ASSIGNMENT

INTERNATIONAL FINANCE
SHRI VAISHNAV INSTITUTE OF MANAGEMENT, INDORE
Section A
 What do you mean by disequilibrium in balance of payment? Analyze various types of disequilibrium.
 It refers to current account of balance of payment. If autonomous receipts are less than autonomous payments,
the balance of payment is in deficit reflecting disequilibrium in balance of payment.
 Or in other words, Disequilibrium is a situation where internal and/or external forces prevent market equilibrium
from being reached or cause the market to fall out of balance.
 Disequilibrium is when external forces cause a disruption in a market's supply and demand equilibrium. In
response, the market enters a state during which supply and demand are mismatched.
 Disequilibrium is caused due to several reasons, from government intervention to labour, market inefficiencies
and unilateral action by a supplier or distributor.
 Disequilibrium is generally resolved by the market entering into a new state of equilibrium.
 India generally experiences a huge deficit of the balance of payment due to its size. This is all down to the fact
that India requires imported technology, machines, and other resources to run its economy successfully. To know
about a country’s economic stability and sustainability, the balance of payment is the measure. Thus, it is usually
accountable for 1 year. Also, these payments and receipts include outflows and inflows like payments and
receipts. So, in terms of the balance of payment, there is a surplus balance of payment and balance of payment
deficit.
 Importance of Balance of Payment - In terms of the balance of payment, a country has to take care of three types
of items.
o Visible items include various types of physical goods that are imported and exported.
o While invisible items include all the services whose import and export are not visible. This includes medical
services, transport services, etc.
o The third one is a capital transfer which is concerned with capital payments and capital receipts. A country can
acquire these goods only by accommodating a capital deficit and this deficit is called the balance of payment.
 Factors causing disequilibrium in balance of payment
Economic factors (a) Imbalance between exports and imports. (It is the main cause of disequilibrium in BOR), (b)
Large scale development expenditure which causes large imports, (c) High domestic prices which lead to imports,
(d) Cyclical fluctuations (like recession or depression) in general business activity, (e) New sources of supply and
new substitutes. Political Factors: Experience shows that political instability and disturbances cause large capital
outflows and hinder Inflows of foreign capital
Social Factors: (a) Changes in fashions, tastes and preferences of the people bring disequilibrium in BOP by
influencing imports and exports; (b) High population growth in poor countries adversely affects their BOP
because it increases the needs of the countries for imports and decreases their capacity to export.
 Measures to correct disequilibrium in BOP: Sustained or prolonged deficit has to be settled by short term loans or
depletion of capital reserve of foreign exchange and gold.
Export promotion: Exports should be encouraged by granting various bounties to manufacturers and exporters.
At the same time, imports should be discouraged by undertaking import substitution and imposing reasonable
tariffs.
Import: Restrictions and Import Substitution are other measures of correcting disequilibrium.
Reducing inflation: Inflation (continuous rise in prices) discourages exports and encourages imports. Therefore,
government should check inflation and lower the prices in the country.

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 Exchange control: Government should control foreign exchange by ordering all exporters to surrender their
foreign exchange to the central bank and then ration out among licensed importers.
Devaluation of domestic currency: It means fall in the external (exchange) value of domestic currency in terms of
a unit of foreign exchange which makes domestic goods cheaper for the foreigners. Devaluation is done by a
government order when a country has adopted a fixed exchange rate system. Care should be taken that
devaluation should not cause rise in internal price level.
Depreciation: Like devaluation, depreciation leads to fall in external purchasing power of home currency.
Depreciation occurs in a free market system wherein demand for foreign exchange far exceeds the supply of
foreign exchange in foreign exchange market of a country (Mind, devaluation is done in fixed exchange rate
system.)
 Types: This can be broken down into the balance of trade, the balance of current account, and capital account.
The balance of trade includes exports and imports. The balance of the current account includes the balances of
service and remittance, the balance of trade, etc. While the capital account is mainly investing and borrowing.
The capital account of any country includes transactions in terms of financial assets for the long term as well as
short term borrowing and lending. The current account is also known as the balance of trade. This includes
private transfer payments like gifts, grants, remittances, etc. It also includes nonfactor trade services like banking
software, shipping, etc. While capital account includes commercial borrowings, foreign investment, other flows,
rupee debt services, etc.

 What do you mean by foreign exchange markets? Explain its structure & settlement system .
 The foreign exchange market in India has been around for about 40 years now. The market started operating in
1978 after the government's decree. After its establishment, the forex market has seen significant growth over
the years. The market is regulated by the central government and all aspects of the trade are defined by national
laws. There are many things about this market that make it distinct from other markets in the world.
 Like other forex markets in the world, the forex in India consists of several stakeholders. The main stakeholders in
this market are:
The three actors mentioned above play different roles in the trade. Traders are generally all individuals in the
public who are also corporate customers of the banks. These customers use the banks as authorized dealers to
access the forex market. There are traders of different kinds but all of them are able to access the market only
through dealers. This is much like elsewhere in the world where brokers are the intermediaries between the forex
and ordinary traders. The banks, on the other hand, are the legally authorized institutions to handle currency. In
India, banks exist in different tiers and there are clear laws that determine which institution is categorized as a
financial institution. From these legal institutions, all those who want to trade can create accounts, access the
market and choose products that they would like to trade in. The trading landscape has changed a lot over the
years especially since the 1990's when the Indian regulatory authorities liberalized this market. Lastly, the
Reserve Bank of India (RBI) is the central financial institution which is responsible for the monetary policy in India.
This institution has been instrumental in shaping the trading landscape in India. Before 1993, the Indian Rupee
had a fixed value which was determined by the RBI. This meant that the currency only attracted a certain
exchange rate even though the market dynamics were changing. In 1993, though, the RBI repealed the prevailing
law at the time to allow for an exchange rate determined by the market itself. Since then, the Rupee's value has
changed a lot in relation to different currencies.
 In 2018, the forex market in India is quite vibrant. Even though it is not the market with the most daily volume, it
is among the top ten markets in the world. As of 2017, the forex assets in India place it as the 8th best market in
the world by forex reserves. The top asset in this market is the United States as represented by US institutional
bonds and government bonds. The Indian forex reserves are also held in terms of gold. Indeed, India is the first
nation in the world in terms of gold consumption.
 The origin of the foreign exchange market may be dated back to the year 1978, when banks in India were
permitted to undertake intraday transactions.

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 However, it is in the year 1990 that foreign exchange market witness far reaching changes also the currency
regime in India.
 FOREIGN EXCHANGE DEALER’S ASSOCIATION OF INDIA (FEDAI) was setup in 1958 as an Association of banks
dealing in foreign exchange in India as a self-regulatory body and incorporated under section 25 of the
companies act, 1956. Its major activities included governing the conduct of inter-banking foreign exchange
business with regard to public and liaison with RBI for reforms and development of forex market.
 The structure of a typical stock market is as shown below −

But the
structure of
the forex
market is
rather
unique because major volumes of transactions are done in Over-The-Counter (OTC) market which is
independent of any centralized system (exchange) as in the case of stock markets.
The participants in this market are
 Central Banks
 Major commercial banks
 Investment banks
 Corporations for international business transactions
 Hedge funds
 Speculators
 Pension and mutual funds
 Insurance companies
 Forex brokers

 Commonly Used Currency Pair

In this section, we will learn about a few commonly used currency pair.
The most traded, dominant and strongest currency is the US dollar. The primary reason for this is the size of the
US economy, which is the world’s largest. The US dollar is the preferred base or reference currency in most of the
currency exchange transactions worldwide. Below are some of the most traded (high liquidity) currency pairs in
the global forex market. These currencies are part of most of the foreign exchange transactions. However, this is
not necessarily the best currency to trade for every trader, as this (which currency pair to choose) depends on
multiple factors −
 EUR/USD (Euro – US Dollar)
 GBP/USD (British Pound – US Dollar)
 USD/JPY (US Dollar – Japanese Yen)
 USD/CHF ( US Dollar – Swiss Franc)

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 EUR/JPY ( Euro – Japanese Yen)
 USD/CAD (US Dollar – Canadian Dollar)
 AUD/USD (Australian Dollar – US Dollar)
As prices of these major currencies keep changing and so do the values of the currency pairs change. This leads to
a change in trade volumes between two countries. These pairs also represent countries that have financial power
and are traded heavily worldwide. The trading of these currencies makes them volatile during the day and the
spread tends to be lower.
 What is fluctuations in foreign exchange rates? What measures will you suggest to control the fluctuations in
the rate of exchange?
 An exchange rate is the value of one nation's currency versus the currency of another nation or economic zone.
For example, how many U.S. dollars does it take to buy one euro? As of Dec. 13, 2019, the exchange rate is 1.10,
meaning it takes $1.10 to buy €1
 Types of Exchange Rates
Free Floating: A free-floating exchange rate rises and falls due to changes in the foreign exchange market.
Restricted Currencies: Some countries have restricted currencies, limiting their exchange to within the countries'
borders. Also, a restricted currency can have its value set by the government.
Currency Peg: Sometimes a country will peg its currency to that of another nation. For instance, the Hong Kong
dollar is pegged to the U.S. dollar in a range of 7.75 to 7.85. This means the value of the Hong Kong dollar to the
U.S. dollar will remain within this range.
Onshore Vs. Offshore: Exchange rates can also be different for the same country. In some cases, there is an
onshore rate and an offshore rate. Generally, a more favorable exchange rate can often be found within a
country’s border versus outside its borders. China is one major example of a country that has this rate structure.
Additionally, China's yuan is a currency that is controlled by the government. Every day, the Chinese government
sets a midpoint value for the currency, allowing the yuan to trade in a band of 2% from the midpoint.3
Spot vs. Forward: Exchange rates can have what is called a spot rate, or cash value, which is the current market
value. Alternatively, an exchange rate may have a forward value, which is based on expectations for the currency
to rise or fall versus its spot price. Forward rate values may fluctuate due to changes in expectations for future
interest rates in one country versus another. For example, let's say that traders have the view that the Eurozone
will ease monetary policy versus the U.S. In this case, traders could buy the dollar versus the euro, resulting in the
value of the euro falling.
Quotation: Typically, an exchange rate is quoted using an acronym for the national currency it represents. For
example, the acronym USD represents the U.S. dollar, while EUR represents the euro. To quote the currency pair
for the dollar and the euro, it would be EUR/USD. In this case, the quotation is euro to dollar, and translates to 1
euro trading for the equivalent of $1.13 if the exchange rate is 1.13. In the case of the Japanese yen, it's USD/JPY,
or dollar to yen. An exchange rate of 100 would mean that 1 dollar equals 100 yen.
 While the impact of a currency’s gyrations on an economy is far-reaching, most people do not pay close attention
to exchange rates because most of their business is conducted in their domestic currency. For the typical consumer,
exchange rates only come into focus for occasional activities or transactions, such as foreign travel, import
payments, or overseas remittances.
 The value of the domestic currency in the foreign exchange market is an important instrument in a central bank’s
toolkit, as well as a key consideration when it sets monetary policy. Directly or indirectly, currency levels affect a
number of key economic variables. They may play a role in the interest rate you pay on your mortgage, the returns
on your investment portfolio, and the price of groceries in your local supermarket, and even your job prospects.
 Current impact on the economy
Merchandise Trade: This refers to a nation’s international trade or its exports and imports. In general terms, a
weaker currency will stimulate exports and make imports more expensive, thereby decreasing a nation’s trade
deficit (or increasing surplus) over time.

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 Capital Flows: Foreign capital tends to flow into countries that have strong governments, dynamic economies, and
stable currencies. A nation needs to have a relatively stable currency to attract investment capital from foreign
investors. Otherwise, the prospect of exchange losses inflicted by currency depreciation may deter overseas
investors.
Inflation: A devalued currency can result in “imported” inflation for countries that are substantial importers. A
sudden decline of 20% in the domestic currency may result in imported products costing 25% more since a 20%
decline means a 25% increase to get back to the original price point.
Interest Rates: As mentioned earlier, the exchange rate level is a key consideration for most central banks when
setting monetary policy. For example, former Bank of Canada Governor Mark Carney said in a September 2012
speech that the bank takes the exchange rate of the Canadian dollar into account in setting monetary policy.
Carney said that the persistent strength of the Canadian dollar was one of the reasons why his country's monetary
policy had been “exceptionally accommodative” for so long.
With the domestic there is also international impacts that a currency has one of which is stated below, The Asian
Crisis of 1997-98. A prime example of the havoc that can be wreaked on an economy by adverse currency moves,
the Asian crisis began with the devaluation of the Thai baht in July 1997. The devaluation occurred after the baht
came under intense speculative attack, forcing Thailand’s central bank to abandon its peg to the US dollar and
float the currency. This triggered a financial collapse that spread like wildfire to the neighboring economies of
Indonesia, Malaysia, South Korea, and Hong Kong. The currency contagion led to a severe contraction in these
economies as bankruptcies soared and stock markets plunged.
 Why a Eurocurrency has a limited scope of transaction as compare to dollar as a currency? Discuss the
advantages and limitations of euro currency.
 Eurocurrency is currency deposited by national governments or corporations, outside of its home market.
Commonly it is currency held in banks located outside of the country which issues the currency.
 It is important to note that the term euro-currency applies to any currency and to banks in any country. Having
"euro" doesn't mean that the transaction has to involve European countries. For example, South Korean won
deposited at a bank in South Africa is considered euro-currency. US dollars held in a UK bank would also be
considered euro-currency. And Euros held in an Asian bank would be considered euro-currency, too. However, in
practice, European countries are often involved.
 For example, Bank A is based in Canada, whereas Bank B is based in the United States. Bank A is planning to make
some rather large loans to a client of theirs and has determined that they would be able to make more money if
they borrowed money from Bank B—in US dollars—and loaned it out to their client.
Bank B makes interest from the loan they offer to Bank A, whereas Bank A profits from the difference in the loan
terms between their client and the loan terms offered from Bank B. Although in theory Bank A might do this at
zero cost in order to satisfy their client, it is much more often the case that they use Eurocurrency as a way to take
advantage of an interest-rate discrepancy.
 Write short note on:
1. Theories of International Trade
 Adam Smith describes trade taking place as a result of countries having absolute advantage in production of
particular goods, relative to each other. Within Adam Smith's framework, absolute advantage refers to the
instance where one country can produce a unit of a good with less labor than another country. In Book IV of his
major work the Wealth of Nations, Adam Smith, discussing gains from trade, provides a literary model for absolute
advantage based upon the example of growing grapes from Scotland. He makes the argument that while it is
possible to grow grapes and produce wine in Scotland, the investment in the factors of production would cost
thirty times than more than the cost of purchasing an equal quantity from a foreign country. The minimization of
aggregate real costs and efficient resource allocation through trade without strong consideration for comparative
costs form the basis of Adam Smith's model of absolute advantage in international trade.
 The Ricardian theory of comparative advantage became a basic constituent of neoclassical trade theory. Any
undergraduate course in trade theory includes a presentation of Ricardo's example of a two-commodity, two-
country model. For the modern development, see Ricardian trade theory extensions. The Ricardian model focuses

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 on comparative advantage, which arises due to differences in technology or natural resources. The Ricardian
model does not directly consider factor endowments, such as the relative amounts of labor and capital within a
country.
New interpretation
The Ricardian model is often presented as being based on the following assumptions:
Labor is the only primary input to production. The relative ratios of labor at which the production of one good can
be traded off for another, differ between countries. This is incomplete, because the Ricardian model can be
extended to the situation where many goods can be inputs for a production. See Ricardian trade theory extensions
below. Relative ratio of labor input coefficients has a valid meaning only for simple cases such as two-country,
many commodity case or many-country, two-commodity case without no intermediate goods. As for the meanings
of four magic numbers, a new interpretation became popular in the 21st century. In 2002, Roy Ruffin pointed the
possibility of new reading of Ricardo's explanations.[6] Andrea Maneschi made a detailed account in 2004.[7] Now
the new interpretation has become almost as established as Ricardo's text, not only for the first third of Chapter
7 but for all descriptions throughout his book concerning international trade.
 Hecksher and Ohlin model: In the early 1900s, a theory of international trade was developed by two Swedish
economists, Eli Heckscher and Bertil Ohlin. This theory has subsequently become known as the Heckscher–Ohlin
model (H–O model). The results of the H–O model are that the pattern of international trade is determined by
differences in factor endowments. It predicts that countries will export those goods that make intensive use of
locally abundant factors and will import goods that make intensive use of factors that are locally scarce.
The H–O model makes the following core assumptions:
Labor and capital flow freely between sectors equalizing factor prices across sectors within a country.
The amount of labor and capital in two countries differ (difference in endowments).
Technology is the same among countries (a long-term assumption).
Tastes are the same upon countries.
2. ADR & GDR
 Investors and companies may wish to invest in publicly traded equity stocks that are not domiciled directly in
their own country. These securities can add diversification to a portfolio and also provide a broader universe for
identifying the highest potential return through stocks. Domestic domiciled securities are freely traded on their
corresponding domestic exchanges daily through brokers and brokerage platforms.
 If a company wants to offer its equity shares in a foreign market it must work with a depositary bank. This means
the underlying company seeking to raise money through the specially structured share issuance must partner
with a depositary bank to do so. As an intermediary, the depositary bank manages the share issuance,
administration aspects of the share listing, and other details involved with the shares being offered. The
underlying company does not necessarily have direct access to manage their depositary receipt shares in the
same way that they manage their domestic shares.
 Global Depositary Receipt (GDR): A global depositary receipt is one type of depositary receipt. Like its name, it
can be offered in several foreign countries globally. Depositary receipts only offered in a single foreign market
will typically be titled by that market’s name, such as American depositary receipts, discussed below, and EDRs,
LDRs, or IDRs. Global depositary receipts are typically part of a program that a company builds to issue their
shares in foreign markets of more than one country. For example, a Chinese company could create a GDR
program that issues its shares through a depositary bank intermediary into the London market and the United
States market. Each issuance must comply with all relevant laws in both the home country and foreign markets
individually.
 American Depositary Receipt (ADR): American depositary receipts are shares issued in the U.S. from a foreign
company through a depositary bank intermediary. ADRs are only available in the United States. In general, a
foreign company will work with a U.S. depositary bank as the intermediary for issuing and managing the shares.
ADRs can be found on many exchanges in the U.S. including the New York Stock Exchange and NASDAQ as well

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 as over the counter. Foreign companies and their depositary bank intermediaries must comply with all U.S. laws
for issuing ADRs. This makes ADRs subject to U.S. securities laws as well as the rules of exchanges. ADRs are
alternative investments which include additional risks that should be thoroughly analyzed by American investors.
Hypothetically, an investor could choose to broaden their investing universe by choosing to consider ADRs. ADRs
ultimately increase the investment options for U.S. investors. They can also simplify international investing by
providing the offering to U.S. investors through U.S. market exchanges. For U.S. investors, ADRs can have some
unique risks. Primarily the risk of currency found in conversion with the payment of dividends. Otherwise, ADRs
are denominated in U.S. dollars but their initial offering value is based on a valuation that is created in terms of
their home currency.
3. Importance & Functions of IMF
 The IMF is an independent international organization. It is a cooperative of 185 member countries, whose
objective is to promote world economic stability and growth.1 the member countries are the shareholders of the
cooperative, providing the capital of the IMF through quota subscriptions (Box 1.1 and the Appendix). In return,
the IMF provides its members with macroeconomic policy advice, financing in times of balance of payments
need, and technical assistance and training to improve national economic management.
 The IMF is one of several autonomous organizations designated by the United Nations (UN) as “Specialized
Agencies,” with which the UN has established working relationships.2 The IMF is a permanent observer at the
UN.
 Functions The IMF pursues the various facets of its mandate in a number of ways. These are summarized below.
1) Surveillance over Members’ Economic Policies: In becoming members of the IMF, countries agree to pursue
economic policies that are consistent with the objectives of the IMF. The Articles of Agreement confer on the IMF
the legal authority to oversee compliance by members with this obligation, making the IMF “the only
organization that has a mandate to examine on a regular basis the economic circumstances of virtually every
country in the world.”
2) Financing Temporary Balance of Payments Needs: The Articles of Agreement enable the IMF to lend to member
countries that have a balance of payments need to provide temporary respite and enable countries to put in
place orderly corrective measures and avoid a disorderly adjustment of the external imbalance. Such lending is
usually undertaken in the context of an economic adjustment program implemented by the borrowing country to
correct the balance of payments difficulties, which also safeguards IMF resources. In addition to providing direct
financing to its member countries, the IMF plays an important catalytic role in helping member countries to
mobilize external financing for their balance of payments needs.
3) Combating Poverty in Low-Income Countries: The IMF provides concessional loans to low-income member
countries to help support these countries’ efforts to eradicate poverty. In this venture, the IMF works closely with
the World Bank and other development partners. In this area the IMF also plays a critical catalytic role to
mobilize external financing and donor support for the countries’ balance of payments and development needs.
The IMF also participates in two international initiatives to provide debt relief: the Heavily Indebted Poor
Countries (HIPC) Initiative and the Multilateral Debt Relief Initiative (MDRI).
4) Mobilizing External Financing: IMF endorsement of a country’s policies serves as an important catalyst for
mobilizing resources from bilateral and multilateral lenders and donors. They rely on an IMF endorsement of a
country’s economic policies or might even require a formal IMF supported economic program before committing
or disbursing their own resources to that country or granting debt relief. IMF policy assessments and
recommendations also provide important signals to investors and financial markets regarding a country’s
economic future, and impact on investor and market confidence in the economy.
5) Strengthening the International Monetary System: The IMF is the central institution in the international
monetary system. It serves as a forum for consultation and collaboration by members on international monetary

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 and financial matters, and works with other multilateral institutions to devise international rules that would
facilitate the prevention and orderly resolution of international economic problems.
6) Increasing the Global Supply of International Reserves: The IMF is authorized to issue an international reserve
asset called the Special Drawing Right (SDR) if there is a global need to supplement existing reserve assets. These
allocated SDRs are part of the net international reserves of members and can be exchanged for convertible
currencies. They are not a claim on the IMF. The SDR is also the IMF’s unit of account for all financial transactions
with members.
7) Building Capacity through Technical Assistance and Training: Technical assistance and training are provided in
the core areas of IMF expertise to help member countries design economic policies and improve economic
management capabilities, which in turn can help reduce the risk of policy failures and the countries’ resilience to
shocks, and facilitating program design and implementation. These activities are particularly important in
developing countries, where resources are scarce and institutions often weak.
8) Dissemination of Information and Research: The IMF is a premier source for economic analysis of its member
countries’ economic policies and statistical information. Information is disseminated through its numerous
economic reports and research studies on member countries, as well as specialized statistical publications. The
IMF also conducts research in areas relevant to its mandate and operations, mainly to improve its economic
analysis and its advice to member countries. The results of this research are disseminated through books, IMF
and academic journals and working papers, occasional papers, and the internet.

Section B
 An authorized dealer has quoted following rates in Inter-bank Market:

INR/ GBP spot: 91.50/91.80 INR/ $ spot: 62.60/62.90

INR/ GBP 3 month forward: 93.40/93.95 INR/ $ 3 month forward: 63.50/66.15

A) Calculate the forward premium or discount on INR with respect to GBP and $?
B) Calculate the GBP/ $ Spot rate and 3 months forward rates.

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