international trade and finance (itf)

PART-A:INTERNATIONAL TRADE

INTERNATIONAL BUSINESS METHODS:

The most common methods of international business are as follows:

a)International Tradeb)Licensingc)Franchisingd)Joint Venturese)Acquisition of existing businessf)Establishing new foreign subsidiaries.

INTERNATIONAL TRADE: It is simple import & exports i.e. buy at lower rate & sell at high rate.

LICENSING:

A company can give technology (copy right, patents, trade mark& trade name etc). in exchange of certain fee.

FRANCHISING:

It is a very popular form of SME these days like KFC, Pizza Hut etc.It is defined as a continuing arrangement between the parent company i.e. franchisor and an entrepreneur i.e. franchisee. The agreement is for a certain period which can be extended as decided mutually.

ADVANTAGES:To the franchisor To the franchisee

Expand distribution without increased capital investment.

Sound management, training and decision making may be available.

Community acceptance of the product

Market tested product so less risk will be there.

Marketing & distribution expanses are shared.

Advertising & promotion is already there.

Some operating cost may be transferred to the franchisee.

Acceptance in large system of retailers.

Flat fee can be collected from franchisee

Credit may be available.

Through agreement, quality control can be maintained.

Advisory available.

Percentage on sale can be earned.

Credit may be available.

DISADVANTAGES:

Franchisor FranchiseeLong distance control over franchisee.

Gives up much freedom in management decision.

Expanses on training sometimes very high.

Profits are always shared.

Loss of some ownership Franchises may be very expensive.

Product can be stolen Undue interference.

Success depends on wise planning & its results.The agreement may include energy, money, ideas, location, experience, training, management, name, know-how etc.

DIFFERNET TYPE OF FRANCISES:

1-Straight product distribution i.e. only product is provided in salable form like general store products.

2-Product license franchises: Only name is used but product is manufactured as per specifications of the franchisor.

3-Trade name franchise: Trade name is given but no control over product or service.

JOINT VENTURES:

Jointly operated & owned by two or more entities like General Mill & NESTLE for cereals. It helps to penetrate the foreign market.

Existing business:

Such a business has a track record so can be run more easily sometimes.

So advantages are as follows:

The business is operating & success can be judged.

Customers are known & feedback is easy. Financial data is available for inspection. Business activity can be verified Bankers etc have an impression of business. Competitors know the business.

While purchasing an existing business following points are required to be considered.

Financial picture Why for sale, is it TITANIC? What are business trends? Books should be checked. All concerned should be interviewed.

START UP OR PURCHASE A FRANCHISE:

All franchises have tested programs so consider the following while purchasing::

Proven operational methods as part of package. Research is available. Training can be provided to entrepreneur. Name & reputation Risks are minimized.

LETTER OF CREDIT, THE SPIRIT OF INTERNATIONAL TRADE

International trade demands a flow of goods from seller to buyer and of payment from buyer to seller. The goods movement may be evidenced by appropriate documents. Payment, however, is influenced by trust between the commercial parties, their need for finance and, possibly, by governmental trade and exchange control regulations.

Consequently, the documentary credit is frequently the method of payment. The buyer’s bank pays the seller against presentation of documents and compliance with conditions stipulated by the buyer.

A world-wide use, with an immense daily turnover in transactions and value, necessitates a universal standard of practice. The International Chamber of Commerce (ICC) provides this with its Uniform and Practice for Documentary Credits(UCP), but their effectiveness is reduced unless the commercial parties and the banks involved understand the basics of the operations.

BUT WHAT IMF SAYS:

Pakistan obtained US$ 11.3B in 2008 from IMF & so far US$ 8.3B has been released. When IMF released US$ 3.1B we paid US$ 3.65B to various institutions in the same period. The foreign debt is at US$ 55B which is estimated to increase to US$ 72.6B in 2015-16.

POSSIBLE PROBLEMS

The seller says,

“We want to be certain that the buyer is able to pay on time once the goods have been shipped. How can we minimize risk of non-payment?”

The buyer says,

“We do not know the seller… can we be sure that he will deliver on time?”

The seller worries,”

We are supplying the buyer with goods that we ourselves have bought from a sub-contractor.

How can we prevent the buyer from finding out and contacting our supplier directly?”

The buyer thinks,

“Before we pay, how can we check that the goods are exactly those we ordered?”

BOTH THE PARTIES WANT:

"How can the banks help us in the practical arrangements for these transactions, specially by assisting us with all the necessary documentation?”

Additional services desired:

“We would prefer to delay paying for the goods until we have sold them. Will our bank provide credit for the intervening period?”

“Where can we get information on currency restrictions, and import or export licenses?”

What the seller wants

Contract Fulfillment

Assurance that he will be paid in full within the agreed time limit.

Convenience

The convenience of receiving payment at his own bank or through a bank in his own country.

Prompt Payment

Prompt payment for the sale of the goods, so as to improve the liquidity of his business.

Advice

The knowledge necessary to conduct complex trade transactions.

What the buyer wants

Contract Fulfillment

Assurance that he does not have to pay the seller until he is certain that the seller has fulfilled his obligations correctly.

Convenience

The convenience of using an intervening third party in whom both buyer and seller have confidence-such as a bank with its documentary expertise-when making payment.

Credit

A managed cash-flow, by the possibility of obtaining bank finance.

Expert assistance

Expert assistance and facilities in dealing with often complex transactions, particularly with the specific procedures to be followed.

TIME FOR PAYMENT

SELLER

In advance

He needs payment before shipment, as he cannot otherwise finance production of the goods the buyer has ordered.

At time of Shipment

He wants assurance of payment as soon as the goods are shipped.

He has to meet regulations stipulating payment at time of shipment rather than before or after it.

After shipment

He is prepared to wait for payment for a certain time after shipment, as he trusts the buyer and appreciates his position.

BUYER

In advance

He trusts the seller, knowing that the contract will be carried out as agreed, and he is therefore prepared to pay in advance.

At time of Shipment

He does not want to take the risk of paying before being certain that the goods are shipped on time and that they are as stipulated in his contract with the seller.

He has to meet regulations stipulating payment at time of shipment rather than before or after it.

After shipment

He possibly wants to sell the goods before he pays the seller.

DOCUMENTARY CREDITS

Definition

In simple terms, a documentary credit/letter of credit is a conditional bank undertaking of payment.

Expressed more fully, it is a written undertaking by a bank (issuing bank) given to the seller (beneficiary) at the request, and on the instructions, of the buyer (applicant) to pay at sight or at a determinable future date up to a stated sum of money, within a prescribed time limit and against stipulated documents.

These stipulated documents are likely to include those required for commercial, regulatory, insurance, or transport purposes, such as commercial invoice, certificate of origin, insurance policy or certificate, and a transport document of a type appropriate to the mode(s) of transport used.

Documentary credits offer both parties to a transaction a degree of security, combined with a possibility, for a creditworthy party, of securing financial assistance more easily.

Buyer

Because the documentary credit is a conditional undertaking, payment is, of course, made on behalf of the buyer against documents which may represent the goods and give him rights in them.

However, according to arrangements made between him and the bank-and, in some cases, by reason of local laws or regulations-he may have to make an advance

deposit at the time of requesting the issuance of the credit, or he may be required to place the issuing bank in funds at the time documents are presented to the overseas banking correspondent of the issuing bank.

Seller

Because the documentary credit is a bank undertaking, the seller can look to the bank for payment, instead of relaying upon the ability or willingness of the buyer to pay subject to fulfillment of certain terms and conditions.

ISSUING A CREDIT

The buyer and the seller conclude a sales contract providing for payment by documentary credit.

The buyer instructs his bank-the “issuing” bank-to issue a credit in favour of the seller (beneficiary).

The advising or confirming bank informs the seller that the credit has been issued.

The issuing bank asks another bank, usually in the country of the seller, to advise or confirm the credit.

Advising/ confirming bank

There are usually two banks involved in a documentary credit operation. The issuing bank is the bank of the buyer. The second bank, the advising bank, is usually a bank in the seller’s country.

The second bank can be simply an advising bank, or it can also assume the more important role of a confirming bank.

In either case, it undertakes the transmission of the credit. Article 8 (UCP) requires the advising bank to take “reasonable care to check the apparent authenticity of the credit which it advises”.

Issuing bank

If the second bank is simply “advising the credit”, it will mention this fact when it forwards the credit to the seller. Such a bank is under no commitment to make payment to the seller, even though it may be nominated in the credit as the bank authorized to pay, to accept drafts, or to negotiate.

If the advising bank is also “confirming the credit”, it will so state. This means that the confirming bank, regardless of any other consideration, must pay, accept, or negotiate without recourse to the seller, provided all the documents are in order and the credit requirements are met.

SOME IMPORTANT RELEVANT SCHEDULE OF BANK CHARGES

IMPORTS:

Sr.# Annual amount

Quarterly payment

Minimum payment for one LC

1 Upto Rs.25M 0.40% per quarter

Rs.1,400 or negotiable

2 Upto Rs.50M 0.35% per quarter

3 Upto Rs.100M

0.29% per quarter

4 Above Negotiable5 LC

amendment& handling charges

Negotiable

6 One off transaction

Normal mark up rate

7 Documents retired with 10 days

No commission

8 If retired during 15 days or more

From 0.29% to 0.46% i.e. negotiable

EXPORTS:

1 LC advising Rs.1,400 per quarter

2 LC advising amendment

Rs.1,200

3 LC confirmation

Minimum Rs.1,400

WHERE WE STAND PRESENTLY:

INDICATORS JULY-SEPT,11 JULY-SEPT 10GDP GROWTH 2.5%-2.8% 4.1%FISCAL DEFICIT 1.5% OF GDP 1.6% OF GDPRS.VS $ Rs.86.12 Rs.83.12IMPORTS $9B $7.6BEXPORTS $5B $4.3BTRADE GAP $3.85B $3.15BCURRENT A/c DEFICIT

$545M 587M

HOME REMITTANCE $2.6B $2.3BFOREIGN INVESTMENT

$455M $636M

FOREX RESERVES $17B $14.4BEXTERNAL DEBT $55.6B $52.3BEXTERNAL DEBT SERVICING

$5.7B $5.3B

The Government borrowings are increasing and in 2010-11 so far Rs.198B has been borrowed due to floods etc.

PAK RS.VS USD SINCE APRIL 2008

The rupee has shed 37% i.e. from Rs.62.57 in April 2008 to Rs.87 in October 2010 in the present Government period due to following reasons:

Losing investors’ confidence on the current Political system.

Global recession.

Flight of capital due to judicial crisis.

Law and order situation after Benazir’s Assassination.

IMF condition to make oil/POL payments through open market in stead of SBP.

High oil & food import prices.

$11.7B loan of IMF.

Freezing of forex exchange companies.

$ =Rs.19.32 in 1989.IMF Support Arrangements to Pakistan

(1980-2004)

Arrangement

Date of Arrangem

ent (expiratio

n)

Amount

(SDR millio

n)

Disbursement

(SDR million)

Signed during rule of

EFF 24-11-80(23-11-

83)

1268.00

1079.00 Ziaul Haq

SBA 28-12-88(7-3-90)

273.15

194.48 Benazir Bhutto

SAF 28-12-88(27-12-

91)

382.41


SBAEFF/ESAF

16-9-93(15-9-94)22-2-94

(21-2-97)

265.40

379.10

88.00123.20172.20

Nawaz Sharif

22-2-94(21-2-97)

606.60

SBA 13-12-95(31-3-97)

562.59


EFF/ESAF

20-10-97(19-10-2000)

454.92

682.38

113.75265.37

Nawaz Sharif

SBA 29-11-2000(30-9-2001)

465.00

465.00 Pervez Musharraf

PRGF 7-12-2001(5-12-2004)

1033.70

861.42 Pervez Musharraf

LATEST LOAN:

Stand-By Arrangement (SBA) 2008-10

Main Features

a) Pakistan submitted to the IMF a Request for Stand-By Arrangement on 20

November, 2008 amounting SDR 5.17 billion ($ 7.6 billion) equal to 500% of Pakistan's quota in the Fund. It has increased to $11.7B. Pakistan has requested to extend it upto 31-12-10 as it was expired on 30-09-10.

b) The Arrangement is for a period of 23 months.

c) It is on interest rate of 3.51-4.51%. The amount will be disbursed in seven tranches - the first tranche of SDR 2.067 billion has been received on 29 November, 2008 and the balance amount will be disbursed in six quarterly instalments during 2009-10. The amount and interest will be repaid in five Years from 2011.

Objective and Economic Program (2009-2010):

The main objectives of the Arrangement are to

(i) restore confidence of domestic and external investors by addressing macroeconomic imbalances through a tightening of fiscal and monetary policies; and

ii) protect the poor and preserve social stability through a well-targeted and adequately funded social safety net. For this purpose the government of Pakistan has initiated an Economic Program covering 24 months. The main elements of the Program are:

· Reduce fiscal deficit: 7.4% of GDP in 2008 to 4.2% in 2009 and 3.3% in 2010

· Tighten monetary policy (increase interest rate, eliminate government borrowing) to reduce inflation to 6% in 2010

· Increase expenditure on social safety net (0.6% of GDP to 0.9% in 2009) -work with World Bank to prepare a comprehensive program of safety net

Conditionality of SBA.

OTHER MAIN POINTS:

a) The program is subject to quarterly review and performance criteria. The conditionality covers actions prior to the approval of arrangement by the IMF Board, performance criteria, benchmarks and quantitative targets.

b) The prior actions included increasing the State Bank's discount rate from 13% to15% as a measure to control inflation.

c) Raise in electricity tariff by an average of 18% effective from 5 September, 2008.

Evaluation of SBA 2008-10.

The IMF arrangements can be seen from different perspectives i.e.

It may refer to the following:

- Bail-out package.- Investors' confidence builder.- Economic stabilizer and revival of growth.- Step towards greater external dependence and source of hardship to the people, and so on.

- Ignores protecting the poor.-Presumes that tight monetary and fiscal policies will ensure economic revival in later years. -Reduced government borrowings

This scenario is based on the premise that the government will be able to take fiscal and monetary measures as stipulated in the Arrangement.

Table Economic Indicators2008 2009 2010

GDP growth rate

%

5.8 3.4 5.0

CPI (end year) %

21.5 20.0 6.0

Gross national

savings (% GDP)

12.9 13.5 15.7

Gross capital

formation

21.3 20.0 21.3

(% GDP)External

resources(% GDP)

8.4 6.5 5.6

Fiscal deficit (%

GDP)

7.4 4.2 3.3

Debt (% GDP)

57.9 54.6 52.4

Current Account

deficit (% GDP)

8.4 6.5 5.7

External debt (% GDP)

26.5 31.4 33.2

Reserves ($ million)

8.591 8.591 11,291

CREDIT APPLICATION

The instructions to be given by the applicant to the issuing bank will cover such items as.

1. The full (and correct) name and address of the beneficiary (seller).

2. The amount of the credit.3. The type of credit, whether

* revocable* irrevocable* irrevocable, with the added

confirmation of the advising bank.

4.How the credit is to be available, e.g. by payment, deferred payment, acceptance or negotiation. In most cases it will be the issuing bank which will determine the bank authorized to pay, or to accept drafts, or to negotiate, i.e. the “nominated bank” – Article 11(b), UCP).

4. The party on whom drafts, if any, are to be drawn and the tenor of such drafts.

5. A brief description of the goods, including details of quantity and unit price, if any.

6. Whether freight is to be prepaid or not.7. Details of the documents required. The place of

dispatch or taking in charge of the goods, or loading on board, as the case may be, and the place of final destination.

8. Whether transshipment is prohibited.9. Whether partial shipments are prohibited.10. The latest date for shipment (if

applicable). The period of time after the date of issuance of the transport documents(s) within which the documents must be presented for payment, acceptance or negotiation.

11. The date and place of expiry of the credit.12. Whether the credit is to be a transferable one. (This would

have to be stated specifically by the applicant). The specimen application form is for a non-transferable credit.

13. How the credit is to be advised, i.e., by mail, or by teletransmission i.e. SWIFT

TYPES OF CREDIT

There are various types of documentary credits. A revocable credit can be amended or cancelled at any time without prior warning or notification to the seller.

An irrevocable credit can be amended or cancelled only with the agreement of the issuing bank, the confirming bank (if the credit has been confirmed) and the seller (as beneficiary). As there are often two banks involved, the issuing bank and the advising bank, the buyer can ask for an irrevocable credit to be confirmed by the advising bank. If the advising bank agrees, the irrevocable credit becomes a confirmed irrevocable credit.

Revocable Credit

Involves risk, as the credit may be amended or cancelled while the goods are in transit and before the documents are presented, or, although presented, before payment has been made, or in the case of deferred payment credit, before the documents have been taken up. The seller would then face the problem of obtaining payment directly from the buyer.

Irrevocable Credit

Gives the seller greater assurance of payment: but he remains dependent on an undertaking of a foreign bank.

Confirmed irrevocable Credit

Gives the seller a double assurance of payment, since a bank in the seller’s country has added its own undertaking to that of the issuing bank.

Revocable Credit:

Gives the buyer maximum flexibility, as it can be amended or cancelled without prior notice to the seller up to the moment of payment by the bank at which the issuing bank has made the credit available.

Irrevocable Credit

Gives less flexibility, as the credit can only be amended or cancelled if all the parties named above agree. (It must be noted, however, that the credit is issued in this form because the commercial parties have so agreed in the sales contract).

Confirmed irrevocable Credit

Represents an additional requirement and is more costly.

PRESENTATION

1.As soon as the seller receives the credit and is satisfied that he can meet its terms and conditions, he is in a position to load the goods and dispatch them.

2.The seller then sends the documents evidencing the shipment to the bank where the credit is available (the nominated bank).

3.The bank checks the documents against the credit. If the documents meet the requirements of the credit, the bank will pay, accept, or negotiate, according to the terms of the credit. In the case of a credit available by negotiation, the issuing bank or the confirming bank will negotiate without recourse. Any other bank, including the advising

bank if it has not confirmed the credit, which negotiates, will do so with recourse.

4.The bank, if other than the issuing bank, sends the documents to the issuing bank.

The issuing bank checks the documents and, if they meet the credit requirements, either

a) effects payment in accordance with the terms of the credit, either to the seller if he has sent the documents directly to the issuing bank, or to the bank that has made funds available to him in anticipation, or

b) reimburses in the pre-agreed manner the confirming bank or any bank that has paid, accepted, or negotiated under the credit (Article 21, UCP).

TRANSPORT DOCUMENTS

The most important thing is the relevant transport document!

The revision of UCP aims at a less troubled future by recognizing – and legislating for –

a) the case where the ‘credit stipulates dispatch of goods by post’, so that the appropriate ‘transport document’ is a ‘post receipt or certificate of posting.

b) the case where the credit envisages ‘carriage by sea’, with the traditional ‘marine bill of lading’ stipulated as the required transport document.

c) all other cases where the credit calls for a transport documents, e.g. where the mode of carriage may be a combination of more than one mode (combined transport), or may be air, road, rail or inland waterway, with the appropriate transport document a combined transport bill of lading, an air waybill, a road or rail consignment note, an inland waterway bill of lading, or even, if so stipulated in the credit.

BILL OF LADING

This is the type of transport document normally applicable to a carriage of goods solely by sea. It is the transport document which must be presented if the credit stipulates a ‘marine bill of lading’.

Unless otherwise stipulated in the credit this document MUST indicate that the goods have been loaded on board or shipped on a named vessel.

If the credit prohibits transshipment this document will be rejected if it specifically states that the goods will be transshipment. COMBINED TRANSPORT BILL OF LADING

This is the type of transport document normally applicable to a carriage of goods by more than one mode of transport.

Unless otherwise stipulated in the credit this document MAY indicate either dispatch or taking in charge of the goods, or loading on board, as the case may be.

COMMERCIAL INVOICE

A commercial invoice is the accounting document by which the seller charges the goods to the buyer.

A commercial invoice normally includes the following information:

* date.* name and address of buyer and seller.* order or contract number, quantity and

description of the goods, unit price (and details of any other agreed charges not included in the unit price), and the total price.

* weight of the goods, number of packages, and shipping marks and numbers.

* terms of delivery and payment.* shipment details.

CERTIFICATE OF ORIGIN

A certificate of origin is a signed statement providing evidence of the origin of the goods.

* In many countries a certificate of origin, although prepared by the exporter or his agent, has to be issued in a mandatory form and manner, with certification by an independent official organization, e.g., a chamber of commerce.

* Such a document contains details of the shipment to which it relates, states the origin of the goods, and bears the signature and the seal or stamp of the certifying body.

INSURANCE CERTIFICATE

The insurance document must:

1. be for the purpose that specified in the credit.

2. be consistent with the other documents in its identification of the voyage and description of the goods.

3. unless otherwise stipulated in the credit,a. be a document issued and/ or signed by

insurance companies or underwriters, or their agents.

b. be dated on or before the date of shipment as evidenced by the transport documents, or appear to show that cover is effective at the latest from such date of shipment be for an amount at least equal to the CIF value of the goods plus 10% and in the currency of the credit.

SETTLEMENT

The seller may sometimes present documents that do not meet the credit requirements. In such a case, the bank can only act in one of the following ways:

1. Return the documents to the beneficiary (seller) to have them amended for resubmission within the validity of the credit and within the period of time after date of issuance specified in the credit, or applicable under (UCP).

2. Send the documents for collection.3. Return the documents to the beneficiary for

sending through his own bankers.4. If so authorized by the beneficiary, cable or

write to the issuing bank for authority to pay, accept or negotiate.

5. Call for an indemnity from the beneficiary or from a bank, as appropriate i.e., pay, accept or negotiate on the understanding that any payment made will be refunded by the party giving the indemnity, together with interest and all charges, if the issuing bank refuses to provide reimbursement against documents, that do not meet the credit requirements.

6. Based on practical experience, and with the agreement of the beneficiary, pay, accept or negotiate “under reserve”, i.e. retain the right of recourse against the beneficiary if the issuing bank refuses to provide reimbursement against documents that do not meet the credit requirements. In view of a court ruling it would be advisable to make sure that the beneficiary fully understands this position.

BY PAYMENT

1. The seller sends the documents evidencing the shipment to the bank where the credit is available (the paying bank).

2. After checking that the documents meet the credit requirements, the bank makes payment.

3. This bank, if other than the issuing bank, then sends the documents to the issuing bank. Reimbursement is obtained in the pre-agreed manner.

BY ACCEPTANCE

1. The seller sends the documents evidencing the shipment to the bank where the credit is available (the accepting bank), accompanied by a draft drawn on the bank at the specified tenor.

2. After checking that the documents meet the credit requirements, the bank accepts the draft and returns it to the seller.

3. This bank, if other than the issuing bank, then sends the documents to the issuing bank, stating that it has accepted the draft and that at maturity reimbursement will be obtained in the pre-agreed manner.

Advising / Confirming bank

By accepting the draft, the bank signifies its commitment to pay the face value at maturity. The seller can, therefore, usually convert the accepted draft into cash by discounting it with his own bank, or on the local money market.

Issuing Bank

All credits must nominate the bank (nominated bank) which is authorized to accept drafts (accepting bank).

BY NEGOTIATION

1. The seller sends the documents evidencing the shipment to the bank where the credit is available (the negotiating bank), accompanied by a draft drawn on the buyer or on any other drawee specified in the credit, at sight or at a tenor, as specified in the credit.

2. After checking that the documents meet the credit requirements, the bank may negotiate the draft. Negotiation by the issuing bank or the confirming bank will be without recourse to the seller. Negotiation by any other bank will be with recourse to the seller.

3. This bank, if other than the issuing bank, then sends the documents and the draft to the issuing bank. Reimbursement is obtained in the pre-agreed manner.

CLASSIFICATION OF TYPES OF LC:

1. REVOLVING CREDIT

A revolving credit is one where, under the terms and conditions thereof, the amount is renewed or reinstated without specific amendment to the credit being needed.

* It can be revocable or irrevocable.* It can revolve in relation to time and

value.

2. RED CLAUSE CREDIT

A red clause credit:

* is a credit with a special clause incorporated into it that authorizes the advising or confirming bank to make advances to the beneficiary before presentation of the documents. The clause is incorporated at the specific request of the applicant, and the wording is dependent upon his requirements.

* is so called because the clause was originally written in red ink to draw attention to the unique nature of this credit.

* specifies the amount of the advance that is authorized: in some instances it may be for the full amount of the credit.

* is often used as a method of providing the seller with funds prior to shipment. Therefore, it is of value to middlemen and dealers in areas of commerce that require a form of pre-financing and where a buyer would be willing to make special concessions of this nature.

3. TRANSFERABLE CREDIT

A transferable credit is one that can be transferred by the original (First) beneficiary to one or more other parties (second beneficiaries).It is normally used when the first beneficiary does not supply the merchandise himself, but is a middleman and thus wishes to transfer part, or all, of his rights and obligations to the actual supplier(s) as second beneficiary(ies).

This type of credit can only be transferred once, i.e., the second beneficiary(ies) cannot transfer to a third beneficiary, The transfer must be

effected in accordance with the terms of the original credit, subject to the following exceptions:

* the name and address of the first beneficiary may be substituted for that of the applicant for the credit.

* the amount of the credit and any unit price may be reduced: this would enable the first beneficiary to allow for his profit.

* the period of validity, the period of time after date of issuance of the transport document for presentation of documents, and the period for shipment may be shortened.

* the percentage for which insurance cover must be effected may be increase in such a way as to provide the amount of cover stipulated in the original credit.

It should be noted that a credit would only be issued as a transferable one on the specific instructions of the applicant. This would mean that both the credit application form and the credit itself must clearly show that the credit is to be transferable. (Only an irrevocable credit would be issued in this form).

The transfer is affected at the request of the first beneficiary, by the bank where the credit is available (the bank).

BACK TO BACK CREDIT

It may happen that the credit in favour of the seller is not transferable, or, although transferable, cannot meet commercial requirements by transfer in accordance with conditions. The seller himself, however, is unable to supply the goods and needs to purchase them from, and make payment to, another supplier. In this case, it may

sometimes be possible to use either a “back-to-back credit”or Counter credit.

Under the back-to-back concept, the seller, as beneficiary of the first credit, offers it as “security” to the advising bank for the issuance of the second credit. As applicant for this second credit the seller is responsible for reimbursing the bank for payments made under it, regardless of whether or not he himself is paid under the first credit. There is, however, no compulsion for the bank to issue the second credit, and, in fact, many banks will not do so.

In the case of a counter credit, the procedure is the same except that the seller requests his own bank to issue the second credit as a counter to the first one. His own bank may agree to issue such a credit if the transaction falls within the seller’s existing credit line or if a special facility is granted for that purpose. The bank will, of course, have rights against him in accordance with the terms of the credit line or special facility.

With both the back-to-back credit and the counter credit, the second credit must be worded so as to produce the documents (apart from the commercial invoice) required by the first credit-and to produce them within the time limits set by the first credit-in order that the seller, as beneficiary under the first credit, may be entitled to be paid within those limits.

Green Clause Credit:

This is an improvement over the red clause credit and permits not only pre shipment but also provides for storage of goods in the name of opening Bank.

Deferred payment credit:

The payment is made in installments for the purchase of heavy machinery and other capital goods.

The principal types will be:

a)SIGHTb)DA

BANKING FACILITIES:

Against sight and DA(usance) LCs, the following facilities can be made available to the customer:

i) Payment Against Documents ii) Finance against imported merchandize (FIM)iii) Finance against trust receipts (FTR)iv) Finance against foreign bills (FAFB)v) Foreign bills purchased (FBP)vi) Finance against packing credit (FAPC)vii) FOREIGN BILLS PURCHASED (FBP): a) Finances the exporter’s receivable period. b) The facility is for sight bill purchased. c) Exporters do not stand to benefit/lose from exchange rate fluctuations between local and foreign currency in which bill is denominated.

FINANCE AGAINST FOREIGN BILLS (FAFB):

a) Finances the exporter’s receivable period.b) Exporters do not sell bills to the Bank but

getfinance.

c) Exporters stand to benefit/lose from exchange rate fluctuations between local and foreign currency in which bill is denominated.

FOREIGN BILLS DISCOUNTED (FBD):

Similar with FBP except the period, this is usance in this case.The pre-shipment facility is risky from Bankers’ point of View.

There are two types of documents:

FINANCIAL DOCUMENTS:

a) Chequeb) Bill of exchangec) Promissory note

COMMERCIAL DOCUMENTS:

a) Transport documentsb) Documents of title

EXPORT FINANCE:

It works under Export Credit Guarantee Scheme through Pakistan Insurance Corporation. It covers the following areas:

a) Pre-shipmentb) Post-shipment

This scheme has following salient features:

PART-I:

It is granted against cases to case basis against confirmed L/C or firm export orders.

PART-II:

It takes place on the basis of their previous year performance with the help of export realization. Repayment should be made within 180 days of the bank borrowing unless and otherwise extended by the Bank.Part-II is allowed at 6/12 of previous year’s export performance from any Bank.SBP has allocated Rs.10B for refinancing. The mark-up rate will be 8% maximum & 5% will be of SBP.

PART-B: FOREIGN EXCHANGE

BALANCE OF PAYMENT:

It is a measurement of all transactions across the borders over a specified time period.

FOREIGN EXCHANGE TRANSACTIONS

i) Current Transactions:

a) Goods and services during one financial year i.e. visible items & it is called balance of trade also. It includes non visible items like services also & factor income i.e. dividend payment & interest payments across the borders.

b) Receipt and payments which do not create new capital items or cancel previous such items (visible or invisible).

ii) Capital Transactions:

a) Receipts and payments of capital nature which do not pertain to current year.It includes DFI, portfolio investment & other capital investments.

b) Long term capital claims.

iii) Short term financial Transaction:

a) Citizen of a country can transfer their foreign exchange recourses to another country due to political or economic reasons.

iv) Working Balances: The commercial Banks maintain foreign currency deposit with Banks in some other countries to avoid various disturbances.

FOREIGN CURRENCY ACCOUNTS:

Banks play a vital role in the international trade settlement. This settlement is made with the help of “NOSTRO” and “VOSTRO”

NOSTRO:Latin word means OUR:

a) A bank can have relationship with foreign correspondents.

b) In UK, can have sterling nostro a/c and so on.

c) They are in current account and do not earn interest.

VOSTRO: a) Latin word means “YOUR”. b) Convertible Pak.RS. accounts maintained by foreign Banks.

EXCHANGE CONTROL

OBJECTIVES OF EXCHANGE CONTROL

Exchange control is management of available resources in foreign currency. It refers to following points:

i) OVERVALUATION: More than the value determined by market forces.

ii) UNDER VALUATION: Less than the value determined by market forces.

iii)STABILITY OF EXCHANGE RATES: Conversion at official rate of exchange to stabilize value.

iv) PREVENTION OF CAPITAL FLIGHT: Gold and foreign currency cannot be exported without Permission.

v) PROTECTION TO DOMESTIC INDUSTRY: To encourage business

environment in the country.

vi) CHECKING NONESSENTIAL IMPORTS: To control import of luxury items.

vii) HELP TO PLANNING PROCESS: How to spend foreign currency on result oriented items.

viii) BALANCE OF PAYMENT PROBLEMS: With prudent policies BOP problem can be controlled.

ix) EARNING REVENUE: Foreign exchange is sold to Businessmen, traders etc. at a certain rate.

x) REPAYING FOREIGN DEBT: By earning and conserving Foreign exchange.

xi) RETALIATION: Monopoly power and better bargaining terms.

FORMS OF EXCHANGE CONTROL

a)EXCHANGE RATIONING:

i) To face foreign exchange difficulties, the citizens will be required to surrender foreign exchange earnings to SBP fully.

ii) Partial rationingiii) Different official rate for different

transactions

b)BLOCKED ACCOUNTS:

It refers to the following:

i) Bank deposits and other assets held by foreigners in controlling country.

ii) The interest and dividend can be used for reinvestment in the same country but will not be allowed to transfer or convert funds.

iii) Allowed to be utilized within the country, if essential.

iv) For export purposes. v) Sometimes for traveling purposes.

c)PAYMENT AGREEMENTS:

It refers to the following points: i) Can be made through

agreement between two countries, which want rationing.

ii) Can be made through agreement between debtor and creditor countries.

iii) Sometimes forced to be formed by creditor for encouragement of their exports.

CLEARING AGREEMENTS:

i) Direct bilateral exchange of goods.ii) May be between individuals and firms located

in different countries.ii) More comprehensive as designed to settle

debt in shortest possible time.

iv) The transactions are settled at an official rate of exchange.

v) Quantity and specification of goods is also pre-defined.

vi) Results are always not fruitful.

Precisely can be done by Government intervention i.e. purchasing of foreign currency by selling local currency as being done in Pakistan.

PREREQUISITES OF EXCHANGE CONTROL:

i) Full control of Government over import and export of gold and bullion.

ii) Buying and selling of Government securities should be controlled so that foreign transactions are restricted.

iii) Stock market operations must be monitored closely so that conversion of foreign assets into interest bearing foreign securities may be avoided.

iv) An effective custom agency is required to control import and export.

v) Trade control may be exercised to ensure early repatriation of export proceeds while free imports may be controlled for a favourable BOP.

The above mentioned methods are DIRECT METHODS in which we can call the OVERVALUATION as PEGGING UP and UNDERVALUATION as PEGGING DOWN.Besides, following are other direct methods:

a) EXCHANGE RESTRICTIONS:As per rules of SBP, forex is released and kept by the Government.

b) ALLOCATION AS PER PRIORITYc) MULTIPLE EXCHANGE RATE.

INDIRECT METHODS:

a)QUANTITATIVE RESTRICTIONS: There is import embargoes, import quota and other restrictions to control disequilibrium in BOP.

b)EXPORT BOUNTIES: To encourage exports, provided funds are available with SBP.

c)RAISING INTEREST RATE: It will attract the inflow of deposits in foreign exchange.

THE FINANCIAL MARKETS:

It is a set of facilities that makes it possible to exchange money for goods or goods for money on regular basis. Securities are the goods.

Major functions of financial markets:

a) Shifting of credit: Mobilize the funds for users.

b) Liquefying securities. Customer should be confident about sale/purchase.

c) Pricing: Mark-up rates.

d) Foreshadowing future: Forecasting of future for financial management.

e) Allocating resources: Considering growth, safety and yield.

CLASSIFICATION OF FINANCIAL MARKET:

a) Primary market.b) Secondary marketc) Money marketd) Capital market

FUNCTIONS OF FOREIGN EXCHANGE MARKET

Currently operating in London, Paris, Brussels, Zurich, New York, Hong Kong and Tokyo.

MOTIVES FOR INVESTING IN FOREIGN EXCHANGE MARKETS:

a) Economic Conditions: The investors can invest in a currency where economy is stable so return can be higher.

b) Exchange rate expectataions: The securities in a currency may be bought where appreciation is higher than the domestic currency.

c) International Diversification: Risk & fluctuations can be managed by investing in other currencies.

MOTIVES FOR PROVIDING CREDIT IN FOREIGN EXCHANGE MARKETS:

a) Higher interest rates: Due to shortage of forex reserves the country may offer better rates on foreign currency deposits.

b) Exchange rate expectations: One can make investment in a country currency which is

expected to appreciate against domestic currency.

c) International Diversification: The chances of risk & fluctuations can be avoided. The economic conditions of the concerned country are very important.

MOTIVES FOR BORROWING IN FOREIGN EXCHANGE MARKETS:

a) Low interest rates: Many countries have bulk supply of foreign reserves so rate of interest are relatively low.

b) Exchange rate expectations: The risk & return can be managed.

FUNCTIONS:

i) To transfer purchasing power from one country to another.

ii) It takes place by debiting and crediting accounts of each Bank.

iii) No physical delivery of currency takes place usually.

iv) It provides credit also to the business community.

v) HEDGING: Hedging means avoidance of foreign exchange risk or covering of an position without buying or tying up funds. This process is carried out in forward Market. This promotes foreign trade.

vi) SPECULATION:

a)It is opposite of hedging.b)The speculator takes the risk Of any transaction.

c)Speculation can take place in forward or spot market. d)If the speculator buys a

currency in expectation of reselling it on profit it will be called” LONG POSITION” it will have STABILIZING EFFECT otherwise it will be called “SHORT POSITION” or

DESTABILIZING EFFECT.

VII)SWAP TRANSACTIONS:It refers to following:i) Simultaneous buying and

selling of foreign currency for different delivery dates in opposite direction.

ii) May cover spot against forward.

iii) May take place between commercial parties or Bank etc.

iv) May be for a limited period of time.

v) May be lesser risky.vi) Very popular with

speculators, as well.

FOREIGN EXCHANGE POSITION MANAGEMENT:

OVER BOUGHT/SOLD AND SQUARE POSITION:

i) In order to facilitate foreign exchange transaction the Banks buy/sell currency in spot or forward.

ii) The difference between buy and sell shows the commitment position of the Bank.

iii) If purchase side is more than sale side it is called overbought and the opposite one is called oversold.

iv) If both positions are equal it is called SQUARE.

v) If both positions are nearly equal, it is called near square.

vi) Sometimes delay in transmitting takes place, which may disturb position.

LEADS AND LAGS:

If a foreign currency weakens or it is devalued, the importers stand to gain on their spot purchases from the Bank while the

exporter will lose. The importer and exporter will move accordingly and this pressure will weaken the currency. If a currency is strong and is expected to be revalued exporter will delay shipment and the importer will expedite payment. This will make the currency actually strong. THIS PHENOMENON OF DELAYING AND EXPEDITING SETTLEMENT BY CUSTOMERS IN ANTICIPATION OF CURRENCY’S DEVALUATION AND REVALUATION IS CALLED “LEADS AND LAGS”.

SYSTEM OF EXCHANGE RATE

TWO major systems:

FIXED RATE: Remains fixed in terms of foreign unit of currency with the home currency. This system has a demerit that when there is adverse BOP, substantial foreign exchange reserves will be needed to maintain the rate at fixed level.

FLOATING(FREE)RATE: It moves in a following direction:i) Demand and supply of the

currency.ii) Places a currency at the

mercy of world’s judgment.iii) May give rise to speculation.

TYPES OF EXCHANGE RATE:

DIRECT QUOTATION:

Rate of exchange is expressed in units of national currency in most currencies:

Rs.60=US$1

INDIRECT QUOTATION:

It values the currencies in terms of the other currencies than in national currencies.

US$ 0.5=Rs.1

CROSS RATES:

i) The rate of exchange between any two currencies is kept the same in different money centers by “ARBITRAGE”.

ii) Sale and purchase is made in and from money centers where the currency is available at lower or higher rates respectively.

iii) When two currencies and two centers are involved it is called “TWO POINT ARBITRAGE’.

iv) When three currencies and three centers are involved it is called “THREE POINT ARBITRAGE’ OR TRIANGULAR.

v) When national currency is not used in the transaction and exchange rate is calculated on the basis of a third currency, it is called CROSS RATE.

vi) It is known as calculated parity between two money centers through a third e.g.

The chain rule is followed….

We can buy EURO in London against GBP then can use EURO to

buy $ in France then we can sell $ in UK.

SPOT RATE:

The spot rate of the currency is the value quoted for the nearest settlement date for the purchase and sale of the currency against another one. The transaction may be settled in two to three working days.

FORWARD RATE:

It covers following concepts:

i) Rate at which the currency can be bought or sold for

the delivery on a future date.ii) Agreement to buy or sell at a

specified future date at rate agreed today.

iii) No payment will be made except security deposit at the time of signing of contract.

iv) No consideration for spot rate at the time of settlement.

v) May be for one to six months or longer.

vi) Longer period contracts are not common due to uncertainties involved.

vii) If forward rate is less than spot, it is called “FORWARD DISCOUNT” otherwise it will be called “FORWARD PREMIUM”.

viii) With its help the importer/exporter can avoid

fluctuations.

ix) The Bank can take help from speculators.

x) There can be BULL or BEAR run.

OTHER SYSTEM OF EXCHANGE RATE:

i) Dirty float:

a) To avoid sharp changes in rates under any system.

b) It is a compromise between fixed & floating rate system.

c) Can be done with interest rate policy.

d) The objective is to stabilize rate of exchange.

ii) Wider band:

a) The rate can be moved in 2.25% range on either side of official rate of exchange.b) It was allowed by IMF in 1971 for the first time.c) Total variation comes to 4.5%.d) It helps in avoiding currency uncertainty.

iii) Crawling Peg:

a) The value of currency is revised automatically.b) There is a support point when it reaches then the central bank intervenes.

c) According to previous agreed weeks or months the support point is changed based on currency average.d) If new support point is near to low point then it will be set downward otherwise upward.e) It gives certainty to rate of exchange.

CURRENCY DERIVATIVES

A forward contract is an agreement between a company & a commercial bank to exchange a specified amount of currency at specified exchange rate (forward rate) on a specified date in the future. The normal period is 30, 60 & multiple. Initial deposit may be needed.

BID/ASK RATE:The ask rate is the selling rate whereas bid rate is the purchase rate. The spread between bid & ask rate is wider in forward contracts.

How to calculate BID & ASK rate in %:

Ask rate-Bid rate/Ask rate

A future contract refers to a specific settlement date for a particular currency’s volume. It is popular with speculators.

DIFFERENCE BETWEEN FORWARD & FUTURE CONTRACTS:

FORWARD FUTURESize of contract

Tailored to individual needs

Standardized

Delivery date

Tailored to individual needs

Standardized

Participants

Bankers, brokers, MNC, speculator

Bankers, brokers, MNC, qualified

s not encouraged

speculators

Security deposit

Not essential

Needed

Transaction cost

Set by spread

Negotiable

CURRENCY CALL OPTIONS:

It grants right to buy specific currency at a designated price within a specific period of time. The currency options are desirable when one wishes to lock in a maximum price to be paid for the currency in the future. The price at which the person is allowed to buy that currency is known as exercise/strike price.Call options are desirable when….

a) One wishes to lock maximum price to be paid for a currency in the future.

b) If the spot rate of currency rises above strike price owners of call options can exercise

option by purchasing it at strike price.

c) Future contract is obligatory but currency option is not.

d) Owners of call option loses premium paid by them initially but that is maximum.

A currency call option is said to be in the money when present exchange rate exceeds strike price, at the money when both are equal & out of money present exchange rate is less that strike price. Higher premium is there in the money option.

FACTORS AFFECTING CURRENCY CALL OPTION PREMIUM:

a) Higher the spot rate relative to strike price, higher the option price will be. This will be due to higher probability of buying currency at lower rate than what you could sell it for.

b) The relationship of expiration date & premium is there.

c) If time is long then chances of raising the spot rate will be higher as compared with strike price.

d) The volatility of currency can increase spot price more rapidly.

CURRENCY PUT OPTIONS:

It grants right to sell specific currency at a designated price (strike price) within a specific period of time. It is also not obligatory like call option.The owners of put option loses premium paid by them initially but that is maximum.

A currency put option is said to be in the money when present exchange rate is less than strike price, at the money when both are equal & out of money when present exchange rate exceeds the strike price. For a given currency & expiration date, an in the money put option will require a higher premium than options that

are there in at the money or out of money.

EXAMPLE FOR CALL OPTION:

Call option premium on C$=$.01/unitStrike price=$0.70One option contract represents C$ 50,000

Amount in C$Narration Per unit

pricePer contract

Selling price of C$

0.74 37,000

Purchase price of C$

-0.70 -35,000

Premium paid for option

-.01 -500

Net Profit 0.03 1,500

If the seller does not purchase the C$ till option was about to be exercised the net profit of seller will be as follows:

Amount in C$

Narration Per unit Per

price contractSelling price of C$

0.70 35,000


-0.74 -37,000

Premium received for option

.01 +500

Net Profit -0.03 -1,500

EXAMPLE FOR PUT OPTION:

Put option premium on GBP=0.04/unitStrike price=GBP1.40One option contract represents GBP 31,250

Amount in GBPNarration Per unit

pricePer contract

Selling price of GBP

1.40 43,750


1.30 40,625

Premium paid for option

-.04 -1,250

Net Profit 0.06 1,875

If the seller does not purchase the GBP till option was about to be exercised the net profit of seller will be as follows:

Amount in GBPNarration Per unit

pricePer contract

Selling price of C$

1.30 40,625


-1.40 -43,750

Premium received for option

.04 +1,250

Net Profit -0.06 -1,875

EURO CURRENCY MARKETS: They exist in all countries to transfer surplus units (savers) to deficit units (borrowers).So out side USA demand of $ will be called EURO DOLLARS & so on for long term it will be EURO BONDS.

DIRECT FOREIGN INVESTMENT:

Investment in real assets like land, buildings etc in the foreign countries are called DFI.

MOTIVES:

Normally the objectives are to maximize share holders’ wealth & to improve profitability but they can be interested in boosting revenue, reducing costs or both.

REVENUE RELATED MOTIVES:

a) Attract new source of demand: This can be done to avoid domestic competition & to increase growth.

b) Enter profitable markets: When the other market is profitable MNC can take its benefit.

c) Exploit monopolistic advantages: More chances for technically advanced MNCs & products in other markets.

d) React to trade restrictions: May enter in other markets

where trade restrictions are no there.

COST REALTED BENEFITS:

a) Fully benefit from economies of scale: Lower average cost with more production.

b) Use foreign factors of production: Set up where factors are available at cheap rates.

c) Use foreign raw material: Let us set up factory where raw material is available. This is to avoid many hindrances.

d) Use foreign technology: Advanced technology can be used & can be imported to home country of MNC.

e) React to exchange movements: When the currency is undervalued then MNC can go for FDI to take benefit of initial low outlay.

OFFSHORE BANKING:

i) Bank decides to deal with foreign nationals.

ii) In the non-tariff area.iii) May be free from

legislations.