International Banking

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 6364
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.h
  tml

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 isnt 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 banks service in currency
  exchange
• difference between a banks 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 timepage 71

27
Foreign Exchange Market Forward Contracts

• Forward contracts have premiums, discounts
• premium forward gt spot rate
• discount forward lt spot rate

28
Foreign Exchange Market Forward Contracts

• Forward contracts have premiums, discounts
• premium forward gt spot rate
• discount forward lt 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 Maduras Text

33
Special Drawing Rights
Refer to your green handout on the IMF
34
Foreign Exchange MarketExchange 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 MarketExchange 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 MarketFutures 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 MarketFutures 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 doesnt 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 intl business with long-term credit
• International stock markets
• provides equity financing in different countries