Depository (custodian of securities registered with the Securities and Exchange Board of India) against the underlying equity of issuing company to enable foreign companies to raise funds from the Indian securities Markets. The foreign company IDRs will deposit shares to an Indian depository. The depository would issue receipts to indian investors against these shares. The benefit of the underlying shares (like bonus, dividends etc.) would accrue to the depository receipt holders in India.

An international depository receipt (IDR) is a negotiable certificate issued by a bank. It represents ownership of a number of shares of stock in a foreign company that the bank holds in trust.

IDRs are purchased by investors as an alternative to the direct purchase of foreign stocks on foreign exchanges. For example, American traders can buy shares of the Swiss bank Credit Suisse Group AG or Swedish automaker Volvo AB directly from American exchanges via ADRs.

Advantages of DRs

1. Exposure to international securities

Investors can diversify their investment portfolio by gaining exposure to international securities, in addition to stocks offered by local companies.

2. Additional sources of capital

Depositary receipts provide international companies a way to raise more capital by tapping into the global markets and attracting foreign investors around the world.

3. Less international regulation

Since it is traded on a local stock exchange, investors do not need to worry about international trading policies and global laws.

Although investors will be investing in a company that is in a foreign country, they can still enjoy the same corporate rights, such as being able to vote for the board of directors.

Disadvantages of DRs

1. Higher administrative and processing fees, and taxes

There may be higher administrative and processing fees because you need to compensate for custodial services from the custodian bank. There may also be higher taxes.

For example, ADRs receive the same capital gains and dividend taxes as other stocks in the U.S. However, the investor is subject to the foreign country’s taxes and regulations aside from regular taxes in the U.S.

2. Greater risk from forex exchange rate fluctuations

There is a higher risk due to volatility in foreign currency exchange rates. For example, if an investor purchases a depositary receipt that represents shares in a British company, its value will be affected by the exchange rate between the British pound and the currency in the buyer’s home country.

3. Limited access for most investors

Sometimes, depositary receipts may not be listed on stock exchanges. Therefore, only institutional investors, which are companies or organizations that execute trades on behalf of clients, can invest in them.

The Eurobond market is made up of investors, banks, borrowers, and trading agents that buy, sell, and transfer Eurobonds. Eurobonds are a special kind of bond issued by European governments and companies, but often denominated in non-European currencies such as dollars and yen. They are also issued by international bodies such as the World Bank. The creation of the unified European currency, the euro, has stimulated strong interest in euro-denominated bonds as well; however, some observers warn that new European Union tax harmonization policies may lessen the bonds’ appeal.

Eurobonds are unique and complex instruments of relatively recent origin. They debuted in 1963, but didn’t gain international significance until the early 1980s. Since then, they have become a large and active component of international finance. Similar to foreign bonds, but with important differences, Eurobonds became popular with issuers and investors because they could offer certain tax shelters and anonymity to their buyers. They could also offer borrowers favourable interest rates and international exchange rates.

Notes Market

The primary objective of the issuance of Euro notes is to structure a debt instrument with short term maturities, generally 3, 6 or 9 months, tenors (duration) and place it in the market. However, the borrowing programme could be for medium or long term (say), 5-7 years or more. Banks that act as financial Market intermediaries agree to underwrite the paper (instrument). In reality, a borrower is able to borrow at short-term interest rates for short periods by issuing the “notes” ‘to investors. At the same time the borrower avails of the benefits and comfort of having a committed medium to long tern borrowing facility (underwritten by banks). The funding portion is divided into two separate components. The first, is a long term committed standby lending facility provided by banks. The second is a mechanism for the distribution of short-term debt instruments (the Euro note). The former component gives the borrower the long term assurance of availability of funds. The latter is the means by which cost-competitive funding can be achieved (since at any specific time, short term funding is usually cheaper than medium-long term funding).

Types of Euro Bonds

Straight Bond: Bond is one having a specified interest coupon and a specified maturity date. Straight bonds may issue with a floating rate of interest. Such bonds may have their interest rate fixed at six-month intervals of a stated margin over the LIBOR for deposits in the currency of the bond. So, in the case of a Eurodollar bond, the interest rate may base upon LIBOR for Eurodollar deposits.

Convertible Eurobond: The Eurobond is a bond having a specified interest coupon and maturity date. But, it includes an option for the hold to convert its bonds into an equity share of the company at a conversion price set at the time of issue.

Medium-term Eurobond: Medium-term Euro notes are shorter-term Eurobonds with maturities ranging from three to eight years. Their issuing procedure is less formal than for large bonds. Interest rates on Euro notes can fix or variable. Medium-term Euro-notes are similar to medium-term roll-over Eurodollar credits. The difference is that in the Eurodollar market lenders hold a claim on a bank and not directly on the borrower.

Benefits to Investors

The main benefit to local investors in purchasing a Eurobond is that it provides exposure to foreign investments staying in the home country. It also gives a sense of diversification, spreading out the risks.

As mentioned previously, Eurobonds are pretty cheap, with a small face value and are highly liquid.

If a Eurobond is denominated in a foreign currency and issued in a country with a strong economy (and currency), then the bond liquidity rises.

Benefits to Issuers

A list of benefits to Eurobond issuers consists of the following:

• A country choice with lower interest rates.
• Flexibility to choose a favorable country to originate bonds and currency.
• Avoidance of currency risk or forex risk by using Eurobonds.
• International bond trade despite being issued in a certain country that broadens potential investor base.
• Access to a huge range of bond maturity periods that can be chosen by the issuer.

Incremental cash flow refers to cash flow that is acquired by a company when it takes on a new project. To estimate an incremental cash flow, businesses must compare projected cash flow if it takes on a new project to when it doesn’t, putting into consideration how accepting such project may affect the cash flow of another part of the business.

Incremental Cash Flow = Cash Inflow – Initial Cash Outflow – Expense

Components

Initial Investment Outlay

It is the amount needed to set up or start a project or a business. E.g., a cement manufacturing company plans to set up a manufacturing plant at XYZ city. So all the investment from buying land and setting up a plant to manufacturing the first bag of cement will come under initial investment.

Operating Cash Flow

Operating cash flow refers to the amount of cash generated by that particular project, less operating, and raw material expense. If we consider the above example, the cash generated by selling cement bags less than the raw material and operating expenses like labour wages, selling and advertising, rent, repair, electricity, etc. is the operating cash flow.

Terminal Year Cash Flow

Terminal cash flow refers to net cash flow that occurs at the end of the project or business after disposing of all the assets of that particular project. Like in the above example, if the cement manufacturer company decides to shut down its operation and sell its plant, the resulting cash flow after brokerage and other costs is terminal cash flow.

• So, ICF is the net cash flow (cash inflow – cash outflow) over a specific time between two or more projects.
• NPV and IRR are other methods for making capital budgeting decisions. The only difference between NPV and ICF is that while calculating ICF, we do not discount the cash flows, whereas, in NPV, we discount it.

Advantages

It helps in the decision of whether to invest in a project or which project among available ones would maximize the returns. Compared to other methods like Net present value (NPV) and Internal rate of return (IRR), Incremental cash flow is easier to calculate without any complications of the discount rate. ICF is calculated in the initial steps while using capital budgeting techniques like NPV.

Limitations

Practically incremental cash flows are complicated to forecast. It is as good as the inputs to the estimates. Also, the cannibalization effect, if any, is difficult to project.

Besides endogenous factors, there are many exogenous factors that may affect a project greatly but are challenging to forecast like government policies, market conditions, legal environment, natural disaster, etc. which may impact incremental cash flows in unpredictable and unexpected ways.

Difficulties in Determining Incremental Cash Flow

Incremental cash flows are helpful, especially in determining if a company should take on a new project or not. However, accountants also encounter certain difficulties when estimating incremental cash flow. Here are some of the challenges:

1. Sunk costs

Sunk costs are also known as past costs that have already been incurred. Incremental cash flow looks into future costs; accountants need to make sure that sunk costs are not included in the computation. This is especially true if the sunk cost happened before any investment decision was made.

2. Opportunity costs

From the term itself, opportunity costs refer to a business’ missed chance for revenues from its assets. They are often forgotten by accountants, as they do not include opportunity costs in the computation of incremental cash flow.

One example is a company that specializes in sound system installations that skips a project that requires the use of five sets of boom boxes. Currently, the business is only putting the five extra sets of boom boxes in its storage facility, instead of taking on the project that will earn $5,000. This illustrates the opportunity cost of $5,000.

3. Cannibalization

As mentioned above, cannibalization is the result of taking on a new project that reduces the cash flow of another product or line of business. For example, an owner with an existing mall that caters to classes A and B, and everything it sells is sold at a premium because it caters to luxury shoppers.

In another part of the same city, it decides to open a new mall that caters to classes B, C, and D, selling the same items as the other mall but at a significantly lower price. This will result in cannibalization because some people will no longer go to the first mall because they can get most things at the new mall for a much lower price.

4. Allocated costs

These are some costs that must be allocated to a specific department or project and there may not be a rational way to do it (i.e. rent expense)..

Innovation in the Euro Bond Markets

The international financial marketplace has undergone a tremendous expansion in terms of the variety of products, the volume of trading, and the capitalized value of available securities.

Innovative financial instruments can attract funding from other public or private investors in areas of EU strong interest but which are perceived as risky by investors. Examples include sectors with high economic growth or innovative business activities.

The fact that the EU invests risk capital in a certain fund or covers part of the risk associated with a certain type of projects can reassure other investors and encourage them to invest alongside the EU. Moreover, innovative financial instruments have important non-financial effects such as promotion of best practices.

Innovative financial instruments are a range of activities such as

• Participation in equity (risk capital) funds
• Guarantees to local banks lending to a large number of final beneficiaries, for instance small and medium-sized enterprises (smes)
• Risk-sharing with financial institutions to boost investment in large infrastructure projects (e.g. The europe 2020 project bonds initiative or the connecting Europe facility financial instruments).

Competitive Advantages of Euro Banks

In most euro area countries potential growth has remained too low, however. Labour market rigidities and inefficient business environment conditions seem to be major impediments. In particular, labour supply is held back by policies which do not sufficiently motivate to take up jobs and do not tackle skill mismatch or labour shortages. Moreover, investment could be strengthened through fostering competition, improve the business environment and reduce uncertainty e.g. through improving the quality and efficiency of public institutions more generally.

European banks will struggle to catch up with their stronger US and Asian peers without radical change. Banks must act now to address these challenges head-on through a profound transformation of their business models. The goal must be to close the yawning gap between bank returns and their cost of equity.

There are actions to take in at least five key areas, all of which directly impact bank profitability. In a series of detailed deep dives, we set out actions to take in those five key areas. None of these areas are new for banks, but they must be revisited and reviewed rigorously with a view to taking decisive strategic action.

Despite favourable economic and financing conditions, structural reform progress has been rather limited, including in several of the weakest countries.

The trend of insufficient structural reform implementation observed in particular since 2014 has continued during the last year. Only a few countries have engaged in more far-reaching structural reforms, most notably Greece and France. Some countries even reversed recent reforms that had been designed to improve the smooth functioning of the economy, most notably in the areas of labour markets and pension systems. Overall, reform efforts were not in line with reform needs.

These policy areas concern national competencies, but in a single markets cross-border spill-over effects are generated. Governments therefore need to act at national levels, enhanced through procedures, rules and harmonization at EU level.

Against the background of limited reform effort and in spite of the robust cyclical upswing, overall risks and vulnerabilities in many cases have only moderately declined since last year.

The Commission’s annual assessment of country specific recommended reforms finds only limited progress. Out of 73 country specific recommendations (CSRs), none saw full implementation, and substantial progress was made in only two cases. For the overwhelming majority of CSRs (more than 90%), the Commission found that Member States made at best some or limited progress. On two CSRs, no progress was made. Most concerning, despite being very vulnerable, the countries experiencing excessive imbalances did not make significantly more reform progress during the last year than the EU average. The same is true for the countries experiencing imbalances. Overall, progress on reforms this year was as weak as last year.

The international role of the euro

But also on the European level there is not only a role to harmonize national action in order to reap the benefits of the Single Market. Where competence has been transferred to the EU level, the need to spur competitiveness is at the EU level.

The European Commission presented a set of action points to strengthen the euro’s global role. More recently, the COM has underscored the increasing relevance of capital markets union in supporting the international role of the euro amid geopolitical changes (e.g. Brexit and US foreign and trade policy).

To this end, the euro should become even more compelling as a means of payment and a trustworthy investment currency. Without prejudice to the ECB’s independence, we took note of the Commission’s support for our initiatives on market infrastructure and payments, which help to increase efficiency and financial market integration in the euro area.

International trade

It was important to resist, the temptation to gain competitive advantage or create national champions by tilting the system in one’s favour (e.g. in the area of tax, privacy, cyber security and fintech policies).

The costs of fragmentation of global trade would be high. IMF staff simulations of a global trading system that had been fragmented into three trading blocs show that in such a scenario, each of the blocs was overall worse off, although individual countries within the bloc may actually gain. These issues would also apply to other areas like the international flow of data and access to the global payments system.

There are five dimensions where progress is needed:

• Consensus on how to address social and economic grievances;
• A rethinking of the appropriate mix of domestic policies;
• Strengthening and updating of the international rules of the game;
• Adequate management of global public goods;
• Securing the global financial safety net.

Payments Systems

The ECB’s responsibility for promoting the smooth operation of payment systems indirectly supports the international standing of the euro. The Eurosystem has contributed to reshaping and consolidating the infrastructure for large-value payments, for post-trading services for financial instruments and, most recently, for instant retail payments.

Over the next two or three years we aim at

• Taking measures to consolidate TARGET2 and TARGET2-Securities (T2S), in particular by delivering a centralised liquidity management function;
• Developing a single collateral management system that will be capable of managing the assets used as collateral in Eurosystem credit operations for all euro area countries.

Harmonization agenda

More harmonization is necessary to achieve a safe and efficient European post trade landscape. The European Post Trade Forum (EPTF) Report identifies barriers which have not yet been dismantled (formerly known as “Giovannini Barriers”), as well as new bottlenecks which need to be addressed to promote more efficient and resilient market infrastructures in the EU. These include:

• Inefficient withholding tax collection procedures
• Legal inconsistencies and uncertainties
• Fragmented corporate actions and general meeting processes

More harmonisation of national insolvency rules is needed to make European resolution more effective. The recently agreed proposal (December 2018) is a minimum harmonization directive allowing member states to go further when transposing the rules into national law.

European issuance

• An important element in a well-functioning capital market is the smooth interplay between issuance on the primary market, investors and secondary markets. In Europe, the issuance and distribution of securities is still complex and operational cost are elevated. Securities are still issued along different national rules, standards and habits.
• Central Securities Depositories (CSD) play a pivotal role in this process. Today, issuers usually issue in one CSD. All other CSDs, and their national customer base, need to access these securities by connecting to this initial one. This chopped-up process is complex and relatively expensive. Investors and issuers alike see scope for improvements.

Eurocurrency is currency held on deposit outside its home market, i.e., held in banks located outside of the country which issues the currency. For example, a deposit of US dollars held in a bank in London, would be considered eurocurrency, as the US dollar is deposited outside of its home market.

The Euro- prefix does not refer exclusively to the “euro” currency or the “eurozone”, as the term predates the creation of the euro. Instead, it can be applied to any combination of deposits in a foreign bank outside of its home market e.g. a deposit denominated in Japanese yen held in a Swiss bank is a Euroyen deposit.

Eurocurrency is used for short-to-medium term financing by banks, multinational corporations, mutual funds, and hedge funds. Eurocurrency is generally seen as an attractive source of global funding due to its ease of convertibility between currencies as well as typically lower regulatory measures compared to sources of funding in domestic markets. Eurocurrency and Eurobond markets avoid domestic interest rate regulations, reserve requirements and other barriers to the free flow of capital.

The relevance of eurocurrency deposits has been disputed over since its inception in the 1950s by notable economists including Ronald McKinnon, yet it remains a prevalent aspect of the global financial system.

Uses of Eurocurrency

Eurocurrency is commonly used by corporations and financial institutions, such as mutual funds and hedge funds, in order to receive financing. It is often seen as an advantageous source of capital and a beneficial way to receive international funding because of its ability to switch to other foreign currencies.

It is also an attractive choice as a financial instrument because local interest rates can be avoided due to relaxed restrictions in comparison to local banking regulations. Therefore, many individuals and businesses use foreign currencies as a way to protect themselves against risks in foreign exchange and international trade.

Eurocurrency Markets

A eurocurrency market is the money market for any currency deposited outside of its home market. The key participants in these markets includes banks, multinational corporations, mutual funds, and hedge funds. Eurocurrency markets are generally chosen as a source of finance over domestic banks for their ability to offer lower interest rates of borrowers and higher interest rates for lenders situationally. This because eurocurrency market have less regulatory requirements, tax laws, and typically no interest caps. Nonetheless, there are higher risks, particularly when banks experience periods of poor solvency which can lead to a run on the banks.

There are several eurocurrency markets, with the two most widely used being the Eurodollar market and the Euroyen market. There are also various smaller eurocurrency markets including the Euroeuro market and the Europound market.

Eurodollar Market

The Eurodollar market involves holdings of US dollars outside of the jurisdiction of the US Central Bank. These holdings may arise via two primary ways. Firstly, from purchases of goods and services made in US dollars to suppliers who maintain European bank accounts; these suppliers may be European or non-European. Secondly, Eurodollar deposits arise from investments of US dollars in European banks, generally for more favourable returns on interest.

Today, the Eurodollar market is the largest source of global funding for businesses and nations, estimated to be financing over 90% of international trade deals. It is the most widely used eurocurrency. Accounting for approximately 75% of all eurocurrency accounts held worldwide. This prevalence is often attributed to economic and political factors. Firstly, the economic power of the US, particularly its influential position in the world economy and steady deterioration of the other currencies during the inception of Eurocurrency in the 1950s. Secondly, the lack of interest caps and limited regulation in the Eurodollar market enables favourable rates of interest for both lenders and borrowers.

Euroyen Market

The Euroyen market involves deposits of yen in banks outside the jurisdiction of the Japanese Central Bank. The market emerged in 1984, at the beginning of the Japanese asset price bubble that saw Japan pursue financial liberalisation and internalisation. During the 1990s, interest rates in Japan experienced substantial declines, making the relatively high rates of interest paid by Euroyen accounts attractive investments. Today Euruyen deposits are used by non-Japanese companies to efficiently obtain investments from Japanese investors. Euroyen bonds allow foreign companies to avoid the regulations enforced by the Bank of Japan (BoJ) and in bond registration with the Tokyo Stock Exchange (TSE).

Euroeuro Market

The Euroeuro market involves deposits of euros outside of the jurisdiction of the European Central Bank.

Europound Market

The Europound market involves deposits of British pounds outside of the jurisdiction of the Bank of England.

Eurocurrency Network

The concept of eurocurrency can have two implications.

Firstly, it can be the accumulation of all the currencies and banking facilities worldwide that are participating of the offshore banking network. This is not limited to the four eurocurrencies (US dollar, Euro, Yen, British Pound) or the home markets of those eurocurrencies. For example, a bank in Denmark that chooses to keep holdings of Swiss franc in London would also be considered a part of the eurocurrency network.

Secondly, it can refer to the sum of all the technologies i.e. data processing and communication lines, used to enable stakeholders around the world to interact and participate in the eurocurrency market. Eurocurrency marks function within the global financial system with market centres spread across the global. Therefore, powerful financial technologies and information systems are required to connect market centres to enable communications and transactions to occur. For example, technologies such as high-speed communication lines link market centres enabling fast eurobanking transactions, and also giving rise to the overnight market.

Origin of Euro Currency Market

The Eurodollar is considered to be the initial origin of Eurocurrency. The Eurodollar was initially a term that refers to how USD was deposited in banks in Europe, especially London. European banks held a lot of USD after World War II, as the United States provided financial aid to Europe.

The fixed exchange rate system at that time also created an opportunity for more countries to invest in USD. Eventually, the Eurodollar transitioned to become Eurocurrency due to globalization. More individuals around the world began to deposit local currency at a foreign bank outside of Europe.

Although it is used all around the world, London remains the center of the Eurocurrency market at present. It’s been able to maintain a competitive advantage in the market because of the freedom in regulations in the commercial banking sector.

Therefore, banks in London are able to provide interest rates that pertain to the class of the borrower and lender, increasing the use of Eurocurrencies in London, while the rest of Europe adhere to tighter banking restrictions.

International equity markets are an important platform for global finance. They not only ensure the participation of a wide variety of participants but also offer global economies to prosper.

An equity market is a market in which shares of companies are issued and traded, either through exchanges or over-the-counter markets. Also known as the stock market, it is one of the most vital areas of a market economy. It gives companies access to capital to grow their business, and investors a piece of ownership in a company with the potential to realize gains in their investment based on the company’s future performance.

To understand the importance of international equity markets, market valuations and turnovers are important tools. Moreover, we must also learn how these markets are composed and the elements that govern them. Cross-listing, Yankee stocks, ADRs and GRS are important elements of equity markets.

The secondary equity markets provide marketability and share valuation. Investors or traders who purchase shares from the issuing company in the primary market may not desire to own them forever. The secondary market permits the shareholders to reduce the ownership of unwanted shares and lets the purchasers to buy the stock.

The secondary market consists of brokers who represent the public buyers and sellers. There are two kinds of orders:

Market order: A market order is traded at the best price available in the market, which is the market price.

Limit order: A limit order is held in a limit order book until the desired price is obtained.

There are many different designs for secondary markets. A secondary market is structured as a dealer market or an agency market.

In a dealer market, the broker takes the trade through the dealer. Public traders do not directly trade with one another in a dealer market. The over-the-counter (OTC) market is a dealer market.

In an agency market, the broker gets client’s orders via an agent.

Cross-listing

Cross-listing refers to having the shares listed on one or more foreign exchanges. In particular, MNCs do this generally, but non-MNCs also cross-list. A firm may decide to cross-list its shares for the following reasons:

• Cross-listing provides a way to expand the investor’s base, thus potentially increasing its demand in a new market.
• Cross-listing offers recognition of the company in a new capital market, thus allowing the firm to source new equity or debt capital from local investors.
• Cross-listing offers more investors. International portfolio diversification is possible for investors when they trade on their own stock exchange.
• Cross-listing may be seen as a signal to investors that improved corporate governance is imminent.
• Cross-listing diminishes the probability of a hostile takeover of the firm via the broader investor base formed for the firm’s shares.

Trading In International Equities

A greater global integration of capital markets became apparent for various reasons:

• Investors understood the good effects of international trade.
• The prominent capital markets got more liberalized through the elimination of fixed trading commissions.
• Internet and information and communication technology facilitated efficient and fair trading in international stocks.
• The MNCs understood the advantages of sourcing new capital internationally.

American Depository Receipts (ADR)

An ADR is a receipt that has a number of foreign shares remaining on deposit with the U.S. depository’s custodian in the issuer’s home market. The bank is a transfer agent for the ADRs that are traded in the United States exchanges or in the OTC market.

ADRs offer various investment advantages. These advantages include:

• ADRs are denominated in dollars, trade on a US stock exchange, and can be purchased through the investor’s regular broker. This is easier than purchasing and trading in US stocks by entering the US exchanges.
• Dividends received on the shares are issued in dollars by the custodian and paid to the ADR investor, and a currency conversion is not required.
• ADR trades clear in three business days as do U.S. equities, whereas settlement of underlying stocks vary in other countries.
• ADR price quotes are in U.S. dollars.
• ADRs are registered securities and they offer protection of ownership rights. Most other underlying stocks are bearer securities.
• An ADR can be sold by trading the ADR to another investor in the US stock market, and shares can also be sold in the local stock market.
• ADRs frequently represent a set of underlying shares. This allows the ADR to trade in a price range meant for US investors.
• ADR owners can provide instructions to the depository bank to vote the rights.

There are two types of ADRs: sponsored and unsponsored.

• Sponsored ADRs are created by a bank after a request of the foreign company. The sponsoring bank offers lots of services, including investment information and the annual report translation. Sponsored ADRs are listed on the US stock markets. New ADR issues must be sponsored.
• Unsponsored ADRs are generally created on request of US investment banking firms without any direct participation of the foreign issuing firm.

Global Registered Shares (GRS)

GRS are a share that are traded globally, unlike the ADRs that are receipts of the bank deposits of home-market shares and are traded on foreign markets. The GRS are fully transferrable GRS purchased on one exchange can be sold on another. They usually trade in both US dollars and euros.

The main advantage of GRS over ADRs is that all shareholders have equal status and the direct voting rights. The main disadvantage is the cost of establishing the global registrar and the clearing facility.

International Equity Market Benchmarks

The World Equity Benchmark Series (WEBS) was an international fund traded on the American Stock Exchange. It was introduced in 1996 by Morgan Stanley and was a type of hybrid security that possesses qualities of both open-end and closed-end funds.

In 2000, WEBS was renamed to iShares MSCI Emerging Markets Exchange Traded Fund (ETF). The iShares MSCI Emerging Markets ETF seeks to track the investment results of the MSCI Emerging Markets Index, an index composed of large- and mid-capitalization emerging market equities.

A closed-end fund is a fund formed as a publicly traded investment. These funds can raise a designated amount of capital with an initial public offering. The money collected goes into a fund that is then listed as a stock and traded on a public exchange. It is a specialized stock portfolio with a one-time fixed number of shares. An open-end fund is a conventional mutual fund, made up of a pool of money from many investors for investing in stocks and bonds. Investors share gains and losses in proportion to their investment in the fund.

An organization that used a WEBS owned each of the securities traded on the MSCI country indexes. Ownership was in an approximate ratio to the initial capitalization or investment. A WEBS could be bought, sold, and traded like stocks.

Investors could use the WEBS to achieve international diversification. The World Equity Benchmark Series was available for many different countries, including Australia, Austria, Belgium, Canada, France, Germany, Hong Kong, Italy, Japan, Malaysia, Mexico, the Netherlands, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

The name change of the World Equity Benchmark Series (WEBS) to iShares MSCI Emerging Markets ETF was intended to reflect the consistent brand name for all exchange-traded funds managed by Barclays Global Investors (now BlackRock).

At the time, the indexes included iShares MSCI Australia, iShares MSCI Austria, iShares MSCI Belgium, iShares MSCI Canada, iShares MSCI France, iShares MSCI Germany, iShares MSCI Hong Kong, iShares MSCI Italy, iShares MSCI Japan, iShares MSCI Malaysia, iShares MSCI Mexico, iShares MSCI Netherlands, iShares MSCI Singapore, iShares MSCI South Korea, iShares MSCI Spain, iShares MSCI Sweden, iShares MSCI Switzerland, and iShares MSCI United Kingdom.

Benchmarks are indexes created to include multiple securities representing some aspect of the total market. Benchmark indexes have been created across all types of asset classes. In the equity market, the S&P 500 and Dow Jones Industrial Average are two of the most popular large-cap stock benchmarks.

In fixed income, examples of top benchmarks include the Barclays Capital U.S. Aggregate Bond Index, the Barclays Capital U.S. Corporate High Yield Bond Index, and the Barclays Capital U.S. Treasury Bond Index. Mutual fund investors may use Lipper indexes, which use the 30 largest mutual funds in a specific category, while international investors may use MSCI Indexes. The Wilshire 5000 is also a popular benchmark representing all of the publicly traded stocks in the U.S. When evaluating the performance of any investment, it’s important to compare it against an appropriate benchmark.

Identifying and setting a benchmark can be an important aspect of investing for individual investors. In addition to traditional benchmarks representing broad market characteristics such as large-cap, mid-cap, small-cap, growth, and value. Investors will also find indexes based on fundamental characteristics, sectors, dividends, market trends, and much more. Having an understanding or interest in a specific type of investment will help an investor identify appropriate investment funds and also allow them to better communicate their investment goals and expectations to a financial advisor.

When seeking investment benchmarks, an investor should also consider risk. An investor’s benchmark should reflect the amount of risk they are willing to take. Other investment factors around benchmark considerations may include the amount to be invested and the cost the investor is willing to pay.

Factors Affecting International Equity Returns

Exchange Rates

Adler and Simon (1986) tested the sample of foreign equity and bond index returns to exchange rate changes. They found that exchange rate changes generally had a variability of foreign bond indexes than foreign equity indexes. However, some foreign equity markets were more vulnerable to exchange rate changes than the foreign bond markets.

Macroeconomic Factors

Solnik (1984) examined the effect of exchange rate fluctuations, interest rate differences, the domestic interest rate, and changes in domestic inflation expectations. He found that international monetary variables had only weak influence on equity returns. Asprem (1989) stated that fluctuations in industrial production, employment, imports, interest rates, and an inflation measure affect a small portion of the equity returns.

Industrial Structure

Roll (1992) concluded that the industrial structure of a country was important in explaining a significant part of the correlation structure of international equity index returns.

In contrast, Eun and Resnick (1984) found that the correlation structure of international security returns could be better estimated by recognized country factors rather than industry factors.

Heston and Rouwenhorst (1994) stated that “Industrial structure explains very little of the cross-sectional difference in country returns volatility, and that the low correlation between country indices is almost completely due to country-specific sources of variation.”

International capital budgeting is very complicated than the domestic capital budgeting because MNC’s are typically large and capital intensive, and because the process involves a larger number of parameters and decision variables. In general, It involves a consideration of more risk than domestic capital budgeting. But international capital budgeting involves the estimation of some measures or criteria that indicate the feasibility or otherwise of a project such as the Net Present Value (NPV). However, certain factors that are not considered in domestic capital budgeting should be taken into account in international capital budgeting because of the special nature of FDI projects.

It involves substantial spending capital investment in projects that are located in foreign countries, rather than in the home country of the MNC. Foreign projects differ from purely domestic projects concerning several factors- the foreign currency dimension, different economic indicators in different countries, and different risk characteristics with which the MNC is not as familiar as those about domestic projects. All these differences lead to a higher level of risk in international capital budgeting than in domestic capital budgeting.

Importance of International capital budgeting

Develop and Formulate Long-term Strategic Goals: The ability to set long-term goals is essential to the growth and prosperity of any business. The ability to appraisal investment projects via capital budgeting creates a framework for businesses to plan out future long-term direction.

Seek out New Investment Projects: Knowing how to evaluate investment projects gives a business the model to seek and evaluate new projects, an important function for all businesses as they seek to compete and profit in their industry.

Estimate and Forecast Future Cash Flows: Future cash flows are what create value for business over time. Capital budgeting enables executives to take a potential project and estimate its future cash flows, which then helps determine if such a project should be accepted.

Facilitate the Transfer of Information: From the time that a project starts as an idea to the time it is accepted or rejected, numerous decisions have to be made at various levels of authority. The capital budgeting process facilitates the transfer of information to the appropriate decision-makers within a company.

Monitoring and Control of Expenditures: Since a good project can turn bad if expenditures aren’t carefully controlled or monitored, this step is a crucial benefit of the capital budgeting process.

Benefits of International Capital Budgeting

• Valuable learning experience.
• Knowledge
• Globalization etc.

Factors Affecting International Capital Budgeting

• Blocked Funds.
• Amenities and Concessions Granted by Host Countries.
• Differing Rates of National Inflation.
• Political Risk involved in Foreign Investment.
• Exchange Rate Fluctuations.
• Subsidized Financing.
• Lost Exports.
• International Diversification Benefits.
• Host Government Incentives.

Major Issues in International Capital Budgeting

• “Parent against the project cash flow” the analyst estimates the relevant cash flows or the incremental cash flow of the particular project when the subsidiary transfer or subsidiary remits that cash flow to the parent company.
• “How to account for the increased economic and political risk of project.”

The foreign exchange market (Forex, FX, or currency market) is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This market determines foreign exchange rates for every currency. It includes all aspects of buying, selling and exchanging currencies at current or determined prices. In terms of trading volume, it is by far the largest market in the world, followed by the credit market.

The main participants in this market are the larger international banks. Financial centers around the world function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. Since currencies are always traded in pairs, the foreign exchange market does not set a currency’s absolute value but rather determines its relative value by setting the market price of one currency if paid for with another. Ex: US$1 is worth X CAD, or CHF, or JPY, etc.

The foreign exchange market works through financial institutions and operates on several levels. Behind the scenes, banks turn to a smaller number of financial firms known as “dealers”, who are involved in large quantities of foreign exchange trading. Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the “interbank market” (although a few insurance companies and other kinds of financial firms are involved). Trades between foreign exchange dealers can be very large, involving hundreds of millions of dollars. Because of the sovereignty issue when involving two currencies, Forex has little (if any) supervisory entity regulating its actions.

The foreign exchange market assists international trade and investments by enabling currency conversion. For example, it permits a business in the United States to import goods from European Union member states, especially Eurozone members, and pay Euros, even though its income is in United States dollars. It also supports direct speculation and evaluation relative to the value of currencies and the carry trade speculation, based on the differential interest rate between two currencies.

In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying with some quantity of another currency.

The modern foreign exchange market began forming during the 1970s. This followed three decades of government restrictions on foreign exchange transactions under the Bretton Woods system of monetary management, which set out the rules for commercial and financial relations among the world’s major industrial states after World War II. Countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed per the Bretton Woods system.

The foreign exchange market is unique because of the following characteristics:

• Its huge trading volume, representing the largest asset class in the world leading to high liquidity;
• Its geographical dispersion;
• Its continuous operation: 24 hours a day except for weekends, i.e., trading from 22:00 gmt on sunday (sydney) until 22:00 gmt friday (new york);
• The variety of factors that affect exchange rates;
• The low margins of relative profit compared with other markets of fixed income; and
• The use of leverage to enhance profit and loss margins and with respect to account size.

Benefits of Using the Forex Market

There are some key factors that differentiate the forex market from others, like the stock market.

• There are no clearing houses and no central bodies that oversee the forex market.
• There are fewer rules, which means investors aren’t held to the strict standards or regulations found in other markets.
• Most investors won’t have to pay the traditional fees or commissions that you would on another market.
• Because the market is open 24 hours a day, you can trade at any time of day, which means there’s no cut-off time to be able to participate in the market.
• Finally, if you’re worried about risk and reward, you can get in and out whenever you want, and you can buy as much currency as you can afford based on your account balance and your broker’s rules for leverage.

Determinants of exchange Rates:

International parity conditions: Relative purchasing power parity, interest rate parity, Domestic Fisher effect, International Fisher effect. To some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions (e.g., free flow of goods, services, and capital) which seldom hold true in the real world.

Balance of payments model: This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for the continuous appreciation of the US dollar during the 1980s and most of the 1990s, despite the soaring US current account deficit.

Asset market model: views currencies as an important asset class for constructing investment portfolios. Asset prices are influenced mostly by people’s willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that “the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.”

Economic factors

Economic factors include:(a) economic policy, disseminated by government agencies and central banks, (b) economic conditions, generally revealed through economic reports, and other economic indicators.

Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government’s central bank influences the supply and “cost” of money, which is reflected by the level of interest rates).

Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country’s currency.

Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country’s currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation’s economy. For example, trade deficits may have a negative impact on a nation’s currency.

Inflation levels and trends: Typically, a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation.

Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country’s economic growth and health. Generally, the healthier and more robust a country’s economy, the better its currency will perform, and the more demand for it there will be.

Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency. Its effects are more prominent if the increase is in the traded sector.

Political conditions

Internal, regional, and international political conditions and events can have a profound effect on currency markets.

All exchange rates are susceptible to political instability and anticipations about the new ruling party. Political upheaval and instability can have a negative impact on a nation’s economy. For example, destabilization of coalition governments in Pakistan and Thailand can negatively affect the value of their currencies. Similarly, in a country experiencing financial difficulties, the rise of a political faction that is perceived to be fiscally responsible can have the opposite effect. Also, events in one country in a region may spur positive/negative interest in a neighboring country and, in the process, affect its currency.

Market psychology

Market psychology and trader perceptions influence the foreign exchange market in a variety of ways:

Flights to quality: Unsettling international events can lead to a “flight-to-quality”, a type of capital flight whereby investors move their assets to a perceived “safe haven”. There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts. The US dollar, Swiss franc and gold have been traditional safe havens during times of political or economic uncertainty.

Long-term trends: Currency markets often move in visible long-term trends. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends.

“Buy the rumor, sell the fact”: This market truism can apply to many currency situations. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction. This may also be referred to as a market being “oversold” or “overbought”. To buy the rumor or sell the fact can also be an example of the cognitive bias known as anchoring, when investors focus too much on the relevance of outside events to currency prices.

Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. “What to watch” can change over time. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.

Technical trading considerations: As in other markets, the accumulated price movements in a currency pair such as EUR/USD can form apparent patterns that traders may attempt to use. Many traders study price charts in order to identify such patterns.

Repatriation of profit is the ability of a firm to send foreign‐earned profits or financial assets back to the firm’s home country in hard currency such as USD, EUR and others, after meeting the host nation’s tax obligations.

Proponents of profit repatriation argue that it encourages foreign direct investments (FDIs). Opponents argue that profit repatriation boosts another country’s economy. Accordingly, different countries impose different restrictions for profit repatriation.

Repatriation in a larger context refers to anything or anyone that returns to its country of origin, which can include foreign nationals, refugees, or deportees.

In the corporate world, repatriation usually refers to the conversion of offshore capital back to the currency of the country in which a corporation is based.

In the global economy, many corporations based in the United States generate earnings abroad. However, today many companies choose not to repatriate their offshore earnings in order to avoid corporate taxes charged on repatriated funds.

Individuals might also repatriate funds. For example, Americans returning from a visit to Japan typically repatriate their currency, converting any remaining yen into U.S. dollars. The number of dollars they receive when they exchange their remaining yen will depend on the exchange rate between the two currencies at the time of the repatriation.

Risks Associated with Repatriation

When companies operate in more than one country, they generally accept the local currency of the economy that they transact business. For example, though Apple is a U.S. based corporation, an Apple store in France will accept euros as payment for product sales since the euro is the currency that French consumers transact in and get paid from their employers.

When a company earns income in foreign currencies, the earnings are subject to foreign exchange risk, meaning they could potentially lose or gain in value based on fluctuations in the value of either currency.

If Apple earned 1,000,000 euros in France from product sales, at an exchange rate of 1.15 dollars per euro, the earnings would equal $1,150,000 or (1,000,000 euros * 1.15). However, if the next quarter, Apple earned 1,000,000 euros, but the exchange fell to 1.10 dollars per euro, the earnings would equal $1,100,000 or (1,100,000 euros * 1.10).

In other words, Apple would have lost $50,000 in earnings based on the exchange rate decline despite having the same amount in sales in euros for both quarters. The volatility or fluctuations in the exchange rate is called foreign exchange risk, which companies are exposed to when they do business internationally. As a result, the volatility in exchange rates can impact a company’s earnings.