export finance & risk management

7/27/2019 Export finance & risk management

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CHAPTER 1 BANKS & EXPORT FINANCE

INDIAN BANKS

DEFINITION OF BANK:-

A financial institution that is licensed to deal with money and its substitutes by

accepting time and demand deposits, making loans, and investing in securities.

The bank generates profits from the difference in the interest rates charged and

paid.

BANKING STRUCTURE IN INDIA:-

Todays dynamic world banks are inevitable for the development of a country.

Banks play a pivotal role in enhancing each and every sector. They have helped

bring a draw of development on the worlds horizon and developing country

like India is no exception.

Banks fulfills the role of a financial intermediary. This means that it acts as a

vehicle for moving finance from those who have surplus money to (however

temporarily) those who have deficit. In everyday branch terms the banks

channel funds from depositors whose accounts are in credit to borrowers who

are in debit.

Without the intermediary of the banks both their depositors and their borrowers

would have to contact each other directly. This can and does happen of course.

This is what has lead to the very foundation of financial institution like banks.

Before few decades there existed some influential people who used to land

money. But a substantially high rate of interest was charged which made

borrowing of money out of the reach of the majority of the people so there arose

a need for a financial intermediate.


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INDIAN BANKING SYSTEM:-

Non-Schedule Banks

State co-op

Banks

Commercial Banks Central co-opBanks and Primary

Cr. Societies

Commercial Banks

Indian Foreign

Public Sector

BanksPrivate Sector Banks HDFC,

State Bank of India

and its Subsidiaries

Other Nationalized Banks Regional Rural

Banks

Reserve Bank of India

Schedule Banks


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EXPORT FINANCE

INTRODUCTION:-

Financial assistance is extended by the banks to the exporters at pre-shipment

and post-shipment stages. Financial assistance extended to the exporter prior to

shipment of goods from India falls within the scope of pre-shipment finance

while that extended after shipment of the goods falls under post-shipment

finance. While the pre-shipment finance is provided for working capital for thepurchase of raw material, processing, packaging, transportation, warehousing

etc. of the goods meant for export, post-shipment finance is generally

provided in order to bridge the gap between shipment of goods and the

realisation of proceeds.

OBJECTIVES

1. To cover commercial and non-commercial risks and political risks attendanton granting credit to a foreign buyer.

2. To cover natural risks such as earthquakes, floods etc.3. To make available funds at the required time to the exporter.4. To ensure that the cost of funds are affordable to the exporter.


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Structure of export finance:-

Export finance in banks

EXIM Bank extends Lines of Credit (LOCs) to overseas governments, financial

institutions, regional banks and other overseas entities, to finance India's exports

to those countries. EXIM Bank's LOC is a risk-free, non-recourse exportfinancing option available to Indian exporters for promoting their exports.

Under this arrangement, overseas importers are required to pay advance

payment to Indian exporters, which is usually 10% of the contract value. EXIM

Bank pays the balance amount, which is normally 90% of the contract value, to

Indian exporters through negotiating banks in India, upon shipment of goods.

EXIM Bank also operates LOCs, announced by the Government of India, to the

country's trading partners.


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Forms of Financial Assistance Provided by EXIM Bank to Indian

Exporters:-

1. Delayed Payment ExportsTerm loans are provided to those exporters who deal with exporting of goods

and services and this enables them to offer delayed credit to the foreign buyers.

This system of deferred credit covers Indian consultancies, technology and other

services. Commercial banks take part in this program either directly or under

risk syndication arrangements.

2. Pre-shipment creditIndian companies which are highly involved in the execution of export activities

beyond the cycle time of six months are funded by EXIM Bank. The

construction or turnkey project exporters enjoy the provision of rupee

mobilization.

3. Term loans for exportproductionEXIM Bank offers term loans to the 100 percent export oriented units, units

involved in free trade zones, and exporters of various soft wares in India.

EXIM bank also works in association with International Finance Corporation,

Washington, to provide financial assistance to the small scale and medium

industrial units EXIM Bank extends Lines of Credit (LOCs) to overseas

governments, financial institutions, regional banks and other overseas entities,

to finance India's exports to those countries.

4. Foreign Investment FinanceEXIM bank provides financial assistance for equity contribution to the Indian

companies who form Joint Venture with the foreign companies.

5. Financing export marketingIt helps the exporters carry out their export market development plan in Indian

market.


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CHAPTER 2

METHODS OF EXPORT FINANCE

INTRODUCTION

Financial assistance is extended by the banks to the exporters at pre-shipment

and post-shipment stages. Financial assistance extended to the exporter prior to

shipment of goods from India falls within the scope of pre-shipment finance

while that extended after shipment of the goods falls under post-shipment

finance. While the pre-shipment finance is provided for working capital for the

purchase of raw material, processing, packaging, transportation, warehousing

etc. of the goods meant for export, post-shipment finance is generally

provided in order to bridge the gap between shipment of goods and the

realisation of proceeds.

OBJECTIVES

5. To cover commercial and non-commercial risks and political risks attendanton granting credit to a foreign buyer.

6. To cover natural risks such as earthquakes, floods etc.7. To make available funds at the required time to the exporter.8. To ensure that the cost of funds are affordable to the exporter.


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PRE SHIPMENT EXPORT FINANCE

Pre Shipment Finance is issued by a financial institution when the seller wants

the payment of the goods before shipment. The main objectives behind preshipment finance or pre export finance is to enable exporter to:

Procure raw materials. Carry out manufacturing process. Provide a secure warehouse for goods and raw materials. Process and pack the goods.

Ship the goods to the buyers. Meet other financial cost of the business.

Types of pre shipment finance

Packing Credit Advance against cheques /Draft etc. representing Advance Payments.

Open accountIn an open account transaction, the seller ships the goods together with the

necessary documents to the buyer before the payment is made and without any

form of guarantee. When the goods have been dispatched, the seller also sends

the buyer an invoice asking for payment within the agreed credit terms, for

example, 60 days from the invoice date.

Seller: Do not agree to an open account when the buyer is new to you or you are

unable to determine the risk or the reliability of the buyer.

Keep in mind that your goods are delivered before payment; therefore,make sure that you supply your goods or services in accordance with the

contract terms, thus avoiding disputes and non-payment.

Insist on an electronic transfer (cleared funds) instead of a bank draft orcheque (unclear funds).


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Buyer:

Make sure that the goods or services are satisfactory before you effectpayment.

Make sure that payment is made in accordance with the agreed creditterms to avoid damaging your trading relationship with the supplier.

Make sure to pay according to the settlement instructions

Documentary creditA documentary creditalso called a letter of creditis a conditional

guarantee of payment in which an overseas bank takes responsibility for paying

you after you ship your goods, provided you present all the required documents

(such as documents of title, insurance policies, commercial invoices and

regulatory documents).

A documentary credit is a separate contract from an export contract. The parties

to a documentary credit deal with documents, not the goods that the documents

relate to.

Documentary credits are a common method of payment in the international

trade of goods as they offer some protection to both you and your buyer.

Costs are involved

Your buyer pays the issuing bank to open and process a documentarycredit.

The Australian bank will charge you a fee for advising and negotiatingthe documentary credit. You may pay a further fee if the credit is

confirmed by another bank or if you receive an advance.


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Types of documentary credit include:

Irrevocablecannot be cancelled or amended without the consent of allparties, including the beneficiary. This is the most common type of

documentary credit in the international trade of goods

Revocablecan be cancelled by the issuing bank without warning to thebeneficiary

Confirmeda confirming bank (either in Australia or overseas) agreesto pay you under a documentary credit, whether or not payment is

received from the issuing bank

Transferablethe original beneficiary of the documentary credit cantransfer their rights to a second beneficiary on the same or similar terms

as the original documentary credit (the original beneficiary may be an

intermediary between you and your ultimate buyer)

Revolvingallows automatic reinstatement of the documentary creditafter the amount for the original shipment has been paid, so subsequent

shipments to your buyer are covered by a single documentary credit

Standbya contingency documentary credit which you can draw on ifyour buyer, using another payment method, defaults in making a payment

to you under the export contract

Back-To-Back/Complementarywhere your buyer is the beneficiary of

a separate documentary credit (in their capacity as a seller under aseparate sales contract), they can sometimes use this credit as security to

apply to their bank for a complementary documentary credit to cover

their payment under an export contract with you

RedClausepre-shipment finance that allows you (the beneficiary) toreceive an advance from the advising bank of all or part of the amount

owed to you under a documentary credit so you can buy raw materials or

other inputs required to manufacture the product for export.


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POST SHIPMENT EXPORT FINANCE

Post shipment finance is also an export finance extended to an exporter ,but

after the export has taken place. Normally it is extended upto the time of

realisation of the export bills.

The characteristics of the post shipment finance

Finance after the shipment of goods.

1. It is extended to those exporters in whose name the documents stand. (He maybe the original exporter or the documents would have been transferred in his

name.)

2. It can be a short term finance (for cash exports), or long term finance (fordeferred exports)

3. It is working capital finance since it is against receivables.4.

It is extended only against the evidence of authenticated documents evidencingshipment of goods.

5. Only a fund based finance.6. Concessionary rate of interest up to due dates (for normal transit period for sight

bills and up to notional due date in case of usance bills). Rate of interest as per

RBI guidelines.

7. Finance can be extended up to 100 % of the bill.


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WORKING CAPITAL

Export working capital (EWC) financing allows exporters to purchase the goods

and services they need to support their export sales. More specifically, EWC

facilities extended by commercial lenders provide a means for small and

medium-sized enterprises (SMEs) that lack sufficient internal liquidity to

process and acquire goods and services to fulfill export orders and extend open

account terms to their foreign buyers. EWC financing also helps exporters of

consigned goods have access to financing and credit while waiting for payment

from the foreign distributor. EWC funds are commonly used to finance three

different areas: (a) materials, (b) labor, and (c) inventory, but they can also be

used to finance receivables generated from export sales and/or standby letters of

credit used as performance bonds or payment guarantees to foreign buyers.

Factoring:

Export factoring is a complete financial package that combines export working

capital financing, credit protection; foreign accounts receivable bookkeeping,

and collection services. A factoring house, or factor, is a bank or a specialized

financial firm that performs financing through the purchase of invoices or

accounts receivable. Export factoring is offered under an agreement between the

factor and exporter, in which the factor purchases the exporters short-term

foreign accounts receivable for cash at a discount from the face value, normally

without recourse. The factor also assumes the risk on the ability of the foreign

buyer to pay, and handles collections on the receivables. Thus, by virtually

eliminating the risk of non-payment by foreign buyers, factoring allows the

exporter to offer open account terms, improves liquidity position, and boosts

competitiveness in the global marketplace. Factoring foreign accounts

receivables can be a viable alternative to export credit insurance, long-term

bank financing, expensive short-term bridge loans or other types of borrowing

that create debt on the balance sheet.


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Characteristics of Export Factoring

Applicability Best suited for an established exporter who wants (a) to have

the flexibility to sell on open account terms, (b) to avoid

incurring any credit losses, or (c) to outsource credit and

collection functions

Risk Risk of non-payment inherent in an export sale is virtually

eliminated

Pros Eliminates the risk of non-payment by foreign buyersMaximizes cash flows

Cons More costly than export credit insuranceGenerally not available in developing countries

DIFFERENT TYPES OF FACTORING:

1.Disclosed2. Undisclosed1. Disclosed Factoring:

In disclosed factoring, clients customers are aware of the factoring agreement.

Disclosed factoring is of two types:

Recourse factoring: The client collects the money from the customer butin case customer dont pay the amount on maturity then the client is

responsible to pay the amount to the factor. It is offered at a low rate of

interest and is in very common use.

Nonrecourse factoring: In nonrecourse factoring, factor undertakes tocollect the debts from the customer. Balance amount is paid to client at the

end of the credit period or when the customer pays the factor whichever

comes first. The advantage of nonrecourse factoring is that continuous

factoring will eliminate the need for credit and collection departments in the

organization.


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2. Undisclosed:In undisclosed factoring, client's customers are not notified of the factoring

arrangement. In this case, Client has to pay the amount to the factor irrespective

of whether customer has paid or not.

Forfeiting:

1. The forfeiting typically involves the following cost elements:Commitment fee, payable by the exporter to the forfeiter for latters

commitment to execute a specific forfeiting transaction at a firm discount

rate with in a specific time

2. Discount fee, interest payable by the exporter for the entire period ofcredit involved and deducted by the forfeiter from the amount paid to the

exporter against the availised promissory notes or bills of exchange.

Benefits to exporter:

100 per cent financing: Without recourse and not occupying exporter's creditline That is to say once the exporter obtains the financed fund, he will be

exempted from the responsibility to repay the debt.

Improved cash flow: Receivables become current cash inflow and its isbeneficial to the exporters to improve financial status and liquidation ability

so as to heighten further the funds raising capability.

Reduced administration cost: By using forfeiting, the exporter will sparefrom the management of the receivables. The relative costs, as a result, are

reduced greatly.


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Risk reduction: forfeiting business enables the exporter to transfer variousrisk resulted from deferred payments, such as interest rate risk, currency risk,

credit risk, and political risk to the forfeiting bank.

Increased trade opportunity: With forfeiting, the export is able to grant creditto his buyers freely, and thus, be more competitive in the market.

Benefits to banks:

Forfeiting provides the banks following benefits:

Banks can offer a novel product range to clients, which enable the clientto gain 100% finance, as against 8085% in case of other discounting

products.

Bank gain fee based income. Lower credit administration and credit follow up.


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STRUCTURED COMMODITY EXPORT FINANCE

Commodity finance aims to provide short-term, self-liquidating finance

facilities to a range of trading companies from the mid-sized specialist producttrader to the globally-integrated major trading houses. These facilities may be

secured or unsecured depending upon our perception of the creditworthiness of

the borrower and the structure of the business we are undertaking. Our major

business lines comprise steel and base metals, energy products and agricultural

commodities. Generally we target business where there are liquid terminal

markets for the underlying commodity, but we will also work selectively withmarket leaders that trade less liquid commodities.

SMBC group's trade finance team for commodities operates on a global basis

providing comprehensive solutions for the finance of international trade. We

employ a team of professionals, all of whom have multi-year experience in

commodity finance and can offer our customers a range of traditional or

structured commodity finance solutions using a full range of products,

including:

Pre-Export Trade Financing Issuance of Letters of Credit, such as Documentary and Standby Letters

of Credit

Warehouse and Receivables Financing

Multi-Purpose Trade Financing Facilities


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CHAPTER 3 FORMS OF RISKS

COMMERCIAL RISKS

The Commercial Risk and Compliance practice provides customized risk

advisory services to companies in the merchant acquiring and commercial card

issuing industries, among others, including those with products that access

deposit accounts.

Payments companies today are operating in a risk landscape that is shifting ever

more rapidly thanks to new technologies, changing regulatory regimes, volatile

financial markets, and their growing interdependencies. Navigating this

complex web of emerging risks and opportunities necessitates a more

anticipatory approach to risk management.

Our commercial risk practice is grounded in decades of industry experience and

an exclusive focus on the payments vertical, ensuring in-depth and up-to-date

understanding of the industry and the issues our clients face. Our roster of

clients, which includes the largest, most successful and dynamic players in the

industry, is testimony to our success in helping companies develop the insights

that they need to detect and mitigate the ever-changing layers of risk. With our

unparalleled industry experience and broad risk management capabilities, we

are uniquely qualified to help clients identify and evaluate risk-adjusted

business opportunities and extend their risk management function beyond

compliance.


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COMMERCIAL RISKS TO BE COVERED:-

Commercial risks arise from foreign banks, companies or project

companies. Typical commercial risks include the buyer's, borrower's or

guarantor's insolvency or unwillingness to pay its debt.

Factors considered assessing of the commercial risks of the transaction

include:

Export transaction/project Line of business Financing Risk-sharing/coverage Securities Environmental aspects Buyer's country Other aspects involved, if any


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TRANSPORTATION RISK

Handling, Stowage, Storage

Nearly half of all transportation losses are due to handling, storage or stowing

problems. Examples of this are:

Rapid acceleration or deceleration while hoisting Turning or lowering goods during loading or unloading Failure of handling equipment Failure of equipment such as lift trucks, cranes or porticoes during lifting Rough handling / incorrect stowage

Damage can be caused when inadequate equipment is used to move the goods

or the operators of the equipment lack the necessary training to use it correctly.

When heavy packages are stored on top of lighter ones damage is almost

inevitable.

Water Damage and Lifting

Water damage occurs to goods through:

Storms or rough seas Failure of watertight seals Leaks or holes in containers Lorries with porous covers Failure of door joints


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Condensation or moisture can be due to :

Variations in temperature (changes in climate on long journeys)

Humidity, Leaking of merchandise itself, Absence or insufficiency of drying products in the containers.

Flooding due to rivers overflowing their banks, heavy rains or failure of local

drainage systems in areas where goods are stored during transit.

Note : The newer container vessels without decks have increased capacities, butthis considerably increases the risk of water damage, as large waves and swells

can more easily penetrate the hold.

Fire or explosion

Common causes of fire or explosion are:

Sparking and fire caused by friction Spontaneous combustion Outside heat Chemical reactions

Any of the above can cause smoke damage or fire during the transportation of

goods.


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Fraud

Marine fraud is as old as marine insurance. Until the middle of the 1970s this

problem was regional, affecting local marine companies and insurance markets.Recently however along with the increasing globalisation of trade fraud is also

breaking regional boundaries.

Since the creation of the International Maritime Bureau in 1981, more than a

million acts of piracy or marine fraud have been reported.

The upsurge in international fraud has focused the attention of many

governments and transportation bodies around the world, particularly as

technology offers the potential for new opportunities for the fraudsters.

Certainly the "best" frauds are the ones we don't know about yet!

Theft and Pilfering

Theft and pilfering constitutes a fifth of all losses. Common types of losses are:

Breaking of cartons and crates, theft of part or all of the goods.. Hijacking of packages, palettes, entire containers, entire lorries and even

entire trains in certain countries.

Insufficient security in the loading and unloading, transit, and storageareas.

Errors in the destination of goods, due to insufficient or illegiblemarkings.


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POLITICAL RISK

Political risks are related either to the country of a foreign buyer or

borrower, or to a third country which can cause the exporter, investor or

financier to incur a credit loss. Political risks include restrictions on

transfer of the credit currency, rescheduling of debts, expropriation, and

war or insurrection.

Sovereign risk is caused by an entity that represents the full faith and credit of

State. In most cases this is the Ministry of Finance or the Central Bank.

When Finnvera covers only the political risks involved, the commercial risks

associated with the buyer, the borrower or the guarantor are not covered

Political risks are assessed by continuously following the creditworthiness of

the countries with political risk. The term political risk refers to all factors or

events which influence the country's economy, internal stability and

international relations.

Political risk may materialise as the consequence of a long course of events, or

may result from internal or external economic and political shocks.

Political risks are assessed according to the following criteria:-


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Economic growth potential

structure of the economy

natural resources export composition geographic location demographic factors

Economic growth potential

structure of the economy

natural resources export composition geographic location demographic factors

Economic policy

macroeconomic factors credibility of economic policy budget deficits

Economic policy

macroeconomic factors credibility of economic policy budget deficits

Vulnerability

size of the economy dependence on exports/imports dependence on foreign aid

Vulnerability

size of the economy dependence on exports/imports dependence on foreign aid


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Chapter 4 Risk Mitigation

Simply put, risk management is a two-step process - determining what risks

exist in an investment and then handling those risks in a way best-suited to yourinvestment objectives. Risk management occurs everywhere in the financial

world. It occurs when an investor buys low-risk government bonds over more

risky corporate debt, when a fund manager hedges their currency exposure with

currency derivatives and when a bank performs a credit check on an individual

before issuing them a personal line of credit

Principles of risk management

The International Organization for Standardization (ISO) identifies the

following principles of risk management

create valueresources expended to mitigate risk should be less than theconsequence of inaction, or (as in value engineering), the gain should

exceed the pain

be an integral part of organizational processes be part of decision making process explicitly address uncertainty and assumptions be systematic and structured be based on the best available information be tailor able take human factors into account be transparent and inclusive be dynamic, iterative and responsive to change be capable of continual improvement and enhancement be continually or periodically re-assessed
http://en.wikipedia.org/wiki/International_Organization_for_Standardizationhttp://en.wikipedia.org/wiki/Value_%28economics%29http://en.wikipedia.org/wiki/Value_engineeringhttp://en.wikipedia.org/wiki/Value_engineeringhttp://en.wikipedia.org/wiki/Value_%28economics%29http://en.wikipedia.org/wiki/International_Organization_for_Standardization


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CREDIT RISK

The risk of loss of principal or loss of a financial reward stemming from a

borrower's failure to repay a loan or otherwise meet a contractual obligationCredit risk arises whenever a borrower is expecting to use future cash flows to

pay a current debt. Investors are compensated for assuming credit risk by way

of interest payments from the borrower or issuer of a debt obligation.

Credit risk is closely tied to the potential return of an investment, the most

notable being that the yields on bonds correlate strongly to their perceived credit

risk. For example; mortgage loan,credit card, line of credit, or other loan, notpay a trade invoice, a government grants bankruptcyprotection to an insolvent

consumer or business

Credit risk mitigation methods

Risk-based pricing: Lenders generally charge a higher interest rate toborrowers who are more likely to default, a practice called risk-based

pricing. Lenders consider factors relating to the loan such as loan

purpose,credit rating, and loan-to-value ratio and estimates the effect

on yield (credit spread).

Covenants: Lenders may write stipulations on the borrower, calledcovenants, into loan agreements:

Periodically report its financial condition Refrain from paying dividends, repurchasing shares, borrowing further,

or other specific, voluntary actions that negatively affect the company's

financial position

Repay the loan in full, at the lender's request, in certain events such aschanges in the borrower's debt-to-equity ratio orinterest coverage ratio
http://en.wikipedia.org/wiki/Mortgage_loanhttp://en.wikipedia.org/wiki/Credit_cardhttp://en.wikipedia.org/wiki/Line_of_credithttp://en.wikipedia.org/wiki/Trade_credithttp://en.wikipedia.org/wiki/Bankruptcyhttp://en.wikipedia.org/wiki/Insolvencyhttp://en.wikipedia.org/wiki/Interesthttp://en.wikipedia.org/wiki/Risk-based_pricinghttp://en.wikipedia.org/wiki/Risk-based_pricinghttp://en.wikipedia.org/wiki/Loan_purposehttp://en.wikipedia.org/wiki/Loan_purposehttp://en.wikipedia.org/wiki/Credit_ratinghttp://en.wikipedia.org/wiki/Credit_ratinghttp://en.wikipedia.org/wiki/Loan-to-value_ratiohttp://en.wikipedia.org/wiki/Credit_spread_%28bond%29http://en.wikipedia.org/wiki/Loan_covenanthttp://en.wikipedia.org/wiki/Dividendhttp://en.wikipedia.org/wiki/Share_repurchasehttp://en.wikipedia.org/wiki/Debt-to-equity_ratiohttp://en.wikipedia.org/wiki/Times_interest_earnedhttp://en.wikipedia.org/wiki/Times_interest_earnedhttp://en.wikipedia.org/wiki/Debt-to-equity_ratiohttp://en.wikipedia.org/wiki/Share_repurchasehttp://en.wikipedia.org/wiki/Dividendhttp://en.wikipedia.org/wiki/Loan_covenanthttp://en.wikipedia.org/wiki/Credit_spread_%28bond%29http://en.wikipedia.org/wiki/Loan-to-value_ratiohttp://en.wikipedia.org/wiki/Credit_ratinghttp://en.wikipedia.org/wiki/Loan_purposehttp://en.wikipedia.org/wiki/Loan_purposehttp://en.wikipedia.org/wiki/Risk-based_pricinghttp://en.wikipedia.org/wiki/Risk-based_pricinghttp://en.wikipedia.org/wiki/Interesthttp://en.wikipedia.org/wiki/Insolvencyhttp://en.wikipedia.org/wiki/Bankruptcyhttp://en.wikipedia.org/wiki/Trade_credithttp://en.wikipedia.org/wiki/Line_of_credithttp://en.wikipedia.org/wiki/Credit_cardhttp://en.wikipedia.org/wiki/Mortgage_loan


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Credit insurance and credit derivatives: Lenders and bond holdersmay hedge their credit risk by purchasing credit insurance or credit

derivatives. These contracts transfer the risk from the lender to the seller

(insurer) in exchange for payment. The most common credit derivative

is the credit default swap.

Tightening: Lenders can reduce credit risk by reducing the amount ofcredit extended, either in total or to certain borrowers. For example, a

distributor selling its products to a troubled retailer may attempt to

lessen credit risk by reducing payment terms from net 30 to net 15.

Diversification: Lenders to a small number of borrowers (or kinds ofborrower) face a high degree of unsystematic credit risk, called

concentration risk. Lenders reduce this risk by diversifying the borrower

pool.

Deposit insurance: Many governments establish deposit insurance toguarantee bank deposits of insolvent banks. Such protection discourages

consumers from withdrawing money when a bank is becominginsolvent, to avoid a bank run, and encourages consumers to hold their

savings in the banking system instead of in cash.
http://en.wikipedia.org/wiki/Bond_%28finance%29http://en.wikipedia.org/wiki/Hedge_%28finance%29#Hedging_credit_riskhttp://en.wikipedia.org/wiki/Credit_derivativeshttp://en.wikipedia.org/wiki/Credit_derivativeshttp://en.wikipedia.org/wiki/Credit_default_swaphttp://en.wikipedia.org/wiki/Distribution_%28business%29http://en.wikipedia.org/wiki/Retailerhttp://en.wikipedia.org/wiki/Systematic_risk#Unsystematic_riskhttp://en.wikipedia.org/wiki/Concentration_riskhttp://en.wikipedia.org/wiki/Diversification_%28finance%29http://en.wikipedia.org/wiki/Deposit_insurancehttp://en.wikipedia.org/wiki/Bank_runhttp://en.wikipedia.org/wiki/Bank_runhttp://en.wikipedia.org/wiki/Deposit_insurancehttp://en.wikipedia.org/wiki/Diversification_%28finance%29http://en.wikipedia.org/wiki/Concentration_riskhttp://en.wikipedia.org/wiki/Systematic_risk#Unsystematic_riskhttp://en.wikipedia.org/wiki/Retailerhttp://en.wikipedia.org/wiki/Distribution_%28business%29http://en.wikipedia.org/wiki/Credit_default_swaphttp://en.wikipedia.org/wiki/Credit_derivativeshttp://en.wikipedia.org/wiki/Credit_derivativeshttp://en.wikipedia.org/wiki/Hedge_%28finance%29#Hedging_credit_riskhttp://en.wikipedia.org/wiki/Bond_%28finance%29


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BANK GUARANTEE

A guarantee from a lending institution ensuring that the liabilities of a debtor

will be met. In other words, if the debtor fails to settle a debt, the bank willcover it.

Legal Requirements

Bank guarantee is issued by the authorised dealers under their obligated

authorities notified vide FEMA 8/ 2000 date 3rd

May 2000. Only in case of

revocation of guarantee involving US $ 5000 or more need to be reported to

Reserve Bank of India (RBI).

TYPES OF GUARANTEES

1. Direct or Indirect Bank Guarantee:A bank guarantee can be either direct or indirect.Direct Bank Guarantee it is

issued by the applicant's bank (issuing bank) directly to the guarantee's

beneficiary without concerning a correspondent bank. This type of guarantee is

less expensive and is also subject to the law of the country.

Indirect Bank Guarantee With an indirect guarantee, a second bank is involved,

which is basically a representative of the issuing bank in the country to which

beneficiary belongs. This type of bank guarantee is more time consuming and

expensive too.


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2. Confirmed Guarantee:It is cross between direct and indirect types of bank guarantee. This type of bank

guarantee is issued directly by a bank after which it is send to a foreign bank for

confirmations. The foreign banks confirm the original documents and thereby

assume the responsibility.

3. Tender Bond:This is also called bid bonds and is normally issued in support of a tender in

international trade. It provides the beneficiary with a financial remedy, if the

applicant fails to fulfill any of the tender conditions.

4. Performance Bonds:This is one of the most common types of bank guarantee which is used to secure

the completion of the contractual responsibilities of delivery of goods and act as

security of penalty payment by the Supplier in case of non delivery of goods.

5.Advance Payment Guarantees:This mode of guarantee is used where the applicant calls for the provision of a

sum of money at an early stage of the contract and can recover the amount paid

in advance, or a part thereof, if the applicant fails to fulfill the agreement.

6.

Payment Guarantees :This type of bank guarantee is used to secure the responsibilities to pay goods

and services. If the beneficiary has fulfilled his contractual obligations after

delivering the goods or services but the debtor fails to make the payment, then

after written declaration the beneficiary can easily obtain his money from the

guaranteeing bank.


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7. Loan Repayment Guarantees:This type of guarantee is given by a bank to the creditor to pay the amount of

loan body and interests in case of non fulfillment by the borrower.

8. B/L Letter of Indemnity:This is also called a letter of indemnity and is a type of guarantee from the bank

making sure that any kind of loss of goods will not be suffered by the carrier.

9.Rental Guarantee:This type of bank guarantee is given under a rental contract. Rental guarantee is

either limited to rental payments only or includes all payments due under the

rental contract including cost of repair on termination of the rental contract.

10.Credit Card Guarantee:Credit card guarantee is issued by the credit card companies to its customer as a

guarantee that the merchant will be paid on transactions regardless of whetherthe consumer pays their credit.


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INSURANCE

Insurance is the equitable transfer of the risk of a loss, from one entity to

another in exchange for payment. It is a form of risk management primarily

used to hedge against the risk of a contingent, uncertain loss.

Credit Insurance:-Credit insurance is a type of life insurance policy purchased by a borrower that

pays off one or more existing debts in the event of a death, disability, or in rare

cases, unemployment. Credit insurance is marketed most often as a credit card

feature, with the monthly cost charging a low percentage of the card's unpaid

balance.

Credit insurance can be a financial lifesaver in the event of certain catastrophes.

However, many credit insurance policies are overpriced relative to their

benefits, as well as loaded with fine print that can make it hard to collect on. If

you feel that credit insurance would bring you peace of mind, be sure to read the

fine print as well as compare your quote against a standard term life insurance

policy.

Use of credit risk:-

Companies of all sizes use credit insurance. Euler Hermes has credit insurance

solutions which suit the needs of an SME up to the largest multinational

company

Major Benefits:-

Effective control of bad debt risks Expand sales securely in new markets A means to obtain more attractive financing Protection of your balance sheet and cash flow

Scope of cover:-

Commercial risk Political risk
http://en.wikipedia.org/wiki/Risk_managementhttp://en.wikipedia.org/wiki/Hedge_%28finance%29http://en.wikipedia.org/wiki/Hedge_%28finance%29http://en.wikipedia.org/wiki/Risk_management


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Transportation insurance:-Whether you are buying or selling goods from or to the international market,

there is always a risk that they may be delayed, damaged or lost in transit. Mostpeople in the supply chain who facilitate the movement of goods operate under

conditions limiting their liability in cases of loss, damage or delay. Traders

should therefore insure their goods against loss, damage or delay in transit. This

guide explains how to ensure appropriate insurance is in place and that you

dont assume another party has made the necessary arrangements, leaving you

liable in the event of a claim. The guide looks at the different clauses in

insurance contracts, contains details about finding the right policy and how to

make a claim. A wide array of clients count on Lock ton for transportation risk

management expertise in all sectors in the trucking industry including:

Truck Load Bulk Tank Fuel Hazardous Auto-Haulers Public Transportation

Transportation insurance coverage expert advice and placement includes:-

Primary Truckers' Liability Excess and Umbrella Liability Workers Compensation Warehouseman's Legal Liability General Liability Motor Truck Cargo Non-Trucking Use Liability

Comprehensive Insurance Programs for public transportation firms


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Exchange Risk Insurance:-An important advantage is that, unlike a currency forward contract, an

obligation to purchase the foreign currency is not applicable. Insurance isprovided in a manner whereby at radius Dutch State Business issues a guarantee

rate (forward rate) and after the entry into force of the contract, the rate

difference is settled (exchange losses or gains). If the relevant export contract is

not awarded, the insurance expires and there are no further obligations.

The 'standard' transferrable currencies (traditional industrialized countries) are

eligible for insurance. These are: USD (US Dollar), CHF (Swiss franc), CAD

(Canadian dollar), GBP (British pounds), AUD (Australian dollar), NZD (New

Zealand dollar), JPY (Japanese yen), NOK (Norwegian krone), SEK (Swedish

krona) and DKK (Danish kroner).

Also some (so called) 'exotic currencies' can be insured. In this case, think of

currencies linked to euro or US dollar but also currencies of certain emerging

markets with a relatively high level of development are insurable. On a case-by-

case basis it can be considered if other exotic currencies are eligible for

coverage. An important indication is the existence of a developed currency

futures market where the forward rates are determined on the basis of interest

rate differentials (covered interest parity). Exotic currency insurance is more

expensive than a standard currency cover.

The standard cover percentage for insurance is 100%, but the possibility exists

to choose a deductible of 1% up to 2.5%. If choose a deductible, the premium is

obviously lower.

The insured period is maximized at 36 months


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CHAPTER 5

FOREIGN EXCHANGE RISK MITIGATION IN

EXPORT FINANCE

Introduction Of Foreign Exchange Risk:-

Foreign exchange risk (also known as exchange rate risk or currency risk) is a

financial riskposed by an exposure to unanticipated changes in the exchange

rate between two currencies. Investors and multinational businesses exporting

or importing goods and services or making foreign investments throughout the

global economy are faced with an exchange rate risk which can have severe

financial consequences if not managed appropriately.

Types Of Exposure

Transaction Exposure Economic Exposure Translation Exposure Contingent exposure

Risk Management

Managers of multinational firms employ a number of foreign exchange hedging

strategies in order to protect against exchange rate risk. Transaction exposure is

often managed either with the use of the money markets, foreign exchange

derivatives such as forward contracts,futures contracts, options, and swaps, or

with operational techniques such as currency invoicing, leading and lagging of

receipts and payments, and exposure netting
http://en.wikipedia.org/wiki/Financial_riskhttp://en.wikipedia.org/wiki/Exchange_ratehttp://en.wikipedia.org/wiki/Exchange_ratehttp://en.wikipedia.org/wiki/Currencyhttp://en.wikipedia.org/wiki/Money_markethttp://en.wikipedia.org/wiki/Foreign_exchange_derivativehttp://en.wikipedia.org/wiki/Foreign_exchange_derivativehttp://en.wikipedia.org/wiki/Forward_contracthttp://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Option_%28finance%29http://en.wikipedia.org/wiki/Swap_%28finance%29http://en.wikipedia.org/wiki/Nettinghttp://en.wikipedia.org/wiki/Nettinghttp://en.wikipedia.org/wiki/Nettinghttp://en.wikipedia.org/wiki/Swap_%28finance%29http://en.wikipedia.org/wiki/Option_%28finance%29http://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Forward_contracthttp://en.wikipedia.org/wiki/Foreign_exchange_derivativehttp://en.wikipedia.org/wiki/Foreign_exchange_derivativehttp://en.wikipedia.org/wiki/Money_markethttp://en.wikipedia.org/wiki/Currencyhttp://en.wikipedia.org/wiki/Exchange_ratehttp://en.wikipedia.org/wiki/Exchange_ratehttp://en.wikipedia.org/wiki/Financial_risk


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Meaning of derivative instrument:-

A derivative is a financial contract which derives its value from the performance

of another entity such as an asset, index, or interest rate, called the "underlying".Derivative transactions include a variety of financial contracts, including

futures, forwards, swaps,options, and variations of these such as caps, floors,

collars, and credit default swaps. Most derivatives are marketed through over-

the-counter (off-exchange) or through an exchange, while most insurance

contracts have developed into a separate industry.

Advantages/importance of derivatives:-

1. Risk Mitigation: Derivatives are convenient risk mitigation contract for

buyers and sellers. These are used has hedging tools in commodity and

especially in currency and stock markets. Forex currency contract are most

popular too hedge risk of exchange rates in case of export and import trades.

2. Rearrangement of Risk: Because of derivatives, risk is packaged

conveniently and is passed on to the willing parties. Derivatives help in

stripping off the risk and sell it separately. In absence of such tools risks remain

integrated with purchase sell contracts.

3. Ease to Trading: Derivatives (F&O) are easy to buy and sell through well

organized markets. So, no elaborate procedures of legal documentations are

necessary. These are ready to buy and sell contract. Its ease in trading.

4. Investment: Derivatives are an additional investment avenue for investors.

Though speculative in nature, they can always be a part of large well manage

portfolio and can fetch leveraged returns.

5. Money Flows: Derivatives assist purchase sale transactions which are not

possible as cash or cash transactions. Hence they indirectly boost the turnover.

6. Equilibrium: more the value of the trade, faster the equilibrium achieved.

Derivatives make our markets more efficient. Inelasticity is curbed.
http://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Forward_contracthttp://en.wikipedia.org/wiki/Swap_%28finance%29http://en.wikipedia.org/wiki/Option_%28finance%29http://en.wikipedia.org/wiki/Interest_rate_cap_and_floorhttp://en.wikipedia.org/wiki/Collar_%28finance%29http://en.wikipedia.org/wiki/Credit_default_swaphttp://en.wikipedia.org/wiki/Over-the-counter_%28finance%29http://en.wikipedia.org/wiki/Over-the-counter_%28finance%29http://en.wikipedia.org/wiki/Insurancehttp://en.wikipedia.org/wiki/Insurancehttp://en.wikipedia.org/wiki/Over-the-counter_%28finance%29http://en.wikipedia.org/wiki/Over-the-counter_%28finance%29http://en.wikipedia.org/wiki/Credit_default_swaphttp://en.wikipedia.org/wiki/Collar_%28finance%29http://en.wikipedia.org/wiki/Interest_rate_cap_and_floorhttp://en.wikipedia.org/wiki/Interest_rate_cap_and_floorhttp://en.wikipedia.org/wiki/Option_%28finance%29http://en.wikipedia.org/wiki/Swap_%28finance%29http://en.wikipedia.org/wiki/Forward_contracthttp://en.wikipedia.org/wiki/Futures_contract


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FORWARD CONTRACT

In the context of foreign exchange, forward contracts enable you to buy or sell

currency at a future date. Then again, all foreign exchange derivatives do thesame. There are differences among foreign exchange derivatives in terms of

their characteristics.

Forward contracts have the following characteristics:

Commercial banks provide forward contracts. Forward contracts are not-standardized. This characteristic indicates that

you can have a forward contract for any amount of money, such as

buying 154,280.72 (as opposed to being able to buy only in multiples of

100,000).

Forward contracts imply an obligation to buy or sell currency at thespecified exchange rate, at the specified time, and in the specified

amount, as indicated in the contract.

Forward contracts are not tradable.The non-standardized and obligatory characteristics of forward contracts work

well for exportimport firms because they deal with any specific amount of

account receivables or payables in foreign currency. Additionally, these firms

know their account receivables and payables in advance, so a binding contract

isnt a problem.

For example: -

Suppose that youre an American importer, and you have to pay 109,735.04 to

a German exporter on November 12, 2012. You get a forward contract today to

buy 109,735.04 at the dollareuro exchange rate of $1.10 on November 12,

2012. In this case, youre contractually obligated to buy 109,735.04 on

November 12, 2012. On this date, you will pay $120,708.54 for it (109,735.04

x 1.10).


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Two types of forward currency exchange contract:

Fixed forward contracts: -You take delivery of your forward currency on a specific date in the

future.

Open forward contracts: -You can take delivery of all the foreign currency at once, or drawn down

smaller amounts as you need them - up to the amount of the value of the

contract.


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FUTURE OR OPTION

Futures and options represent two of the most common form of "Derivatives".

Derivatives are financial instruments that derive their value from an'underlying'. The underlying can be a stock issued by a company, a currency,

Gold etc. The derivative instrument can be traded independently of the asset.

The value of the derivative instrument underlying changes according to the

changes in the value of the underlying.

Derivatives are of two types -- exchange traded and over the counter.

Exchange traded derivatives, as the name signifies are traded through organized

exchanges around the world. These instruments can be bought and sold through

these exchanges, just like the stock market. Some of the common exchange

traded derivative instruments are futures and options.

Important Options and Futures Terminology

For both options and futures, there are certain terms that are important to know.

In the world of options, the terms put and call are key to the business. A

put is the ability to sell a certain asset at a given price. A call is the ability

to purchase an item at a pre-negotiated price. The price itself is called a strike

price or an exercise price. In addition, options usually come with an

expiration date. This date is the date by which the option would need to be put

into action, otherwise the option will become null and void.

Futures have their own terminology as well. The exercise price or futures

price is the price of the item that will be paid in the future. Buying an item in

the future means that the purchaser has gone long. The person selling the

futures contract is called short.
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Comparisons between Future & Option Contract

Feature Future Contract Option contract

1 Concept It is a standardized form of

forward contract.

Its a totally different concept as

commercial privilege

2 Buy To buy a future no upfront

payment is required except

for margin money to broker

which is more of a safety

feature of exchange trading.

To buy an option, upfront option

premium is paid. This is non

refundable sunk cost.

3 Types Future writer writes a future

contract with a spirit of

selling an underlying asset.

Future contract buyer buys it

with spirit of buying that

asset.

Option writer could write it with

a spirit of buying as asset (put

option) or selling (call option).

Option buyer is in opposite will.

Put option is to sell the

underlying asset and call option

to buy the asset.

4 Settlement On settlement date either

writer is at loss or buyer. It is

settled for cash payment.

Options are either exercised or

are lapsed. Writer gains with

premium. He may make loss on

exercise of the option.

5 Risk Risks of written & buyer are

almost equal. This is linearity

feature of futures.

Maximum gain of option writer

is premium. Loss potential is

unlimited. Loss of option buyer

is limited to premium paid (and

he lets the option lapse). Gain

potential s unlimited. The is

Non-linearity


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OTC (OVER THE COUNTER) MARKET

Definition of 'Over-The-Counter Market':

A decentralized market, without a central physical location, where market

participants trade with one another through various communication modes such

as the telephone, email and proprietary electronic trading systems. An over-the-

counter (OTC) market and an exchange market are the two basic ways of

organizing financial markets. In an OTC market, dealers act as market makers

by quoting prices at which they will buy and sell a security or currency. A trade

can be executed between two participants in an OTC market without others

being aware of the price at which the transaction was effected. In general, OTC

markets are therefore less transparent than exchanges and are also subject to

fewer regulations.

OTCContract

An over-the-counter contract is a bilateral contract in which two parties (or their

brokers or bankers as intermediaries) agree on how a particular trade or

agreement is to be settled in the future. It is usually from an investment bank to

its clients directly. Forwards and swaps are prime examples of such contracts. Itis mostly done via the computer or the telephone. For derivatives, these

agreements are usually governed by an International Swaps and Derivatives

Association agreement. This segment of the OTC market is occasionally

referred to as the "Fourth Market."
http://en.wiktionary.org/wiki/bilateralhttp://en.wikipedia.org/wiki/Forward_contracthttp://en.wikipedia.org/wiki/Swap_%28finance%29http://en.wikipedia.org/wiki/Derivative_%28finance%29http://en.wikipedia.org/wiki/International_Swaps_and_Derivatives_Associationhttp://en.wikipedia.org/wiki/International_Swaps_and_Derivatives_Associationhttp://en.wikipedia.org/wiki/Fourth_markethttp://en.wikipedia.org/wiki/Fourth_markethttp://en.wikipedia.org/wiki/International_Swaps_and_Derivatives_Associationhttp://en.wikipedia.org/wiki/International_Swaps_and_Derivatives_Associationhttp://en.wikipedia.org/wiki/Derivative_%28finance%29http://en.wikipedia.org/wiki/Swap_%28finance%29http://en.wikipedia.org/wiki/Forward_contracthttp://en.wiktionary.org/wiki/bilateral


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Importance of OTC derivatives in modern banking

OTC derivatives are significant part of the world of global finance. The OTC

derivatives markets are large and have grown exponentially over the last twodecades. The expansion has been driven by interest rate products, foreign

exchange instruments and credit default swaps. The notional outstanding of

OTC derivatives markets rose throughout the period and totaled approximately

US$601 trillion at December 31, 2010. In the past two decades, the major

internationally active financial institutions have significantly increased the share

of their earnings from derivatives activities. These institutions manage

portfolios of derivatives involving tens of thousands of positions and aggregate

global turnover over $1trillion. The OTC market is an informal network of

bilateral counterparty relationships and dynamic, time-varying credit exposures

whose size and distribution are tied to important asset markets. International

financial institutions have increasingly nurtured the ability to profit from OTC

derivatives activities and financial markets participants benefit from them. As a

result, OTC derivatives activities play a central and predominantly a beneficial

role in modern finance.

The advantages of OTC derivatives over exchange-traded ones are mainly the

lower fees and taxes, and greater freedom of negotiation and customization of a

transaction, as it involves only a seller and a buyer and no standardization

authority.

The NYMEX has created a clearing mechanism for a slate of commonly traded

OTC energy derivatives which allows counterparties of many bilateral OTC

transactions to mutually agree to transfer the trade to Clear Port, the exchange's

clearing house, thus eliminating credit and performance risk of the initial OTC

transaction counterparts.
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SWAPS

Swap is one more derivative concept. It is a combination of two forwards.

Somewhat like a barter with future date. In finance, a foreign exchange swap is

a simultaneous purchase and sale of identical amounts of one currency for

another with two different value dates (normally spot to forward). See Foreign

exchange derivative. Foreign Exchange Swap allows sums of a certain currency

to be used to fund charges designated in another currency without acquiring

foreign exchange risk. It permits companies that have funds in different

currencies to manage them efficiently.

Interest rate swaps are also common. Fixed rate of interest is swapped with

floating one. Two floating rates in two markets/ currencies are also swapped.

This is called as basis swap.

Benefits of swap contact:

The benefits in question depend on the type of financial instruments involved.

For example, in the case of a swap involving two bonds, the benefits in question

can be the periodic interest (orcoupon) payments associated with such bonds.

Specifically, two counterparties agree to exchange one stream ofcash

flows against another stream. These streams are called the legs of the swap. The

swap agreement defines the dates when the cash flows are to be paid and the

way they are accrued and calculated. Usually at the time when the contract is

initiated, at least one of these series of cash flows is determined by a random or

uncertain variable such as a floating interest rate, foreign exchange rate, equity

price, or commodity price. The cash flows are calculated over a notional

principal amount. Contrary to a future, a forward or an option, the notional

amount is usually not exchanged between counterparties. Consequently, swaps

can be in cash orcollateral. Swaps can be used to hedge certain risks such

as interest rate risk, or to speculate on changes in the expected direction of

underlying prices.
http://en.wikipedia.org/wiki/Financehttp://en.wikipedia.org/wiki/Foreign_exchange_derivativehttp://en.wikipedia.org/wiki/Foreign_exchange_derivativehttp://en.wikipedia.org/wiki/Bond_(finance)http://en.wikipedia.org/wiki/Coupon_(bond)http://en.wikipedia.org/wiki/Cash_flowshttp://en.wikipedia.org/wiki/Cash_flowshttp://en.wikipedia.org/wiki/Accrualhttp://en.wikipedia.org/wiki/Floating_interest_ratehttp://en.wikipedia.org/wiki/Foreign_exchange_ratehttp://en.wikipedia.org/wiki/Notional_principal_amounthttp://en.wikipedia.org/wiki/Notional_principal_amounthttp://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Forward_contracthttp://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Collateral_(finance)http://en.wikipedia.org/wiki/Hedge_(finance)http://en.wikipedia.org/wiki/Interest_rate_riskhttp://en.wikipedia.org/wiki/Speculationhttp://en.wikipedia.org/wiki/Speculationhttp://en.wikipedia.org/wiki/Interest_rate_riskhttp://en.wikipedia.org/wiki/Hedge_(finance)http://en.wikipedia.org/wiki/Collateral_(finance)http://en.wikipedia.org/wiki/Option_(finance)http://en.wikipedia.org/wiki/Forward_contracthttp://en.wikipedia.org/wiki/Futures_contracthttp://en.wikipedia.org/wiki/Notional_principal_amounthttp://en.wikipedia.org/wiki/Notional_principal_amounthttp://en.wikipedia.org/wiki/Foreign_exchange_ratehttp://en.wikipedia.org/wiki/Floating_interest_ratehttp://en.wikipedia.org/wiki/Accrualhttp://en.wikipedia.org/wiki/Cash_flowshttp://en.wikipedia.org/wiki/Cash_flowshttp://en.wikipedia.org/wiki/Coupon_(bond)http://en.wikipedia.org/wiki/Bond_(finance)http://en.wikipedia.org/wiki/Foreign_exchange_derivativehttp://en.wikipedia.org/wiki/Foreign_exchange_derivativehttp://en.wikipedia.org/wiki/Finance


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Feature of swap contract:

1) Negotiated contracts: Swaps are not readily available on exchanges.These are negotiated by two parties with each other and are tailor made in

rate and quantity.

2) Intermediary: Two parties of equal and opposite needs should meet forswap transaction. Intermediaries play an important role in match-making

and also in negotiations process.

3) Combination of Forward Contracts: Swap contract is a combination oftwo forward contracts. Two forward sellers of two different assts (Dollars

and Euros), buy each other forward contract. This is swap.

4) Settlement: Settlement may be by actual delivery or the perceived gain /loss between each other is settled by cash payment.


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COMMODITY LINKED LOANS BONDS

Less-developed countries (LDCs) have for years been faced with colossal

foreign debt. This debt, which is denominated in U.S. dollars at floating interest

rates, became impaired in the 1970s and 1980s when interest rates were very

high. Moreover, unfavorable terms of trade, due to volatile prices of export

commodities and falling export revenue, have hampered the ability of LDCs to

retire and/or service their debts. Consequently, the debt overhang has limited

their access to new foreign capital, forcing them to adjust their domestic

investment and consumption. Unfortunately, the LDCs are still mired in a debt

crisis, which is seriously stifling their economic growth

The purpose of this paper is to examine whether commodity-linked bonds could

provide a potential means for LDCs to raise money on the international capital

markets, rather than through standard forms of financing. Commodity-linked

bonds differ from conventional bonds in terms of their payoffs to the holder.

The bearer of the conventional bond receives fixed coupon (interest) payments

during the life of the bond, and face value (principal) at maturity.

In both the conventional and the commodity-linked bonds, the payments

referred to are promised (or contractual). If the issuer is unable or unwilling to

make the contractual payments, default occurs, and the bearer receives a smaller

or zero payment. In the event of default, substantial bankruptcy, legal, and

renegotiating costs may be incurred, and new uncertainties may be introduced

(especially in international borrowing). These are dead-weight losses (asopposed to simple wealth transfer) to the parties involved in the contract.

There are two types of commodity-indexed bonds: forward and option.

Experiences with Commodity-Linked Bonds

1. Gold-linked bonds2. Silver-linked bonds3.

Oil-linked bonds

4. Other forms of commodity-indexed securities


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Ways to Protect Export Commodities from Price Volatility

For years, LDCs have been faced with colossal foreign debt. The retirement

and/or servicing of this debt has been a major problem for LDCs and their

creditors due to the volatility of the prices of export commodities and hence

their export revenues. The crisis created by these debt overhangs has drawn

academics and practitioners to research ways and means for creditors to receive,

if not the principal, at least the interest payments on the debt. The crisis has also

made it difficult for LDCs to obtain new loans.

The difficulty that LDCs face in meeting their debt obligations would be

reduced if they could embark on measures that would protect their export

commodities from price volatilities. One measure suggested in the literature is

that LDCs adopt hedging strategies. Whereas some researchers suggest the use

of futures markets by these countries, other researchers call for LDCs to shift

the risk that their commodity prices face to the financial markets.

Fall (1986) describes three methods LDCs use to hedge against the risk their

export commodity prices face:

1. International commodity agreements (ICAS),2. The futures markets, and3. Countertrade


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CONCLUSION

Export finance:-

This Chapter has explained the need for trade finance and introduced some of

the most common tradefinance tools and practices. A proactive role of

governments in trade finance may alleviate the lack of trade finance in emerging

GMS economies and contribute to trade expansion and facilitation.

However, the best long-term solution in resolving the constraints in trade

financing is to encourage the growth and development of a vibrant and

competitive financial system, comprising mainly private sector players. This

point is important as some of the government-supported trade financing

schemes may increasingly be challenged by competing countries as unfair

export subsidies under existing and future WTO rules. The role of the

government and other parties involved in trade finance will need to evolve

along with the countrys economy.

Risk management:

The results obtained from the project clearly support the assertion that

poor credit risk management contributed to a greater extent to the bank failures

in banking system. Therefore effective credit risk management is important in

banks and allows them to improve their performance and prevent bank distress.

The success of the systems depends critically upon a positive risk culture.

Banks should have in place a comprehensive credit risk management process to

identify, measure, monitor and control credit risk and all material risks and

where appropriate, hold capital against these risks. Establishment of a

comprehensive credit risk management system in banks should be a prerequisite

as it contributes to the overall risk management system of the bank. There is

also need for banks to adopt sound corporate governance practices, manage

their risks in an integrated approach, focus on core banking activities and adhere

to prudential banking practices


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CHAPTER 6

BIBLIOGRAPHY

BIBLIOGRAPHY

1) Banking in India of Vipul Publication

2) International Finance Management3) ExportImport & Letter Of Credit


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Chapter 7

WEBLIOGRAPHY

WEBLIOGRAPHY

1)www.economictimes.com2)www.axisbank.com3)

www.export.gov

4)www.lockton.com5)www.icici.com
http://www.economictimes.com/http://www.economictimes.com/http://www.economictimes.com/http://www.axisbank.com/http://www.axisbank.com/http://www.axisbank.com/http://www.lockton.com/http://www.lockton.com/http://www.lockton.com/http://www.lockton.com/http://www.axisbank.com/http://www.economictimes.com/


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export finance & risk management

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