Forex management Study Note Calicut university

1 Prepared by Amal James
UNIVERSITY OF CALICUT
MASTER OF BUSINESS ADMINISTRATION
FOREX MANAGEMENT
Module I
Foreign Exchange
Foreign Exchange can be defined as exchange of money or credit in one country for money or
credit of another country.
Nature of foreign exchange
1) Affected by demand and supply.
2) Affected by rate of interest.
3) Affected by balance of payment surplus and deficit.
4) Affected inflation rate.
5) Spot and forward rates are different.
6) Affected by the economic stability of the country.
7) Affected by the fiscal policy of the government.
8) Affected by the political condition of the country.
Need for foreign currencies
1) International Trade 2) Foreign Investment
3) Lending to and borrowing from foreigners
EXCHANGE MARKET
Foreign exchange market can be defined as the market where foreign currencies are bought
and sold. Exporters sell foreign currencies for domestic currencies and importers buy foreign
currencies with domestic currencies.
Features of the foreign exchange market
1. Global market
2. Over the counter market: The market does not denote a particular place where currencies
are transacted.
3. Around the clock market
4. Currency is only traded
5. Dynamic
6. No geographical boundaries
7. Variety of participants (individual customer, agency, organisations, central monetary
authority of the country)
8. Fast Transaction
9. System: (It is a system of private banks, financial banks, foreign exchange dealers and
central bank through which individual, business and government trade foreign exchange)
10. Wholesale and retail segment: The wholesale segment of the market, where the dealing
take place among the banks. The retail segment refers to the dealings take place between
banks and their customers.
Functions of Foreign Exchange Market
1. Transfer Function:
The transfer of funds from one country to another for the settlement of payments.
Conversion of one currency to another.
2. Credit Function: It provides credit for foreign trade.

3. Hedging Function
Hedging means the avoidance of a foreign exchange risk. In a free exchange market
when exchange rate (i.e., the price of one currency in terms of another currency)
change, there may be a gain or loss. Through forward contracts in exchange this risk
is been reduced. A forward contract is normally for three months which help to buy
or sell foreign exchange at some fixed date in the future.
Foreign exchange controls
Foreign exchange controls are various forms of controls imposed by a government on the
purchase/sale of foreign currencies by residents or on the purchase / sale of local currency by
non-residents.
Evolution of Exchange Control & Statutory basis of Foreign Exchange
History
 Foreign Exchange control was first introduced in September, 1939 under
Defence of India Rules.
 The Foreign Exchange Regulation Act (FERA), 1973.
 FERA was very strict and even has a provision for imprisonment.
 FERA was not suitable in the new and liberal economy, thus it was replaced by
Foreign Exchange Management Act (FEMA) 1999, which came into effect from
1st June 2000.
 RBI plays a key role in the management of foreign exchange
FOREIGN EXCHANGE REGULATORY ACT (FERA 1973)
 FERA emphasized strict exchange control over everything that was specified,
relating to foreign exchange.
 Law violators were treated as criminal offenders.
 Aimed at minimizing dealings in foreign exchange and foreign securities.
 To regulate certain payments.
 To regulate dealings in foreign exchange and securities.
 To regulate transactions, indirectly affecting foreign exchange.
 To regulate the import and export of currency.
 To conserve precious foreign exchange.
 The proper utilization of foreign exchange so as to promote the economic
development of the country
FOREIGN EXCHANGE MANAGEMENT ACT (FEMA 1999)
 FEMA has been introduced as a replacement of FERA.
 FEMA facilitating external trade & payments.
 Deal with the law relating to foreign exchange.
 Promoting the orderly development & maintenance of foreign exchange market
in India.
 49 Section in the Act.
 The main objective of FEMA is to utilize foreign exchange resource of the country
effectively.

 It facilitates external trade and payment
 For promoting orderly development & maintenance of foreign exchange in India.
 It is applicable to all parts of India.
 It maintains a good relation with other countries.
The FEMA, is applicable:
 To the whole of India.
 Any Branch, office & agency, which is situated outside India, but is owned or
controlled by a person resident in India.
Transactions Regulated by Exchange Control
 Purchase and sale and other dealings in foreign exchange.
 Procedure for Payments to non-residents or to their accounts in India
 Transfer of securities between residents and non-residents
 Export and import of currency, cheques, drafts, travellers cheques and other
financial instruments, securities, etc.
 Activities in Indian branches of foreign firms and companies and foreign nationals
 Foreign direct investment and portfolio investment in India including investment
by non-resident Indian nationals/persons of Indian origin and corporate bodies
predominantly owned by non-residents.
 Appointment of non-residents and foreign nationals and foreign companies as
agents in India
EXPORT
Export can be defined as the process of transfer of goods and services from one
country to another to sell them outside country boundaries.
Types of export.
Direct export - A manufacturer or exporter sells directly to an importer or buyer
located in a foreign market
Indirect export
It involves the use of independent middlemen (brokers, bank) to market the firm’s
products overseas.
Advantages of export
1. Increasing your market
2. Increasing sale & profits
3. Reducing risk and balancing growth
4. Sell excess production capacity.
5. Gain new knowledge and experience
IMPORT
The process of bringing in the goods and services into the port of a country.
Advantages of import
1. Reduce dependence on existing markets
2. Exploit international trade technology
3. Extend sales potential of existing products
4. Maintain cost competitiveness in your

India’s Forex Scenario
 BOP crisis of 1990
Balance of payments
The balance of payments of a country is a systematic record of all economic
transactions between the residents of a country and the rest of the world. It
presents a classified record of all receipts on account of goods exported, services
rendered and capital received by residents and payments made by them on
account of goods imported and services received and capital transferred to non-
residents or foreigners.
The main causes behind the Balance of Payments crisis of 1990-91 were as follows:
 Break-up of the Soviet Bloc: Rupee trade (payment for trade was made in rupees)
with the Soviet Bloc was an important element of India’s total trade up to the 1980s.
However, and the break-up of the Eastern European countries led to termination of
several rupee payment agreements in 1990-91. As a consequence, the flow of new
rupee trade credits declined abruptly in 1990-91. Further, there was also a decline in
exports to Eastern Europe
 Iraq-Kuwait War: The Gulf crisis began with the invasion of Kuwait by Iraq at the
beginning of August 1990. Crude oil prices rose rapidly. Iraq and Kuwait were the
major sources of India’s oil imports and the war made it necessary to buy oil from the
spot market. Short term purchases from the spot market had to be followed up by
new long term contracts at higher prices. As a result, the oil import bill increased.
 Slow Growth of Important Trading Partners: Slow growth in economies of important
trading partners. Export markets were weak in the period leading up to India’s crisis,
as the world growth declined steadily.
 Political Uncertainty and Instability: Within a span of one and half years there were
three governments and three Prime Ministers. This led to delay in tackling the ongoing
balance of payment crisis, and also led to a loss of investor confidence.
 Loss of Investors’ Confidence: The widening current account deficits and reserve
losses contributed to low investor confidence, which was further weakened by
political uncertainty.
 Fiscal Indiscipline: These were the conventional budgetary deficit, the revenue deficit,
the monetized deficit and gross fiscal deficit. Moreover, the concept of fiscal deficit is
a more complete measure of macroeconomic imbalance as it reflects the
indebtedness of the Government.
 in Non-oil Imports: The trends in imports and exports show that imports rose
much faster than exports during the eighties. Imports increased by 2.3 percent
of GDP, while exports increased by only 0.3 percent of GDP.
Exchange rate
Exchange rate is the rate at which one currency can be exchanged for another.
 Spot Exchange Rate: When foreign exchange is bought and sold for
immediate delivery, it is called spot exchange. It refers to a day or two in
which two currencies are involved. The basic principle of spot exchange rate
is with the help of demand and supply forces. The exchange rate of dollar is
determined by intersection of demand for and supply of dollars in foreign
exchange.

 Forward Exchange Rate: Here foreign exchange is bought or sold for future
delivery i.e., for the period of 30, 60 or 90 days: There are transactions for
180 and 360 days also. Thus, forward market deals in contract for future
delivery. The price for such transactions is fixed at the time of contract; it is
called a forward rate.
Theories of exchange rate:
1. Mint Par Theory
The mint par is an expression of the ratio of weights of gold's used for the coinage
of the currencies. This theory is associated with the working of the international
gold standard. Under this system, the currency in use was made of gold or was
convertible into gold at a fixed rate. The value of the currency unit was defined
in terms of certain weight of gold, that is, so many grains of gold to the rupee,
the dollar, the pound, etc. The central bank of the country was always ready to
buy and sell gold at the specified price. The rate at which the standard money of
the country was convertible into gold was called the mint price of gold. Example:
If the gold content of Indian rupee is 5 grains of standard purity and the US$ is 40
grains of standard purity, the rate of exchange will be determined as Rupee 1 = 5
grains $1 = 40 grains
2. Purchasing Power Parity Theory
This theory holds that the rate of exchange between two currencies depends
upon their relative purchasing power in the countries concern. Theory
propounded by Dr. Gustav Cassel (1918). There are two versions of Purchasing
Power Parity theory: a) Absolute Version of the PPP theory. b) Relative Version
of the PPP theory.
a) Absolute Version of the PPP theory: The PPP theory suggests that at any point
of time, the rate of exchange between two currencies is determined by their
purchasing power. If e is the exchange rate and PA and PB are the purchasing
power of the currencies in the two countries, A and B, the equation can be
written as e = PA/PB Example: if one bag of sugar cost rupee 500 in India and $
50 in USA, the rate of exchange between these two currencies will be- $50 = Rs
500 $1 = Rs 10
b) Relative Version of the PPP theory: In view of the above limitation, another
version of this theory has evolved, which is known as the relative version of the
PPP theory. The relative version of PPP theory states that the exchange rate
between the currencies of the two countries should be a constant multiple of the
general price indices prevailing in two countries. In other words, percentage
change in the exchange rates should equal the percentage change in the ratio of
price indices in the two countries. Example: The price index in India and the USA
for a particular year was 100 and at that time rate of exchange was US$ 1 = Rs 8.
Subsequently the price index in India increased to 150 points which means
purchasing power of the Rs as reduced to that extent. In this case the new rate
of exchange between Rs and $ will be— $ 1 = Rs 8×150/100 = 12 Rs.
3. Balance of Payment Theory:
This theory states that the rate of exchange is determined by the demand and
supply for the currency in foreign exchange market.

There will be two conditions: 1. When BOP is at deficits- It indicates that the
supply of foreign exchange is less than demands. 2. When BOP is at surplus- It
indicates that the supply of foreign exchange is more than demands.
4. Portfolio Theory
This theory argues that exchange rate is determined by the portfolio decision of
all investors. Exchange rate between freely traded currencies are influenced
more by capital flows than by trade flows. The theory emphasized that risk
factors and current account imbalance may have an important rate to play in
exchange rate development. It says that interest rate reduction affects
investments, output and prices and that will ultimate affect rate of exchange or
exchange rate.
Convertibility
Convertibility of rupee means that those who have foreign exchange can get them
converted into rupees and vice-versa at the market determined rate of exchange.
1. Soft Convertibility
Soft convertibility entails the ability to freely exchange currencies at market
determined exchange rate.
2. Hard Convertibility
The hard convertibility entails the right to freely exchange currencies at a given
exchange rate
3. Capital Account Convertibility
CAC refers to the freedom to convert local financial assets into foreign financial
assets and vice-versa, at market determined rates of exchange
4. Current Account Convertibility
Current account convertibility refers to freedom of payments and transfers
for current international transactions. In other words, if Indians are allowed to
buy only foreign goods and services but restrictions remain on the purchase of
assets abroad, it is only current account convertibility.
International Monetary Developments
International monetary system
International monetary systems are system with sets of internationally agreed rules,
regulations, policy, procedure, conventions and supporting institutions, that facilitate
international trade, cross border investment and generally their allocation of capital
between nation states. The international monetary system refers to the institutional
arrangements that countries adopt to govern exchange rates.
 Classical Gold Standard:
The most important fixed-exchange-rate system was the gold standard, which was used
off and on from 1717 until 1933 (Samuelson and Nordhaus, 2005, p.610). In this system,
each country defined the value of its currency in terms of a fixed amount of gold, thereby
establishing fixed exchange rates among the countries on the gold standard. The United
States adopted the gold standard in 1879 and defined the US$ as 23.22 fine grains of
gold. With 480 fine grains per troy ounce, it took $20.67 to equal one ounce of gold
(Levich, 2001, p. 26). Similarly, the British pound was defined as £1 = 113 grains of fine
gold. So it took £4.2474 to equal one ounce of gold. The exchange rate was determined

at $4.86656/£ based on the gold contents of the currencies. Exchange rates were fixed
for all countries on the gold standard. The exchange rates (also called “part values” or
“parities”) for different currencies were determined by the gold content of their
monetary units.
Rules of this system:
1. Each country defined the value of its currency in terms of gold.
2. Exchange rate between any two currencies was calculated as X currency per ounce of
gold/ Y currency per ounce of gold.
3. These exchange rates were set by arbitrage depending on the transportation costs of
gold.
4. Central banks are restricted in not being able to issue more currency than gold
reserves.
 Bretton Woods System
The Bretton Woods system was monetary management system that established a new
monetary order. The name comes from the location of the meeting where the
agreements were drawn up, Bretton Woods, New Hamshire. This meeting took place in
July 1944. The Bretton Woods agreement was responsible for the setup of the
International Monetary Fund. The Bretton Woods System was an attempt to avoid
worldwide economic disasters such as the ones experienced in the 1930's
Purpose of Bretton Woods System
1. The purpose of the Bretton Woods meeting was to set up new system of rules,
regulations, and procedures for the major economies of the world.
2. The main goal of the agreement was economic stability for the major economic
powers of the world.
3. The system was designed to address systemic imbalances without upsetting the
system as a whole.
4. British and American policy makers began to plan the post war international
monetary system in the early 1940s.
5. The objective was to create an order that combined the benefits of an integrated and
relatively liberal international system with the freedom for governments to pursue
domestic policies aimed at promoting full employment and social wellbeing.
 Fixed exchange rate system
a. Fixed exchange rates refer to the system under the gold standard
b. Rate of exchange tends to stabilize around the mint par value.
c. Any large variation of the rate of exchange from the mint par value would
entail flow of gold into or from the country.
d. In the present day situation where gold standard no longer exists, fixed
rates of exchange refer to maintenance of external value of the currency
at a predetermined level.
There may be two situations:
a) When demand of foreign currency is greater than supply (Demand > Supply):

When demand of foreign currency is more than supply, then central
bank maintains the exchange rate by increasing the foreign currency
in market. In this way supply of foreign currency will increases and
there will be equality between demand & supply. In case of demand
more than supply price of foreign currency in terms of domestic
currency would be costly.
b) When Supply of foreign currency is greater than Demand (Supply > Demand):
When Supply of foreign currency is more than demand, then central bank maintains the
exchange rate by purchase of foreign currency or creates the demand of foreign currency
in market through. In this way supply of foreign currency will decrease and there will be
equality between demand & Supply. In case of supply more than demand price of foreign
currency in terms of domestic currency would be cheaper.
 Flexible Exchange Rate System
 It is also called free/floating and unregulated exchange rate system.
 The exchange rate is determined by the market forces. (equality of market
demand for and supply of currencies generated on trade, investment hedging,
arbitrageurs and speculative accounts.)
 The exchange rate are free to fluctuate according to the changes in demand and
supply forces with no restrictions on buying and selling of foreign currencies in
the foreign exchange market.
 Under the system if the supply of forex is greater than the demand, the exchange
rate is lower rate vice-versa.
 In a floating-rate system, it is the market forces that determine the exchange rate
between two currencies.
 In floating exchange Rate system the central bank does not control demand or
supply of foreign currency. Thus the central bank has to show or provide order
line in the movement of exchange rate.
There are two situations:
a) Crawling Peg: In this situation central bank fix the upper limit &
lower limit of exchange rate. The exchange rate will lie between
these two limits.
 Upper Limit  Lower Limit
This can be explained with diagram:
b) Over shooting peg: Under this condition exchange rate can over
the upper limit and below the lower
EURO MARKET
Euro Market is the financial market of EURO currency. The Euro market is a
large market comprising many member nations of EU and facilitates the free
movement of goods and services, in other words efficient trade mechanisms such as
low tariffs, quotas etc. are put in place and have a centralized monetary policy with
most of them using a common currency - Euro. The European commission describes
the single market as "one territory without any internal borders or other regulatory
obstacles to the free movement of goods and services."

Features of Euro-currency market
1. International Market: The Euro-currency market is an international market which
accepts deposits and gives credit in currencies from throughout the world.
2. Independent Market: It is a free and independent market which does not function
under the control of any monetary authority.
3. Wholesale Market: It is a wholesale market in which different currencies are
bought and sold usually above $ 1 million.
4. Competitive Market: It is a highly competitive market in which the supply and
demand for currencies depends on interest rate changes of Euro-banks.
5. Short-Term Market: It is a short-term money market in which deposits in different
currencies are usually accepted for a period ranging from a few days to a year and
interest is paid on them.
6. Inter-Bank Market: It is an inter-bank market in which the Euro-banks borrow and
lend dollars and other Euro-currencies from each other.

MODULE 2
Finance Function
Finance function involves the acquiring and utilization of funds necessary for efficient
operations.
Classification
 Long-Term Finance– This includes finance of investment 3 years or more. Sources of long-
term finance include owner capital, share capital, long-term loans, debentures, internal
funds and so on.
 Medium Term Finance– This is financing done between 1 to 3 years, this can be sourced
from bank loans and financial institutions.
 Short Term Finance – This is finance needed below one year. Funds may be acquired from
bank overdrafts, commercial paper, advances from customers, trade credit etc.
Objectives of Finance Functions
 Investment Decisions– This is where the finance manager decides where to put the
company funds. Investment decisions relate to management of working capital, capital
budgeting decisions, management of mergers, buying or leasing of assets. Investment
decisions should create revenue, profits and save costs.
 Financing Decisions– Here a company decides where to raise funds from. They are two
main sources to consider from mainly equity and borrowed. From the two a decision on
the appropriate mix of short and long-term financing should be made. The sources of
financing best at a given time should also be agreed upon.
 Dividend Decisions– These are decisions as to how much, how frequent and in what form
to return cash to owners. A balance between profits retained and the amount paid out as
dividend should be decided here.
 Liquidity Decisions– Liquidity means that a firm has enough money to pay its bills when
they are due and have sufficient cash reserves to meet unforeseen emergencies. This
decision involves management of the current assets so you don’t become insolvent or fail
to make payments.
Non-resident Accounts
Non-Resident bank accounts are those, which are maintained by Indian nationals and
Persons of Indian origin resident abroad, foreign nationals and foreign companies in
India
Types
1. NRE (Non Residents External) Savings Account /Fixed Deposit Account
 NRE Accounts are maintained in INR. This means that when you deposit the money in
the NRE Account, the foreign currency is converted to Indian rupees at the prevailing
foreign exchange rates.
 It is mainly used to house your savings from income that you have earned abroad.
 The principal amount, as well as the interest, are fully reparable, i.e., transferable.
 The interest income earned on the amount in an NRE account is non-taxable in India.

 You can have other NRIs or Resident Indians as joint account holders on NRO Accounts.
2. NRO (Non residents ordinary)Savings Account/Fixed Deposit Account
a) NRO Accounts are maintained in INR. This means that when you deposit the money in
the NRO Account, the foreign currency is converted to Indian rupees at the prevailing
foreign exchange rates.
b) It is used to house funds from your income that you have earned from India or abroad.
c) Income like rent, dividend, pension, etc. can be sent abroad through the NRO Account.
d) Interest income earned on the amount in an NRO Account is liable for TDS or Tax
Deductible at Source.
e) You can have other NRIs or resident Indians as joint account holders on NRO Accounts.
3. Foreign Currency Non -Resident (FCNR) Fixed Deposit Account
 Foreign Currency Non -Resident Accounts have to be opened and maintained in foreign
currency.
 Your principal amount and the interest in an FCNR Account are fully repatriable, i.e.,
transferable
 Interest income earned on your money in an FCNR account is non-taxable in India.
Methods of International Trade Settlement
1. Cash in Advance
 The Cash in Advance or Advance Payment method allows the buyer to pay cash
in advance to the seller.
 Paying in advance gives the greatest protection for the seller and puts the risk on
the buyer
 Payment does not guarantee the shipment or delivery of the goods from the
seller.
 Therefore, the buyer will rarely pay cash up front before receiving an assurance
that the goods will be shipped and that the quality and quantity of the goods
ordered will be delivered.
2. Open Account
 Open account means that payment is left open to an agreed-upon future
date. It is one of the most common methods of payment in international
trade and many large companies will only buy on open account.
 Payment is usually made by wire transfer or check.
 This can be a very risky method for the seller unless he has a long and
favourable relationship with the buyer or the buyer has excellent credit.
3. On Consignment
 With consignment sales, the seller does not receive payment until the
importer sells or resells the goods.
 The product stays with the importer until all the terms of the sale have been
satisfied.
 In the consignment method, the importer is called the consignee and he/she
is responsible for paying for the goods when they are sold.
 Consignment sales are very risky and there is no control available to the
exporter.

4. Draft or Documentary Collection
 The Draft or Documentary collection method is employed when either the cash
in advance method is not acceptable to the buyer, or the open account method
is not acceptable to the seller.
 With the Draft or Documentary Collection Method, the seller or exporter ships
the goods and draws a draft or bill of exchange on the buyer or importer through
an intermediary bank.
 The draft is an unconditional order to make a payment in accordance with certain
terms.
5. Letter of Credit
A Letter of Credit is a document issued by a bank at the buyer’s request in favor of the
seller; it guarantees that the buyer will pay the agreed amount of money to the seller
within a specified period of time, provided that the seller conforms to the product
specifications and document requirements of the buyer
Parties involved
 Applicant: The party that organizes for the Letter of Credit to be issued, usually
the buyer (importer) in a commercial transaction or the borrower in a financial
transaction.
 Beneficiary: The party named in the Letter of Credit in whose favour the Letter
of Credit is issued, it is generally the seller (exporter) in a commercial transaction
or the creditor in a financial transaction.
 Issuing Bank: The Applicant’s bank that issues its undertaking to the Beneficiary
in the form of a Letter of Credit.
 Advising Bank: The bank, usually in the Beneficiary’s country, which informs the
Beneficiary that another bank has issued a Letter of Credit in their favour.
TYPES OF LETTER OF CREDIT
1. Irrevocable LC. This LC cannot be cancelled or modified without consent of the
Seller. This LC reflects absolute liability of the Bank (issuer) to the other party.
2. Revocable LC. This LC type can be cancelled or modified by the Bank (issuer) at
the customer's instructions without prior agreement of the beneficiary (Seller).
The Bank will not have any liabilities to the beneficiary after revocation of the LC.
3. Confirmed letters of credit – When a buyer arranges a letter of credit they usually
do so with their own bank, known as the issuing bank. The seller will usually want
a bank in their country to check that the letter of credit is valid. – For extra
security, the seller may require the letter of credit to be confirmed by the bank
that checks it. By confirming the letter of credit, the second bank agrees to
guarantee payment even if the issuing bank fails to make it. So a confirmed letter
of credit provides more security than an unconfirmed one.
4. Unconfirmed letters of credit - In case of unconfirmed LC, the advising bank
forwards an unconfirmed letter of credit directly to the exporter without adding
its own undertaking to make payment or accept responsibility for payment at a
future date, but confirming its authenticity
5. Stand-by LC. This LC is closer to the bank guarantee and gives more flexible
collaboration opportunity to Seller and Buyer. The Bank will honour the LC when
the Buyer fails to fulfil payment liabilities to Seller.

6. Transferable letters of credit – A transferable letter of credit can be passed from
one beneficiary (person receiving payment) to others. They’re commonly used
when intermediaries are involved in a transaction.
7. Revolving LC – The revolving credit is used for regular shipments of the same
commodity to the same importer. – It can revolve in relation to time or value. –
If the credit is utilised it is re-instated for further regular shipments until the
credit is fully drawn. – If the credit revolves in relation to value once utilised and
paid the value can be reinstated for further drawings. – Revolving letters of credit
are useful to avoid the need for repetitious arrangements for opening or
amending letters of credit.
8. Payment at Sight LC. According to this LC, payment is made to the seller
immediately (maximum within 7 days) after the required documents have been
submitted.
9. Deferred Payment LC. According to this LC the payment to the seller is not made
when the documents are submitted, but instead at a later period defined in the
letter of credit. In most cases the payment in favour of Seller under this LC is
made upon receipt of goods by the Buyer.
APPLICATIION WITH ILLUSTRACTION

Module 3
Documents involved in International trade
Government Documents / Statutory Documents
1. Certificate of Origin (CO) – This certifies the place of manufacture of the exported
goods to meet the requirements of the importing authorities.
2. Certificate of Origin Generalized Systems of Preferences (GSP) Form A (or as Form
A) Form A is issued only when the goods have met both the origin rules of the
preference receiving country as well as the origin criteria of the respective donor
country's GSP.
3. Import / Export Declaration – A statement made to the Director of Customs at port
of entry / exit, declaring full particulars of the shipment, eg. the nature and the
destination / exporting country of the ship's cargo. – Its primary use is for compiling
trade statistics. – Prepared by: exporter / importer
4. Import / Export License – A document issued by a relevant government department
authorizing the imports and exports of certain controlled goods. – Prepared by: Trade
and Industry Department, Customs & Excise Department, etc
5. International Import Certificate (IIC) – A statement issued by the government of
country of destination, certifying the imported strategic goods will be disposed of in
the designated country. In Hong Kong, it is issued only to meet an exporting country's
requirement. – Prepared by: Trade and Industry Department
6. Delivery Verification Certificate (DVC) – A statement issued by the government of
country of destination, certifying a specific strategic commodity has been arrived in
the designated country. In Hong Kong, it is issued only to meet an exporting country's
requirement. – Prepared by: Trade and Industry Department
7. Landing Certificate – A document issued by the government of country of
destination, certifying a specific commodity has been arrived in the designated
country.
Financial Documents
1. Documentary Credit D/C – A bank instrument (issuing or opening bank), at the
request of the buyer, evidencing the bank's undertaking to the seller to pay a certain
sum of money provided that specific requirements set out in the D/C are satisfied. –
Prepared by: the issuing bank upon an application made by the importer
2. Standby Credit - A credit set up between the exporter and the importer guaranteeing
the exporter will pay the importer a certain amount of money if the contract is not
fulfilled. – It is also known as performance bond. – This is usually found in large
transactions, such as crude oil, fertilizers, fishmeal, sugar, urea, etc. – Prepared by:
exporter / issuing bank
3. Collection Instruction – An instruction given by an exporter to its banker, which
empowers the bank to collect the payment subject to the contract terms on behalf
of the exporter. – Prepared by: exporter
4. Bill of Exchange (B/E) or Draft – An unconditional written order, in which the
importer addressed to and required by the exporter to pay on demand or at a future

date a certain amount of money to the order of a person or bearer. – Prepared by:
exporter
5. Trust Receipt (T/R) – A document to release a merchandise by a bank to a buyer (the
bank still retains title to the merchandise), the buyer, who obtains the goods for
processing is obligated to maintain the goods distinct from the remainder of his / her
assets and to hold them ready for repossession by the bank. – Prepared by: importer
6. Promissory Note – A financial instrument that is negotiable evidencing the
obligations of the foreign buyer to pay to the bearer. – Prepared by: importer
7. Customs Invoice – A document specified by the customs authorities of the importing
countries stating the selling price, costs for freight, insurance, packing and payment
terms, etc, for the purpose of determining the customs value.
Transport Documents
1. Shipping Order S/O – A document with details of the cargo and the shipper's
requirements, – Basic document for preparing other transport documents such as
bill of lading, air waybill, etc. – Prepared by: shipper / transport companies
2. Dock Receipt D/R or Mate's Receipt –The dock receipt is used as documentation to
prepare a bill of lading. – It has no legal role regarding processing financial
settlement. – Prepared by: shipping company
3. Bill of Lading (B/L) – An evidence of contract between the shipper of the goods and
the carrier. – The customer usually needs the original as proof of ownership to take
possession of the goods. – Prepared by: shipping company
4. House Bill of Lading (Groupage) – A bill of lading issued by a forwarder and, in many
cases, not a title document. – Shippers choosing to use a house bill of lading, should
clarify with the bank whether it is acceptable for letter of credit purpose before the
credit is opened. – Advantages include less packing, lower insurance premiums,
quicker transit, less risk of damage and lower rates than cargo as an individual parcel
/ consignment. – Prepared by: forwarder
5. Sea Waybill – A receipt for cargo which incorporates the contract of carriage
between the shipper and the carrier but is non-negotiable and is therefore not a title
document. – Prepared by: shipping company
6. Air Waybill (AWB) – A kind of waybill used for the carriage of goods by air. This serves
as a receipt of goods for delivery and states the condition of carriage but is not a title
document or transferable / negotiable instrument. – Prepared by: airline
7. Shipping Guarantee – Usually a pre-printed form provided by a shipping company or
the bank, given by an importer's bank to the shipping company to replace the original
transport document. – The consignee may then in advance take delivery of goods
against a shipping guarantee without producing the original bill of lading. The
consignee and the importer bank will be responsible for any loss or charges occurred
to the shipping company if fault is found in the collection. It is usually used with full
margin or trust receipt to protect the bank's control to the goods. – Prepared by:
importer's bank / shipping company / consignee
8. Packing List (sometimes as packing note) – A list providing information needed for
transportation purpose, such as details of invoice, buyer, consignee, country of
origin, vessel / flight date, port / airport of loading, port / airport of discharge, place

of delivery, shipping marks / container number, weight / volume of merchandise and
the fullest details of the goods, including packing information. – Prepared by: shipper
Commercial Documents / Risk Bearing Documents
1. Quotation – An offer to sell goods and should state clearly the price, details of
quality, quantity, trade terms, delivery terms and payment terms. – Prepared by:
exporter
2. Sales Contract – An agreement between the buyer and the seller stipulating every
detail of the transaction. Since this is a legally binding document, it is therefore
advisable to seek legal advice before signing the contract. – Prepared by: exporter
and importer
3. Pro Forma Invoice – An invoice provided by a supplier prior to the shipment of
merchandise, informing the buyer of the kinds and quantities of goods to be sent,
their value, and importation specifications (weight, size and similar characteristics).
– This is not issued for demanding payment but may be used when applying for an
import license / permit or arranging foreign currency or other funding purposes. –
Prepared by: exporter
4. Commercial Invoice – A formal demand note for payment issued by the exporter to
the importer for goods sold under a sales contract. – It should give details of the
goods sold, payment terms and trade terms. – It is also used for the customs
clearance of goods and sometimes for foreign exchange purpose by the importer. –
5. Packing List – A list with detailed packing information of the goods shipped. –
6. Inspection Certificate – A report issued by an independent surveyor (inspection
company) or the exporter on the specifications of the shipment, including quality,
quantity, and / or price, required by certain buyers and countries. – Prepared by:
inspection company or exporter
7. ATA Carnet – An international customs document used to obtain a duty-free
temporary admission for goods such as exhibits for international trade fairs, samples
and professional equipment, into the countries that are signatories to the ATA
Convention. – Prepared by: exporter
8. Insurance Certificate – This certifies that the shipment has been insured under a
given open policy and is to cover loss of or damage to the cargo while in transit. –
Prepared by: insurer or insurance agent or insurance broker
9. Product Testing Certificate – This certifies the products are conformed to a certain
international / national technical standard, such as product quality, safety and
specifications. – Prepared by: accredited laboratories
10. Health Certificate – Document issued by the competent country when agricultural
or food products are being exported, to certify that they comply with the relevant
legislation in the exporter's country and were in good condition at time of inspection,
prior to shipment and fit for human consumption. – Prepared by: exporter /
inspection authority

INCOTERMS (International Commercial TERMS)
First created in 1936 by the International Chamber of Commerce
INCOTERMS are uniform, internationally recognized foreign trade terms that refer to the
type of agreement for the purchase and shipping of goods internationally
There are 13 different terms, each of which helps users deal with different situations
involving the movement of goods.
The difference between the 2000 and the 2010 version is the number of INCOTERMS has
been reduced from 13 to 11. – (Four INCOTERMS (DAF, DES, DEQ, DDU) have been
replaced by two new INCOTERMS (DAT, DAP). The replaced INCOTERMS DAF, DES and
DEQ were not used much in day to day trading.)
Major areas in INCOTERMS
1. Costs: Who is responsible for the expenses involved in a shipment at a given point in
the shipment's journey?
2. Control: Who owns the goods at a given point in the journey?
3. Liability: Who is responsible for paying damage to goods at a given point in a
shipment's transit?
Cost, Insurance and Freight (Named port of destination) (CIF)
 A shipping term included in contract of sale, CIF indicates that the seller agrees
to take full responsibility for delivering the goods to the port of loading, clear the
goods for export, and arrange and pay for transportation and marine insurance
over the goods to the named port of discharge, such costs being included in the
price of the goods.
 Nonetheless, all risk of loss of or damage to the goods, as well as any additional
costs due to events occurring after the time the goods have been delivered on
board the vessel, is transferred from the seller to the buyer when the goods pass
the ship's rail at the port of loading.
 It is up to the buyer to arrange transportation from the port of discharge.
Free on board (Named port of shipment) (FOB)
 A shipping term included in a contract of sale, FOB indicates that the seller fulfils
his obligation to deliver when the goods have passed over the ship's rail at the
named port of shipment, all costs of inland transportation and loading being
included in the price of the goods.
 The buyer has to bear all costs and risks of loss of or damage to the goods from
that point.
Carriage and Insurance Paid - C.I.P
 Can be used for any transport mode, or where there is more than one transport
mode.
 The seller is responsible for arranging carriage to the named place, and also for
insuring the goods.

 “Carriage and Insurance Paid to” means that the seller delivers the goods to the
carrier or another person nominated by the seller at an agreed place (if any such
place is agreed between parties) and that the seller must contract for and pay
the costs of carriage necessary to bring the goods to the named place of
destination.
 The seller also contracts for insurance cover against the buyer’s risk of loss of or
damage to the goods during the carriage. The buyer should note that under CIP
the seller is required to obtain insurance only on minimum cover. Should the
buyer wish to have more insurance protection, it will need either to agree as
much expressly with the seller or to make its own extra insurance arrangements.
EXPORT FINANCE
a) Deemed Exports
 "Deemed Exports" refers to those transactions in which the goods supplied do
not leave the country and the payment for such supplies is received either in
Indian rupees or in free foreign exchange.
The following categories of supply of goods by the main/ sub-contractors shall be
regarded as "Deemed Exports" under this Policy, provided the goods are manufactured
in India:
1. Supply of goods against Advance License/Advance License for annual
requirement/DFRC under the Duty Exemption /Remission Scheme;
2. Supply of goods to Export Oriented Units (EOUs) or Software Technology Parks (STPs)
or Electronic Hardware Technology Parks (EHTPs) or Bio Technology Parks (BTP);
3. Supply of capital goods to holders of licenses under the Export Promotion Capital
Goods (EPCG) scheme;
4. Supply of goods to projects financed by multilateral or bilateral agencies/funds as
notified by the Department of Economic Affairs, Ministry of Finance under International
Competitive Bidding in accordance with the procedures of those agencies/ funds, where
the legal agreements provide for tender evaluation without including the customs duty;
5. Supply of capital goods, including in unassembled/ disassembled condition as well as
plants, machinery, accessories, tools, dies and such goods which are used for installation
purposes till the stage of commercial production and spares to the extent of 10% of the
FOR value to fertilizer plants.
Benefits for Deemed Exports
 Deemed exports shall be eligible for any/all of the following benefits in respect
of manufacture and supply of goods qualifying as deemed exports.
 Advance License for intermediate supply/ deemed export/DFRC/ DFRC for
intermediate supplies. Deemed Export Drawback.
 Exemption from terminal excise duty where supplies are made against
International Competitive Bidding. In other cases, refund of terminal excise duty
will be given.
b) Pre-shipment finance
 Pre-shipment finance refers to the financial assistance provided to the exporters
before actual shipment of goods.

 Pre-shipment finance is provided to the exporters for the purposes like purchase
of raw materials, their processing and converting into finished goods and
packaging them.
 Funds to cover an exporter's cost before goods are sent overseas.
 Pre shipment finance is issued by a financial institution when the seller want the
payment of goods before shipment.
The main objectives are to enable exporter to:
 Procure raw materials
 Carry out manufacturing process
 Provide a secure warehouse for goods & raw materials
 Process & pack the goods
 Ship goods to buyers
 Meet other financial costs of the business
c) Post-shipment finance
 Post-shipment finance may be as “any loan or advance granted or any other
credit provided by a bank to an exporter of goods from India from the date of
extending the credit after shipment of goods to the date of realization of export
proceeds.”
 Post-shipment finance serves as bridge loan for the period between shipment of
goods and the realization of proceeds.
 Such loan is usually provided for a maximum period of 6 months. Interest is
charged at the rate of 8.65 per cent.
Post shipment finance can be classified as under
 Negotiation (settlement) of document under L/C
 Purchase of document without L/C
 Advance against document sent on collection basis
 Advance against retention money
 Advance against undrawn balance
 Person eligible for post shipment finance
 Basis of post shipment finance
 Purpose of post shipment finance
 Quantum of post shipment finance
 Period of post shipment finance
 Rate of post shipment finance
Export Credit Guarantee Corporation
 Export Credit Guarantee Corporation is a central government undertaking body
to provide credit guarantee on the default of payments by the buyer. It works as
an insurance firm who guarantees export payment, if the buyer defaults in
making payment.
Functions of ECGC
 Provides a range of credit risk insurance covers to exporters against loss in export
of goods and services.
 Offers guarantees to banks and financial institutions to enable exporters to
obtain better facilities from them.

 Provides Overseas Investment Insurance to Indian companies investing in joint
ventures abroad in the form of equity or loan.
Procedures with ECGC to cover insurance:
 Once after finalizing the order, buyer execute a purchase order to the seller with
the terms and conditions as agreed by both. The purchase order should contain
full details of buyer and buyer’s bank account details.
 The exporter approaches Export Guarantee Corporation to get approval on the
buyer with amount of limit. Here, the ECGC with their available contact with
overseas network finds out the credit worthiness of the said buyer and arrives a
figure of creditworthiness and inform the maximum limit of amount can be
shipped at any point of time.
 Export Credit Guarantee Corporation collects premium on the amount of
approval and issue insurance policy accordingly.
 The exporter can apply with ECGC for insurance on shipment wise order as
specific insurance policy, or at lump sum as comprehensive policy.
 If an exporter obtains a specific policy, the contract of insurance is only for that
particular shipment.
 You as an exporter has to pay premium only against the said shipment.
 If you prefer to obtain a comprehensive policy against any buyer, you can get
approval from ECGC, the amount of credit worthiness of the said buyer
UCPDC Guidelines Uniform Customs and Practice for Documentary Credit
 UCPDC is a set of predefined rules established by the International Chamber of
Commerce (ICC) on Letters of Credit.
 Used by bankers and commercial parties in more than 200 countries including
India to facilitate trade and payment through LC
 UCPDC was first published in 1933 and subsequently updating it throughout the
years.
 In 1994, UCPDC 500 was released with only 7 chapters containing in all 49 articles.
 The latest revision was approved by the Banking Commission of the ICC at its
meeting in Paris on 25 October 2006.
 This latest version, called the UCPDC600, formally commenced on 1 July 2007.
 It contains a total of about 39 articles covering the following areas, which can be
classified as 8 sections according to their functions and operational procedures
Uniform Rules for Collections (URC)
The Uniform Rules for Collections is a set of rules that help assist in the process of
collecting debts or owed money or assets.
The URCs were established – or proposed – by the International Chamber of Commerce
(ICC) What the Uniform Rules for Collections Do
The latest revision of the URC, drafted in the mid-1990s, outline the issues that
practitioners – businesses, banks, buyers, and sellers – face on a daily basis when trying
to collect payments
The Uniform Rules for Collections also provides useful rules for such practitioners to
follow when initiating the collections process.

The last draft of the Uniform Rules for Collections, otherwise known as URC 522, sets out
the need for the primary or remitting bank to draw up and attach a sheet that explicitly
explains the purpose of, and the process that should be followed when, collecting debts.
Documentary Collection
 It is a transaction where the exporter entrusts the collection of a payment to the
remitting bank (exporter’s bank) which delivers the corresponding documents to
the collecting bank (importer’s bank) along with the instructions for payment.
 Exporter ship the goods before payment but retain control of them until they
receive payment from overseas buyer or receive a legal undertaking of future
payment, such as an endorsed (signed) bill of exchange (also called a draft) or
promissory note.
 Also known as “Sight Drafts and Time Drafts” or D/P (documents against
payment) or D/A (Documents against Acceptance)
Documents against Payment (D/P)
 D/P also known as "Sight Draft" or "Cash against Documents” (CAD).
 The buyer must pay before the collecting bank releases the title documents.
 Time of Payment: After shipment, but before documents are released.
 Transfer of Goods: After payment is made on sight.
 Exporter Risk: If draft is unpaid, goods may need to be disposed.
Documents against Acceptance (D/A)
 The buyer accepts a time draft, promising to pay for the goods at a future date.
 After acceptance, the title documents are released to the buyer.
 Time of Payment: On maturity of draft at a specified future date.
 Transfer of Goods: Before payment, but upon acceptance of draft.
 Exporter Risk: Has no control of goods and may not get paid at due date

Module 4
Exchange Rate Mechanism (ERM)
An exchange rate mechanism (ERM) is a device used to manage a country's currency
exchange rate relative to other currencies. It is part of an economy's monetary policy
and is put to use by central banks
Types of Exchange Rates
1. Fixed Exchange Rate 2. Floating/Flexible Exchange Rate
Spot Exchange Rate
 The spot exchange rate is the amount one currency will trade for another today.
 The spot rates represent the prices buyers pay in one currency to purchase a
second currency.
 Although the spot exchange rate is for delivery on the earliest value date, the
standard settlement date for most spot transactions is two business days after
the transaction date.
 The spot exchange rate is the price paid to sell one currency for another for
delivery on the earliest possible value date
Forward Exchange Rate
 The forward exchange rate (also referred to as forward rate or forward price) is
the exchange rate at which a bank agrees to exchange one currency for another
at a future date when it enters into a forward contract with an investor.
 Multinational corporations, banks, and other financial institutions enter into
forward contracts to take advantage of the forward rate for hedging purposes.
 A forward rate is a rate applicable to a financial transaction that will take place in
the future.
 Forward rates are based on the spot rate, adjusted for the cost of carry and refer
to the rate that will be used to deliver a currency, bond or commodity at some
future time.
 It may also refer to the rate fixed for a future financial obligation, such as the
interest rate on a loan payment.
Foreign exchange arithmetic
 A foreign exchange transaction has two aspects – Purchase (Buy) and Sell.
 The Foreign exchange transaction is always talked from the Bank’s point of view and
the item referred to is the foreign currency.
 Hence when we say “Purchase”, it means that the bank has purchased and it has
purchased foreign currency & when we say “Sale”, the bank has sold and sold the
foreign currency.
 In purchase transaction, the Bank acquires the foreign currency and parts with home
currency.
 In a sale transaction the Bank parts with the foreign currency and acquires home
currency.
 The Exchange rate is quoted as
a) Direct Quotation b) Indirect Quotation”.

 In a “Direct Quotation “, the foreign currency is fixed and the home currency is
variable.
 In a “Indirect Quotation “, the home currency is fixed and the foreign currency is
variable.
Deriving the Actual Exchange Rate
Forwards, Swaps, Futures and Options
a) Forward contract
A forward is a contract in which one party agree to buy and the other party commits to
sell a specified quantity of an agreed upon asset for a pre-determined price at a specific
date in the future.
Risks in Forward Contracts
 Credit Risk – Does the other party have the means to pay?
 Operational Risk – Will the other party make delivery? – Will the other party
accept delivery?
 Liquidity Risk – In case either party wants to opt out of the contract, how to find
another counter party?
b) Options
 Contracts that give the holder the option to buy/sell specified quantity of the
underlying assets at a particular price on or before a specified time period.
 There are three parties involved in the option trading,
1. The option seller or writer - A person who grants someone else the option to
buy or sell. He receives premium on its price
2. The option buyer – A person who pays a price to the option writer to induce
him to write the option.
3. The securities broker – A person who acts as an agent to find the option buyer
and the seller, and receives a commission or fee for it.
Types of Options
 Call option
Call option give the buyer the right but not the obligation to buy a given quantity
of the underlying asset, at a given price on or before a particular date by paying
a premium.
 Put Option
Give the buyer the right, but not obligation to sell a given quantity of the
underlying asset at a given price on or before a particular date by paying a
premium.
c) Swaps
 Swaps are private agreements between two parties to exchange cash flows in the
future according to a prearranged formula. They can be regarded as portfolios of
forward contracts
 There are 2 main types of swaps: –
a) Interest Rate Swap
A company agrees to pay a pre-determined fixed interest rate on a
notional principal for a fixed number of years. In return, it receives
interest at a floating rate on the same notional principal for the same

period of time. The principal is not exchanged. Hence, it is called a
notional amount.
b) Currency Swap
It is a swap that includes exchange of principal and interest rates in one
currency for the same in another currency. It is considered to be a foreign
exchange transaction. It is not required by law to be shown in the balance
sheets. The principal may be exchanged either at the beginning or at the
end of the tenure. However, if it is exchanged at the end of the life of the
swap, the principal value may be very different. It is generally used to
hedge against exchange rate fluctuations.
Guarantees in trade
1. Letter of credit (pg. 12)
2. Bank guarantee
 The Bank has agreed and undertakes that, if the Applicant failed to
fulfil his obligations either Financial or Performance as per the
Agreement made between the Applicant and the Beneficiary, then
the Guarantor Bank on behalf of the Applicant will make payment of
the guarantee amount to the Beneficiary upon receipt of a demand or
claim from the Beneficiary.
3. Performance bond (guarantee)
 A bond or guarantee which has been issued as security for one party's
performance: if that party (the principal) fails to perform the
beneficiary under the bond/guarantee may obtain payment.
 A performance bond may be of either the demand or conditional
variety, which means that the beneficiary may or may not be required
to prove default by the principal in order to obtain payment.
4. Bid or Tender Bonds
 A Tender or Bid Bond is usually for between 2% and 5% of the contract
value, and the aim is to guarantee that the contract will be taken up
if it is awarded.
 In the event that the contract is not taken up, then there will be a
resultant penalty for the value of the Bond.
 The Tender Bond usually commits both the Seller and its Bank to
joining in a Performance Bond if the contract is granted.
5. Advance Payment Bonds
 This will provide protection to the Buyer when an advance or progress
payment is made to the Seller prior to completion of the contract.
 The Bonds undertake that the Seller will refund any advance
payments that have been made to the Buyer in the event that the
product is unsatisfactory.
 This is typical in large construction matters where a contractor will
purchase high-value equipment, plant or materials specifically for the
project.
6. Warranty or maintenance bonds

 These provide a financial guarantee to cover the satisfactory
performance of equipment supplied during a specified maintenance
or warranty period.
 The undertaking is by a bond issuer to pay the buyer an amount of
money if a company's warranty obligations for products that are
provided are not met and the amount will often be as a stated
percentage of the export contract value.
 A warranty bond may be conditional or unconditional.
 If conditional, it may be a condition of the contract that a warranty
bond is purchased before a buyer makes the final payment.
7. Guarantees
 A guarantee is issued by a bank on the instruction of a client and is
used as an insurance policy, to be used when one fails to fulfil a
contractual commitment.
 A financial institution issuing a Letter of Credit will carry out
underwriting duties to ensure the credit quality of the party looking
for the Letter of Credit before contacting the bank of the party that
requests the Letter of Credit. Letters of Credit are usually open for a
year.

Forex management Study Note Calicut university

Empfohlen

Empfohlen

Weitere ähnliche Inhalte

Was ist angesagt?

Was ist angesagt? (20)

Ähnlich wie Forex management Study Note Calicut university

Ähnlich wie Forex management Study Note Calicut university (20)

Kürzlich hochgeladen

Kürzlich hochgeladen (17)

Forex management Study Note Calicut university