Global Financial System (BFIB233)

Unit I Environment of Global Financial System 6 Hours

Introduction – Global Financial System vs Domestic Financial System, Rise of
Multinational Corporation- Internationalization of Business and Finance-
Participants - Technological Advances and Other Developments

Unit II The Economic Environment 10 Hours

Introduction - Factors Determining Economic Activity- The Economic Cycle and
Economic Policy - Balance of Payments (BoP) and Exchange Rates Country Risk
Analysis Measuring Political
Risk- economic and political factors underlying country risk-Key Indicators of
Country Risk and Economic Health-Country Risk Analysis in International lending

Unit III Global Financial Securities- I 8 Hours

Equities/Stocks- Company Formation and Features and Benefits of Shares- The
Risks of Owning Shares- Corporate Actions- Bonds – Introduction- Characteristics
of Bonds- Types of Bonds- Asset-Backed Securities (ABSs)- International Bonds-
Yields- Other Financial Assets- Cash Deposit
Unit IV Global Financial Securities -II 8 Hours
Investment Funds-: Open-Ended Funds, Closed-Ended Investment Companies,
Exchange-Traded Funds (ETFs), Alternative Investment Funds (AIFs)- Derivatives

Unit V Global Financial Markets 10 Hours

Primary and Secondary Markets- Depositary Receipts- World Stock Markets-
Stock Market Indices- Settlement Systems. Money Markets- Property- Foreign
Exchange (FX)

Unit VI Global Financial Services 10 Hours

Financial Advice- Budgeting- Borrowing- Protection- Critical Illness Insurance
Cover- Investment and Saving- Legal Concepts in Financial Advice- The Financial
Advice Process- Other Financial Service: Wealth Management- Portfolio
Management- Brokerage Services-Credit Rating- Investment Banking- Factoring-
Depositories
Unit VII Regulation and Ethics 8 Hours
Need- Regulatory Principles- Financial Crime- Insider Trading and Market
Abuse- Integrity and Ethics in Professional Practice

Essential Reading:
• Shapiro Alan. C.(2012), Multinational Financial Management(9ed), Prentice
Hall, New Delhi.

Recommended Reading
1. Apte P.G (2011) , International Financial Management(6 ed), Tata McGraw Hill,
New Delhi.
2. Jeevanandam. C. Foreign Exchange and Risk Management. New Delhi: Sultan
Chand & sons.
3. Vij, M (2010). International Financial Management (3 ed). New Delhi: Excel
Books
 Company Formation
1. Promotion of the company
2. Registration of the company
3. Certificate of incorporation
4. Commencement of the business
 Promotion of the company
• The plan to start a company is brought into reality by this step.
Business ideas are brought into the frame in this step. The
promoter has a very important role at this stage.
• Promoter is a person who is starting with the stages of
formation of a company and is concerned with the promotion
of the business. he would be the person who would be
pitching in the business idea, finding out ways to fund his
business . that person would start the legal procedure for the
incorporation of the company. they would appoint the board
of directors and bankers for the company.
Now there are mainly 4 types of promoters
• Professional promoters- They promote the company in the
initial stage and as soon as the company is incorporated and
has a good position in the market the company would be
handed over to its shareholders.
• Occasional promoters- As the name suggests are not very
active in the promotion of the company. they might be
promoters of a few other companies. they are only involved in
the important affairs of the company.
• Financial promoters- Venture capitalists would invest money
or capital into a venture and hold an important stake in the
venture. They hold a strong power over the working of the
company.
• Managing agents as promoters of the company- These
promoters would float new companies in India. They would
get managing agency rights in return.
 Registration of The Company
According to the Companies Act, 2013;
• Memorandum of Association- The Memorandum of Association has to be signed
by the owners of the company. In the case of a public company, a minimum of 7
people has to sign the Memorandum of Association . In the case of a private
company, only two people have to sign it at a minimum.
• Articles of Association- It is also required to sign the Article of Association. Those
who have signed the Memorandum of Association are required to sign the Articles
of Association.
• List of Directors- In the next step the list of directors and their details have to be
prepared and it should be filed with the registrar of the companies.
• Written consent of the directors- The directors who have been selected should
write a written consent in which they agree to be the director of the company. This
has to be filed with the Registrar of Companies.
• Notice of address of the registered office- In this step the address of the registered
office has to be filed.
• Statutory declaration – A statutory declaration has to be made by any advocate
of the supreme court or the high court or the person who is the director,
secretary, or any practicing chartered accountant or manager of the company.
This has to be filed with the Registrar of Companies.
• Payment of Fee: Along with document mentioned above, required fees have to be
paid for the registration of the company.
• The registrar of the Company would then check all the documents and then would
verify them. If they are satisfied with the documents, then they would issue a
certificate called the certificate of incorporation.
 Certificate of Incorporation

• The certificate of incorporation is issued when the Registrar of

the company feels satisfied with the document filed in the step
mentioned above. The certificate of incorporation is required
to show that the company is incorporated according to the
Companies Act, 2013.
 Certificate of Commencement Of
business
• A private company can start its functioning once it receives the
certificate of incorporation, but that is not the case with the public
companies. For a public company to start doing its business, it needs
a certificate of commencement of business. After a private company
has received the certificate of incorporation, it can issue a prospectus
by which the public can subscribe to its shares and raise the capital.

• It is also required that the public buys the minimum number of

shares that are given in the prospectus. After the minimum number
of shares has been received, a letter has to be sent to the registrar
with bank details showing that the amount has been received. The
registrar goes through the documents and if he feels satisfied then
the registrar would issue the certificate of commencement of the
business. This is the proof that it is used to show the commencement
of the business.
 Equity shares
• Equity shares are long-term financing sources for any company. These
shares are issued to the general public and are non-redeemable in nature.
Investors in such shares hold the right to vote, share profits and claim assets
of a company.

• Features:
• Equity share capital remains with the company. It is given back only
when the company is closed.
• Equity Shareholders possess voting rights and select the company's
management.
• The dividend rate on the equity capital relies upon the obtain ability of
the surfeit capital.
 Types of equity shares
• Authorized Share Capital- This amount is the highest amount an organization can
issue. This amount can be changed time as per the companies recommendation
and with the help of few formalities.
• Issued Share Capital- This is the approved capital which an organization gives to
the investors.
• Subscribed Share Capital- This is a portion of the issued capital which an investor
accepts and agrees upon.
• Paid Up Capital- This is a section of the subscribed capital, that the investors give.
Paid-up capital is the money that an organization really invests in the company’s
operation.
• Right Share- These are those type of share that an organization issue to their
existing stockholders. This type of share is issued by the company to preserve the
proprietary rights of old investors.
• Bonus Share- When a business split the stock to its stockholders in the dividend
form, we call it a bonus share.
• Sweat Equity Share- This type of share is allocated only to the outstanding workers
or executives of an organization for their excellent work on providing intellectual
property rights to an organization.
 PREFERENCE SHARES
Preference shares, also known as preferred stock, is an exclusive
share option which enables shareholders to receive dividends
announced by the company before the equity shareholders.

Features of preference shares:

• Preferential dividend option for shareholders.
• Preference shareholders do not have the right to vote.
• Shareholders have a right to claim the assets in case of a wind
up of the company.
• Fixed dividend payout for shareholders, irrespective of profit
earned.
• Acts as a source of hybrid financing.
 TYPES OF PREFERENCE SHARES
Types of preference share are:
• Cumulative preference share: Cumulative preference shares are a special type
of shares that entitles the shareholders to enjoy cumulative dividend payout
at times when a company is not making profits.

• Non-cumulative preference shares: These types of shares do not accumulate

dividends in the form of arrears. In the case of non-cumulative preference
shares, the dividend payout takes place from the profits made by the company
in the current year. If there is a year in which the company doesn’t make any
profit, then the shareholders are not paid any dividends for that year and they
cannot claim for dividends in any future profit year.

• Participating preference shares: These types of shares allow the

shareholders to demand a part in the surplus profit of the company at the
event of liquidation of the company after the dividends have been paid to
the other shareholders.
• Non-participating preference shares: These shares do not yield the shareholders the additional
option of earning dividends from the surplus profits earned by the company. In this case, the
shareholders receive only the fixed dividend.

• Redeemable Preference Shares: Redeemable preference shares are shares that can be repurchased
or redeemed by the issuing company at a fixed rate and date. These types of shares help the
company by providing a cushion during times of inflation.

• Non-redeemable Preference Shares: Non-redeemable preference shares are those shares that
cannot be redeemed during the entire lifetime of the company. In other words, these shares can
only be redeemed at the time of winding up of the company.

• Convertible Preference Shares: Convertible preference shares are a type of shares that enables the
shareholders to convert their preference shares into equity shares at a fixed rate, after the expiry
of a specified period as mentioned in the memorandum.

• Non-convertible Preference Shares: These type of preference shares cannot be converted into
equity shares. These shares will only get fixed dividend payout and also enjoy preferential dividend
payout during the dissolution of a company.
 Benefits of Owning Shares
• Dividends
• Capital Gains
• Shareholder Benefits
• Right to Subscribe for New Shares
• Right to Vote
 The Risks of Owning Shares
• Price and Market Risk
• Liquidity Risk
• Issuer Risk
• Foreign Exchange Risk
 Corporate Actions
Corporate actions can be classified into the following three types.
1. A mandatory corporate action is one mandated by the company, not
requiring any intervention from the shareholders or bondholders. The
most obvious example of a mandatory corporate action is the payment of
a dividend, since all shareholders automatically receive the dividend.
2. A mandatory corporate action with options is an action that has some
sort of default option that will occur if the shareholder does not intervene.
However, until the date at which the default option occurs, the
individual shareholders are given the choice to select another option.
3. A voluntary corporate action is an action that requires the shareholder
to make a decision. An example is a takeover bid – if the company is
being bid for, each individual shareholder will need to choose whether to
accept the offer or not.
 Types of Corporate Action
• Rights Issue
• Open Offers (An open offer is made to existing shareholders
and gives the holders the opportunity to subscribe for
additional shares in the company or for other securities,
normally in proportion to their holdings)
• Bonus Shares
• Stock Splits and Reverse Stock Splits (A stock split involves
sub-dividing or splitting each share into a number of shares. A
reverse split or consolidation is the opposite of a split: shares
are combined or consolidated.)
• Dividends
• Mergers and takeovers
 BONDS
• A bond is, very simply, a loan.
• A company or government that needs to raise money to
finance an investment could borrow money from its bank or,
alternatively, it could issue a bond to raise the funds it needs
by borrowing from the investing public.
• With a bond, an investor lends in return for the promise to
have the loan repaid on a fixed date and (usually) a series of
interest payments. Bonds are commonly referred to as loan
stock, debt or (in the case of those which pay fixed income)
fixed-interest securities.
 Characteristics of Bonds
• Face Value/Par Value
• Coupon (The Interest Rate)
• Maturity
• Bond Security
When a company is seeking to raise new funds by way of a bond issue, it will
often have to offer security to provide the investor with some guarantee for the
repayment of the bond. The greater the security offered, the lower the cost
of borrowing should be. The security offered may be fixed or floating. Fixed
security implies that specific assets (eg, a building) of the company are charged
as security for the loan. A floating charge means that the general assets of the
company are offered as security for the loan; this might include cash at the
bank, trade debtors or stock.
• Redemption Provisions
A corporate bond will have a call provision which gives the issuer the option to
buy back all or part of the issue before maturity. This is attractive to the issuer
as it gives it the option to refinance the bond.
 Zero coupon bonds
A zero-coupon bond, also known as an accrual bond, is a debt security that does not pay
interest but instead trades at a deep discount, rendering a profit at maturity, when the bond
is redeemed for its full face value.

Features of zero coupon bonds

• Fixed maturity: The maturity date is fixed in Zero coupon bonds. The investor will only be
fully redeemed at face value on the specified maturity date. Due to this, the investor finds
it to be a very useful tool for long-term investing.
• Interest payments: No periodic interest payments are given to the investors in Zero coupon
bonds. As well as they are sold at a discount to their face value and then redeemed at face
value when they mature.
• Interest rate risk: The interest rates generally fluctuate as per the market condition, and
the scenario is similar for tax-free bonds as well.
• Long-term investment: Zero coupon bonds have a fixed maturity date and are treated as
long-term investment options. Because it works on the principle of longer maturity, higher
interest rates, and provides a great return on investments.
 Callable bonds
• Callable or redeemable bonds are bonds that can be redeemed or paid off
by the issuer prior to the bonds' maturity date. When an issuer calls its
bonds, it pays investors the call price (usually the face value of the bonds)
together with accrued interest to date and, at that point, stops making
interest payments.
Pros and Cons of callable bonds
 Deep-discount bonds
• A deep-discount bond is a bond that sells at a significantly
lesser value than its par value. In particular, these bonds sell
at a discount of 20% or more to par and has a yield that is
significantly higher than the prevailing rates of fixed-income
securities with a similar profiles.
Types of bonds
 Asset-Backed Securities (ABSs)

• There is a large group of bonds that trade under the

overall heading of asset-backed securities (ABSs).
• These are bundled securities, so called because they are
marketable securities that result from the bundling or
packaging together of a set of non-marketable assets.
• The assets in this pool, or bundle, range from mortgages
and credit card debt to accounts receivable.
• Mortgage-backed bonds are created by bundling together
a set of mortgages and then issuing bonds that are backed
by these assets. These bonds are sold on to investors, who
receive interest payments until they are redeemed.
 International bonds
Domestic and Foreign Bonds
• Bonds can be categorised geographically. A domestic bond is
issued by a domestic issuer into the domestic market, for
example, a UK company issuing bonds, denominated in
sterling, to UK investors.

• In contrast, a foreign bond is issued by an overseas entity into

a domestic market and is denominated in the domestic
currency. Examples of a foreign bond are a German company
issuing a sterling bond to UK investors or a US dollar bond
issued in the US by a non-US company.
• Eurobonds are large international bond issues often made by
governments and multinational companies.

The euro bond market offers a number of advantages over a domestic bond
market that make it an attractive way for companies to raise capital,
including:

• a choice of innovative products to more precisely meet issuers’ needs

• the ability to tap potential lenders internationally, rather than just
domestically
• anonymity to investors as issues are made in bearer form
• gross interest payments to investors lower funding costs due to the
competitive nature and greater liquidity of the market
• the ability to make bond issues on short notice, and
• less regulation and disclosure.
 YIELDS
• Yields are a measure of the returns to be earned on bonds.
• The coupon reflects the interest rate payable on the
nominal or principal amount. However, an investor may
have paid a different amount to purchase the bond, so a
method of calculating the true return is needed. The
return, as a percentage of the cost price, which a bond
offers is often referred to as the bond’s yield.
YIELD CURVE
 Cash deposits
• Cash deposits comprise accounts held with banks or other savings institutions.
They are held by a wide variety of depositors – from retail investors through to
companies, governments and financial institutions.

The main characteristics of cash deposits are:

• The return simply comprises interest income with no potential for capital
growth.
• The amount invested (the capital) is repaid in full at the end of the investment
term.
 Advantages of investing in cash
• One of the key reasons for holding money in the form of cash
deposits is liquidity. Liquidity is the ease and speed with
which an investment can be turned into cash to meet spending
needs. Most investors are likely to have a need for cash at
short notice and so should plan to hold some cash on deposit to
meet possible needs and emergencies before considering other
less liquid investments.
• The other main reasons for holding cash investments are as a
savings vehicle and for the interest return that can be earned
on them.
• A further advantage is the relative safety that cash investments
have and that they are not exposed to market volatility, as is
the case with other types of assets.
Dis-Advantages of investing in cash
• Banks and savings institutions are of varying
creditworthiness and the risk that they may default needs to
be assessed and taken into account.
• Inflation reduces the real return that is being earned on cash
deposits and often the after-tax return can be negative.
• Interest rates vary, and so the returns from cash-based
deposits will also vary.
• During periods of low global interest rates, charges on
money market accounts or funds can result in negative or flat
returns.
• When cash is deposited overseas, depositors should also
consider the following:
– The costs of currency conversion and the potential
exchange rate risks if the deposit is not made in the
investor’s home currency.
– The creditworthiness of the banking system and the
chosen deposit-taking institution, and whether a depositors’
protection scheme exists and if non-residents are protected
under it.
– The tax treatment of interest applied to the deposit.
– Whether the deposit will be subject to any exchange
controls that may restrict access to the money and its
ultimate repatriation.
 Money Market
• The money markets are the wholesale or institutional markets for cash
and are characterised by the issue, trading and redemption of short-
dated negotiable securities. These can have a maturity of up to one
year, though three months or less is more typical.
• By contrast, the capital markets are the long-term providers of finance
for companies, either through investment in bonds or shares.
• Treasury bills – these are usually issued weekly by, or on behalf of,
governments, and the money is used to meet the government’s short-
term borrowing needs.
• Certificates of deposit (CDs) – these are issued by banks in return for
deposited money: think of them as tradeable deposit accounts, as they
can be bought and sold in the same way as shares.
• Commercial paper (CP) – this is the corporate equivalent of a Treasury
bill. CP is issued by large companies to meet their short-term borrowing
needs. A company’s ability to issue commercial paper is typically
agreed with banks in advance.
 Property
• Property as an asset class is unique in its distinguishing features:
– Each individual property is unique in terms of location, structure
and design.
– Valuation is subjective, as property is not traded in a centralised
marketplace, and continuous and reliable price data is not available.
– Property is subject to complex legal considerations and high
transaction costs upon transfer.
– It is relatively illiquid as a result of not being instantly tradeable.
– It is also illiquid in another sense: the investor generally has to sell
all of the property or nothing at all. It is not generally feasible for a
commercial property investor to sell, for example, one factory unit
out of an entire block (or at least, to do so would be commercially
unattractive) – and a residential property owner cannot sell their
spare bedroom to raise a little cash.
 REVIEW QUESTION
• Discuss the functions and importance of
financial securities and financial services in
shaping the global financial system.
1. List of financial instruments and services
2. Their importance and functions
3. Their impact on domestic and global
financial system from economic
prospective of the company and country.