International Banking and Trade Finance

1. International Banking and Trade Finance Chpt 3

2. Overview Corporate use of: • Foreign exchange market • Eurocurrency market • Eurocredit market • Eurobond market • International stock markets

3. Motives for Investing in a Foreign Market Which would therefore require financial considerations to assist in the investment

4. Why FDI Exits • Land, Resources and some types of business cannot be relocated • If a company wants access, they have to go there • eg. Mining operations, forest harvesting • If your customer moves overseas, you may follow to continue to be able to supply • eg. Autoparts companies

5. Why FDI Exits • Some companies set up operations overseas because manufacturing locally is cheaper than exporting and paying the shipping costs • Companies also setup mfg. Overseas in low-wage areas to make products that are then sent back to customers in the Home Country, or to a 3rd market • eg. Japanese companies mfg. Electronic goods in Malaysia, and export to the USA Page 63~64

6. Why would you want to provide Credit in Foreign Markets • Some countries have higher interest rates so the businesses in those countries find it expensive to borrow • eg. Japanese interest rate is low, mathematically it is cheaper for North American businesses to sometimes borrow money from Japanese banks, than North American banks Page 64

7. Why would you want to provide Credit in Foreign Markets • Exchange rate expectations • Japanese banks would lend money to U.S. companies if the U.S. dollar goes up • - it means when they get paid back, they make more money because the U.S. dollar rose in the meantime Page 64

8. Why would you want to provide Credit in Foreign Markets • International diversification • Some lenders might want to lend money to business in several different countries to reduce the risk • If a lender in one country goes bankrupt because of the situation in that country - they still have income from businesses in other countries Page 64

9. Why would you want to borrow money from Foreign Markets • Low Interest Rates • Some banks in some countries have a lot of money to lend at low interest rates - and nobody to lend to because the businesses in that country cannot, or do not borrow this money • These banks make effort to attract foreign lenders - especially those with currency exchange rates that are going up Page 65

10. Why would you want to borrow money from Foreign Markets • Exchange rate expectations • If you expect a foreign currency to go down, it would be advantageous to borrow that money, then you have less to pay back Page 65

11. Why would you want to borrow money from Foreign Markets • Exchange rate expectations • If an American company borrowed $ 1,000,000 from a Canadian bank, it might cost them $800,000 US to do this • If the Cdn currency goes down, they might only have to pay back $750,000 because at the time of paying back, their US dollars are worth more Page 65

12. Foreign Exchange Market • Facilitates trade with exchange of currencies • Developed over long period of time • gold standard, 1876-1913 • pegged rates in 1930s • fixed exchange rates 1944-1973 • market determined exchange rates 1973-present

13. Foreign Exchange Market: • No specific trading market • Market is just a word for the global collection of various buyers and sellers • US banks’ opening exchange rates use prevailing rates of London banks

14. Foreign Exchange Market: “The most common type of 4X transaction is for immediate exchange at the Spot Rate” Page 66

15. Foreign Exchange Market: • Spot Contract • a 4X transaction with funds delivered for immediate value • the rate “on the spot” • in practice, this means settlement within 2 days • see http://www.mellon.com/inst/fx/tools/services.html

16. Foreign Exchange Market: Role of Banks • immediate exchanges made at banks • volume of exchange linked to international trade and finance • 20 large banks handle 50% of the volume • six currencies comprise 90% of US exchange volume • Japanese yen, German mark, British pound • Canadian dollar, French franc, Swiss franc

17. ? Why would it be that the chart on page 67 shows German Marks, Japanese Yen and British Pounds being used much more than Canadian dollars - cause isn’t Canada the largest trading partner with the U.S.? Because Cdn dollar business done by Canadian banks and because Cdn business with the U.S. is more frequently quoted in U.S. dollars anyway - negating the need for conversion

18. Foreign Exchange Market: Role of Banks • “… the exchange rate between 2 currencies should be similar across the various banks that provide 4X - cause • if there was a large difference, customers, or other banks would immediately start trading currency page 66

19. Foreign Exchange Market: Role of Banks • “… if a bank begins to experience a shortage of a particular foreign currency it can purchase this from other banks. This trading is called the Interbank Market…” page 67

20. Foreign Exchange Market: Role of Banks • US banks’ opening exchange rates use prevailing rates of London banks • sometimes change happen the world over night which negate the exchange rate used the previous day • due to time zones, people trade 24hrs a day around the planet

21. Attributes of Banks- things you look for in deciding to use a particular bank for 4x • Competitiveness • Special Relationship • Speed of Execution • Advice about current market conditions • Forecasting advicepage 68

22. Foreign Exchange Market: Bid/Ask Spread • Represents fee for bank’s service in currency exchange • difference between a bank’s bid (buy) quote and ask (sell) quote • remember: banks buy low, sell high bid/ask spread = (ask-bid)/ask

23. Foreign Exchange Market: Bid/Ask Spread • In currencies that are bought and sold frequently, the bid / ask spread is usually not too big • In currencies that are NOT bought and sold frequently, the bid / ask spread is larger so the bank can have a better chance of making some money • This also helps them if they cannot sell some currencies page 71

24. Foreign Exchange Market: Forward Contracts • Agreement made today to buy or sell currency at a specific time in the future • “… allow for the purchasing or selling of currencies in future periods…” • “… establishes a firm rate today, for settlement at a future day” Mellon Bank • Bank acts as middle agent Page 70

25. Foreign Exchange Market: Forward Contracts • MNCs use forward contracts for: • hedging against currency fluctuations • bypassing cashflow constraints • they might not have the money right now • MNCs cannot always plan exactly when the product will be finished, and need to be shipped and paid for, so forward contracts are sometimes bought and sold if the planning time changes

26. Foreign Exchange Market: Forward Contracts • “MNCs also use forward contracts to lock in the rate at which they can sell currencies - this is used to hedge against the possibility of the currencies depreciating over time”page 71

27. Foreign Exchange Market: Forward Contracts • Forward contracts have premiums, discounts • premium: forward > spot rate • discount: forward < spot rate

28. Foreign Exchange Market: Forward Contracts • Forward contracts have premiums, discounts • premium: forward > spot rate • discount: forward < spot rate • example • If McCains foods bought

29. Arbitrage • “… capitalizing on a discrepancy in quoted prices…” page 203 • TR - “taking advantage of the fact that one thing has two different prices - you can then buy it at the low price, and sell it for a profit to the person who is paying the higher price”

30. Interpreting Foreign Exchange Quotes • Direct quote • dollar value of foreign currency per one unit of the foreign currency • e.g., British pound = $1.5205 • Indirect quote • number of currency units per one US dollar • e.g., British pound = 0.6557

31. Interpreting Foreign Exchange Quotes • Direct quote YEN • one unit of that currency equal to the number of dollars • one Yen = 0.01179 CDN $ • Indirect quote • the number of units of that currency per one dollar • 80.45 Yen = 1 $ CDN

32. Interpreting Foreign Exchange Quotes For consistency, Direct Quotes are used in Madura’s Text

33. Special Drawing Rights Refer to your green handout on the IMF

34. Foreign Exchange Market:Exchange Rates • Cross exchange rates • exchange rate between non-US currencies • value of Canadian dollar in German marks • value of one CD in $US = $0.7236 • value of one DM in $US = $0.6077 Value of $CD in DM = $0.7236/$0.6077 = 1.1907

35. Foreign Exchange Market:Exchange Rates • Cross exchange rates • exchange rate between non-US currencies • value of Canadian dollar in German marks • value of one CD in $US = $0.6757 • value of one DM in $US = $0.5297 Value of $CD in DM = $0.6757/$0.5297 = 1.275 17 May 1999 Using the handout of 17May99, calculate the cross rate

36. Foreign Exchange Market:Futures and Options • Futures • contract for future delivery of a currency • specific volume of a currency to be delivered on a specified date at a specified rate • volume is a fancy way of saying “how much” eg, dollars volume = 50,000,000

37. The difference between a Futures Contract and a Forward Contract is that the Future Contract specifies the volume on a specific date - sold on an Exchange , the Foward Contract specifies the exchange rate - sold by commercial banks

38. Foreign Exchange Market:Futures and Options • Options • contract for the option to buy/sell a currency at a specified price in a specified time period • call option gives right to buy a currency • put option gives right to sell a currency

39. Eurocurrency Market • Eurodollar market • MNCs depositing $US in European banks • mostly American companies making deposits in European banks • the European banks took this money cause they could easily lend it to European customers who needed dollars to buy American goods and services

40. Eurocurrency Market • Eurodollar market • outgrowth of international banking needs and circumvention of US banking regulations • US limits foreign lending by US banks • meaning US law doesn’t allow US banks to lend money easily to non-US customers • If they do lend money at all, reserve limits are high • Eurobanks have no reserve requirements • smaller bid/ask spread exists in the more efficient European market for US dollars Page 76

41. Eurocurrency Market • Composition of market • Eurobanks work with deposits and loans in different currencies • primarily work with US dollars • petrodollars are deposits by OPEC countries, in dollars

42. Syndicated Loans • When you want to borrow a very large amount of money, several banks form a temporary alliance to provide the amount • this “syndication” allows for very large projects to be financed, and the people who lend the money, will proportionately share in the interest payments Page 77

43. Asian dollar market • Asian banks (usually in Hong Kong, Singapore) • accommodate financing needs of MNCs with $US

44. Eurocredit Market • Medium-term funds • financing for one to five years • LIBOR • - London Interbank Offer Rate • rate commonly charged for loans between Eurobanks Page 80

45. Foreign Bonds • Foreign bonds • issued by a MNC in a foreign country • “… issued by a borrower foreign to the country in which the bond is placed” page 80 • e.g., US company issues bond in London that are denominated in British pounds

46. Euro Bonds • Euro bonds • “… sold in countries other than the country represented by the currency denominating them” page 80 • e.g., English company issues bond in Germany that are denominated in British pounds • issued in bearer form • coupon payments made yearly • most are denominated in U.S. dollars

47. International Stock Markets • Equity financing in non-domestic countries • Yankee stock offerings • issuance in the US by non-US companies • MNCs attracted by the liquidity of US market • American Depository Receipts (ADR) • certificates traded in US • represent bundles of stock in foreign countries

48. Summary • Foreign exchange market • facilitates financial trade/transactions by exchanging currencies • Eurocurrency market • provide services for deposits, short-term loans • Eurobond market • facilitates int’l business with long-term credit • International stock markets • provides equity financing in different countries