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IBO 06. International Business Finance. BLOCK 1. International Financial System. It involves the management of three processes (I) the adjustment of balance of payments positions, including the establishment and alteration of exchange rates;

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ibo 06

IBO 06

International Business Finance

block 1

BLOCK 1

International Financial System

international monetary system
It involves the management of three processes

(I) the adjustment of balance of payments positions, including the establishment and alteration of exchange rates;

(2) the financing of payments imbalances among countries by the use of credit or reserves; and

(3) the provision of international money (reserves).

International Monetary System

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evolution of international monetary system
Evolution of International Monetary System
  • Gold Standard-period prior to the 1914-18 was considered as gold standard
  • International debt settlement in gold
  • It was the foundation of international trading system
  • When the country had surplus then gold flowed into central bank
  • When the country had deficit then gold flowed outside

the country

| | <document classification>

slide5
Bretton Woods in IMF agreement
  • International conferrence was held in Bretton Woods in 1944
  • It was signed by 44 nations
  • IMF was to be established to promote consultation and collaboration on international problems
  • To lend to member countries

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regional financial institution
Regional Financial Institution
  • Asian Development Bank
  • African Development
  • European Investment Bank
  • Inter-American Development Bank
  • Atlantic Development Group for Latin America
  • Arab Fund for Economic And Social Development
  • European Bank for reconstruction and Development

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international financial markets
International Financial Markets
  • International financial markets is concerned with buying and selling currencies banking transactions

and capital market operations

  • International markets can be money (trading with the instruments less than 1 year)and capital market(deals with instruments maturity exceeds 1 year)

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slide8
International financial market include Euro Market
  • Euro is the official currency of the eurozone which includes Australia, finland, Germany, Greece, Italy, Spain etc.
  • Euro market quotes two rates Offered Rate (LIBOR), Bid rate (LIBID)

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international debt instruments
International Debt Instruments
  • Euro Notes is a promissory note with short term maturities
  • Euro Commercial papers large corporations with strong credit ratings is to raise funds by issuing CP. It is issued as unsecured security by commercial and financial institution . The prominent markets for commercial papers are US,Canada,UK,Japan,Australia
  • Medium Term Notes
  • Floating Rate Notes
  • Euro Bonds

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international banking
International Banking
  • International Money Transfer Mechanism
  • Correspondent bank
  • Foreign branch
  • Foreign agencies
  • Foreign subsidiary banks
  • Representative offices

| | <document classification>

terms of account in international banking
Terms of account in international banking
  • Two are used
  • Nostro
  • Vostro

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money market instruments
Money Market Instruments
  • Treasury Bills
  • Commercial papers
  • Banker’s acceptance
  • Certificate of deposits
  • Repurchase agreements

| | <document classification>

international banking risks and capital adequacy requirements
International Banking Risks and Capital Adequacy Requirements
  • Capital adequacy consists of
  • Core Capital (Tier I)
  • Supplemental Capital (Tier II) consists of
  • Secret reserves
  • Revaluation reserves
  • General provision and loss reserves
  • Hybrid debt capital instruments
  • Subordinated Debt

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international transactions and balance of payment
International transactions and balance of payment
  • BOP=all inflows-all outflows on current account and capital account
  • Value of visible exports can be balanced against the value of visible imports
  • Value of invisible exports can be balanced against the value of invisible imports to determine invisible balance
  • Balance of payment consists of balance of investment and other capital flows

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adjustment policies
Adjustment Policies
  • Unilateral Adjustments
  • Bilateral adjustments
  • Regional adjustments
  • Multilateral adjustments

| | <document classification>

block 2

BLOCK 2

Foreign Exchange Risk Management

foreign exchange markets
Foreign Exchange Markets
  • Foreign exchange market is the market where one currency is exchanged for another currency
  • Foreign currency market can be domestic as well as international
  • Currencies are also traded in the form of derivative contracts such as swaps,options,futures
  • Outcry method replaced by screen based trading
  • Foreign exchange rate is the rate at which one currency is traded in exchange for another in the forex market
  • In free market freely movement of prices as per the demand and supply

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slide18
In regulated market exchange rates are regulated and controlled
  • Forex markets are least partially regulated

| | <document classification>

foreign exchange quotations
Foreign Exchange Quotations
  • Direct Quotations
  • Indirect Quotations
  • Cross Rates

| | <document classification>

foreign exchange transactions
Foreign Exchange Transactions
  • Trade transaction
  • Interbank transactions
  • Spot transactions
  • Forward transactions

| | <document classification>

determination and forecasting of exchange rate
Determination and Forecasting of Exchange Rate

Approaches to exchange rate

  • Purchasing power parity It states prices of a similar products of two different countries should be equal when measured in common currency
  • Interest rate parity The forward discount/premium is app. equal to the interest differential between currencies
  • The Fisher Effect
  • The International Fisher Effect

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currency risk management
Currency Risk Management
  • Risk means the variability from the most likely happening.
  • Types of currency risk
  • Translation Risk
  • Transaction Risk
  • Economic Risk
  • Political Risk
  • Interest rate Risk

| | <document classification>

derivatives
Derivatives
  • Derivatives are financial instruments whose prices derived from the prices from the prices of other financial instruments. The action of managing risk is called derivatives
  • Hedging is the technique by which uncertainities can be reduced.

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derivative instruments
Derivative Instruments
  • Forward Contract and Forward Rate Agreements
  • Future Contracts
  • Currency Options
  • Currency Swaps
  • Interest Rate Swaps

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transaction exposure
Transaction Exposure
  • Transaction exposure is on transactions that a firm has already entered into and that are denominated in a foreign currency, the firm could incur future gains or losses owing to the unanticipated exchange rate fluctuations

| | <document classification>

techniques of transaction exposure
Techniques of Transaction Exposure
  • Forward market hedge
  • Money market hedge
  • Exposure netting
  • Currency risk sharing
  • Leading and lagging
  • Currency options currency futures
  • Currency swaps

| | <document classification>

translation exposure
Translation Exposure
  • It refers to the amount of risk facing as a result of the need to translate financial statements prepared in one currency into statements in another currency

| | <document classification>

currency translation methods
Currency Translation methods
  • Current/non current method
  • Monetary/non-monetary method
  • Temporal method
  • Current rate method

| | <document classification>

designing a hedging strategy
Designing a hedging strategy
  • Funds flow adjustment
  • Forward contracts
  • Exposure netting

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economic exposure
Economic Exposure
  • It is related with cash flow risk
  • Cash flow means net dividend and liquidation proceeds available to the owners
  • Free cash flow
  • Future earnings of the company
  • It is based on the extent to which the value of a company as measured by the present value of its expected future cash flows will change when exchange rate change

| | <document classification>

managing economic exposure
Managing Economic Exposure

Marketing initiatives

  • Market selection and segmentation
  • Pricing strategy
  • Promotional strategy
  • Product strategy

Production initiatives

  • Input mix
  • Shifting production among plants
  • Plant location
  • Raising productivity

Financial initiatives

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block 3

BLOCK 3

Investing in Foreign Operations

corporate strategy and foreign direct investment
Corporate Strategy and Foreign Direct Investment
  • Multinational Corporation is a corporate undertaking whose industrial operating are based in more than two countries and whose decision making process is based on the overall strategy

| | <document classification>

foreign direct investment
Foreign Direct Investment
  • FDI involves the setting up of subsidiaries in foreign countries for the domestic production of commodities which previously imported fro the parent company.
  • It is more concerned to developing countries where financial resources have more constraint.
  • It makes an opportunity of proper globalization concept and deployment of resources and technology in world wide.
  • In competitive advantage scenario it gives an opportunity of marketing expansion and as well as production and operation activity leveraged.

| | <document classification>

slide36
It is often used in the context of a company's plan of action that causes it to allocate its scarce resources (specially finance) over time "to get from where it is to where it wants to go". "Strategy" has been depicted as the base of a cold triangle (three hard elements), superimposed by four soft elements. in the well-known "SEVEN S's MODEL“

Corporate strategy, in association with structure (organisation chart) and systems (procedures), is supposed to achieve superordinate goals (significant objectives/guiding concepts) through skills (distinctive capabilities), staff (personnel) and style (organisational culture).

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indian regulation of foreign direct investment and guidelines
Indian Regulation of Foreign Direct Investment and Guidelines
  • In December 1996, the Reserve Bank of India allowed automatic approval of FDI up to74% in nine categories :

i) Electricity generation and transmission:Non-conventional energy generation and transmission;

iii) Maintenance of roads, bridges, ports, harbours, runways, waterways, tunnels, pipelines. industrial and power plants:

iv) Pipeline transport except POL (petroleum, oil and lubricant) and gas;

v) Water transport

| | <document classification>

foreign exchange regulation fera and fema
Foreign Exchange Regulation:FERA AND FEMA
  • FERA(Foreign Exchange Regulation Act) 1973 was inacted on the recommendations 47th report of Law Commission.After reviewing FERA FEMA was enacted in 1999
  • FERA considered offence as criminal offence while FEMA considered civil offence
  • Appellate board replaced by Appellate Tribunal and Special Director(appeals) under FEMA
  • The defaulters shall be liable to civil imprisonment
  • The penalty is thrice the sum involved or upto two lakfh rupees

| | <document classification>

international project appraisal
International ProjectAppraisal
  • Projects involve long term expenditure, the amount of expenditure being generally large. An important characteristic of projects is Once committed, it is difficult to liquidate without substantial loss.
  • An obvious implication of it is that the cost of error of judgement in case of projects is very high.
  • So,an international investor should appraise a project as 'stand alone'

| | <document classification>

project appraisal
Project Appraisal

Project appraisal is whether or not to put the money in the project it means comparing return on investment with the cost of the funds. Only if the return is higher than the cost of funds, it would make sense to put the money in a project.

  • Under the financial appraisal, market-price-based cash flows accruing to the project arc considered.
  • Under the economic appraisal, economic prices or shadow price based cash flows accruing to the project are considered.
  • Under the social appraisal, economic prices based cash flows accruing to project and its social and environmental context are considered.
  • Technological appraisal involves assessment of the requirements of the
  • construction, commissioning, operation and maintenance and abandonment phases of the project.

| | <document classification>

project appraisal technique
Project Appraisal Technique

Discounted Cash Flow technique

  • NPV
  • IRR

Non-Discounted Cash Flow Technique

  • Pay back Period
  • Accounting Rate of Return

| | <document classification>

adjusted present value technique
Adjusted Present Value Technique
  • It includes
  • Initial investment
  • Project’s Remittable Cash Flow
  • Contribution of subsidies and concession to project
  • Tax savings and other transfers to parent

| | <document classification>

cost of capital for foreign investment
Cost of Capital for Foreign Investment
  • Cost capital is the measure of financial performance of a firm
  • Cost capital is the minimum risk adjusted return required by investors for undertaking an investment
  • the net present value of the future cash flows of the project exceeds or at least be equal to the project's cost of capital. This cost is used as a discount rate.

| | <document classification>

weighted average cost of capital for foreign projects
Weighted Average Cost of Capitalfor Foreign Projects
  • The weighted average cost of capital (WACC) of the project, is the cost of equity combined with the after-tax cost of debt.
  • KO = ko( I - L ) K e + L i d ( l - t )
  • Where,
  • KO = Weighted cost of capital
  • L = debt ratio (debt to total assets) of the parent company
  • Ke = cost of the equity capital
  • id (1-t) = after-tax cost of the debt.

| | <document classification>

cost of various sources of funds
Cost of Various Sources of Funds
  • Cost of Parent Company's Funds
  • KO' = KO + (I-L) (Ke'-Ke)

KO* = Cost of capital in changed conditions of riskiness

Ke' = Cost of equity based on new perceptions of riskiness

Ke = Company's cost of equity capital

L = Debt ratio of the parent company

| | <document classification>

slide46
The Cost of Retained Earnings
  • ks= Ke x (1 - t)
  • where
  • Ks = cost of retained earnings
  • t = tax rate
  • Cost of Foreign Debt :

Rfd = Rf(l-t)(l-d)-d

where

Rfd = Cost of foreign debt

Rf = ' Foreign interest rate 1

d = Percentage depreciation of foreign currency

| | <document classification>

cost of equity capital
Cost of Equity Capital
  • Cost of equity is the minimum rate of return necessary to induce investors to buy or hold the
  • Rr = Rf+ Rp
  • Rr = required rate of return
  • Rf = risk free rate of return
  • Rp = risk premium

| | <document classification>

dividend valuation model
Dividend Valuation Model
  • Ke=Div1/Po+g

Ke=company cost of equity capital

Div1=expected dividend in year 1

Po=current price of share

g=growth rate of dividend

| | <document classification>

capital asset pricing model
Capital Asset Pricing Model
  • Ri = Rf+bi(Rm-Rf)
  • Ri=equilibrium expected return for asset I
  • Rf=risk free rate
  • Rm=expected return on market portfolio
  • Bi=covariance between return and market portfolio

| | <document classification>

political risk and tax aspects
Political Risk And Tax Aspects
  • Political risk is defined as the possibility of unwanted consequences of political activity and events. There are three major categories of political risks. (a) forced disinvestment

(b) unwelcome regulation and

(c) interference with operations. Forced disinvestment occurs when a host government acquires assets of a company against company's will.

| | <document classification>

assessment of political risk
Assessment of Political Risk
  • a) The recognition of political risk and its likely consequence; this stage is concerned with measuring political risk.
  • b) The development of policies to cope with political risk; this stage is concerned

with managing political risk.

  • c) Should expropriation occur, the development of tactics to maximise compensation; this stage is concerned with developing post expropriation policies.

| | <document classification>

measuring political risk
Measuring Political Risk
  • There are two approaches to measure the political risk.
  • Firstly, there is the country- specific route (called macro approach), and
  • secondly one can take the firm specific route (called the micro-approach)

| | <document classification>

managing political risk
Managing Political Risk
  • Pre-investment Planning

An MNC can follow each or all of the following policies.

  • 1) avoidance
  • 2) insurance
  • 3) negotiating the environment
  • 4) structuring the investment.

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slide54
Operating Policies

a) Planned dis-investmant,

b) Short-term profit maximisation,

c) Changing the benefit/cost ratio of expropriation,

d) Developing total stakeholders,

e) Adaptation.

| | <document classification>

post expropration policies
Post Expropration Policies
  • Rational negotiations
  • Applying power
  • Legal remedies
  • Management Surrender

| | <document classification>

multilateral investment guarantee agency
Multilateral Investment GuaranteeAgency

MIGA policies and practices can be divided into two classes:

a) Investment Marketing Services

b) lnvestment Guarantee Services

| | <document classification>

slide57
Investment Marketing Services : Marketing Core services fall into three broad areas

1) Capacity building

2) Information dissemination

3) Investment facilitation

| | <document classification>

block 4

BLOCK 4

Financing International Operations

designing global capital structure
Designing Global CapitalStructure

Financial theory states that for each firm there is a combination of different sources of finance i.e. debt, equity, and other forms (preferred stock, etc.) which maximises its value, while simultaneously minimising its cost of capital.

| | <document classification>

sources of external funds
Sources of External Funds
  • Foreign Bonds
  • Foreign Bank Loans
  • Foreign Equity

| | <document classification>

world wide capital structure
World-Wide Capital Structure

designing capital structure would require

(1) determining the cost of individual sources of funds employed (or planned to be employed),

(2) determining the proportion in which different sources of funds are employed (or planned to be employed)

(3) computing the weighted average cost of capital of different sources of funds employed (or planned to be employed).

| | <document classification>

foreign subsidiary capital structure
Foreign Subsidiary Capital Structure

The problem is whether foreign subsidiary capital structures

a) Conform to the capital structure of the parent company

b) Reflect the capitalization norms in each foreign country

c) Vary to take advantage of opportunities to minimise the MNC's cost of capital

| | <document classification>

international cash management
International Cash Management
  • Cash management can be examined from two perspectives: an intracountry perspective and

an intercountry perspective.

lntracountry cash management deals with the payment systems, banks, investments and borrowing sources available in a particular country.

Intercountry cash management deals with cash movement among several countries.

| | <document classification>

integrating cash and foreign exchange management
Integrating Cash and Foreign Exchange Management

The objectives of a system integrating cash and foreign exchange management are to:

a) maxirnise total cash or to minimise total borrowings in all currencies together, avoiding concurrent investment and borrowing unless there are arbitrage opportunities;

b) minimise foreign exchange exposure levels and insure exposure netting;

C) minirnise fluctuations of foreign exchange exposure levels; and

d) minimise transaction costs.

| | <document classification>

factors affecting working capital cash management
Factors Affecting Working Capital/Cash Management
  • Absence of Forward Markets
  • Transaction Costs
  • Political Risk
  • Liquidity requirements
  • Taxes

| | <document classification>

importance of cash cycle in cash management
Importance of Cash Cycle in Cash Management
  • Information is distributed on the basis of a need to know which is different from cash requirements.
  • Short payment channels involving a minimum number of banks allow for maximum control.
  • Modern commnunication systems are used.
  • Efficient banks with high standards of customer service are employed.
  • There is a minimal impact on the internal corporate organisation, decision making pattern and accounting system.

| | <document classification>

float management
Float Management
  • Float is created in business transactions when funds are moved from one party to another.
  • Float is simply the availability of funds to one of the parties.
  • four types of float can be identified: settlement float, transit (or mail) float, processing float, and clearing (or value dating) float.

| | <document classification>

centralised cash management
Centralised Cash Management
  • continuously monitor net open positions and take action;
  • identify all opportunities for netting exposures between operating units;
  • provide foreign exchange and investment expertise in support of the operating unit
  • provide centralised foreign exchange reporting.

| | <document classification>

advantages of centralised cash management
Advantages of centralised cash management
  • Netting
  • Currency Diversification
  • Pooling

| | <document classification>

foreign trade financing
Foreign Trade Financing
  • Financing of trade requires large amount of money and financial services. The banks and financial institutions play vital role in providing the necessary help in this regard. There are uniform customs and rules for documentary credits followed all over the world in foreign trade.

| | <document classification>

payment terms in international trade
Payment Terms in International Trade
  • EXW - Ex works: Title and risk pass to buyer including payment of all transportation and insurance cost from the seller's door.
  • FCA - Free Carrier: Title and risk pass to buyer including transportation and insurance cost when the seller delivers goods cleared for export to the carrier. Seller is obligated to load the goods on the buyer's collecting vehicle; it is the buyer's obligation to receive the seller's arriving vehicle unloaded.

| | <document classification>

slide72
FAS - Free Alongside Ship : Title and risk pass to buyer including payment of all transportation and insurance cost once delivered alongside ship by the seller. Used for sea or inland waterway transportation. The export clearance obligation rests with the seller.
  • FOB - Free On Board : Title and risk pass to buyer including payment of all transportation and insurance cost once delivered on board the ship by the seller..
  • CFR - Cost and Freight : Title, risk and insurancecost pass to buyer when delivered on board the ship by seller who pays the transportation,

| | <document classification>

slide73
CIF - Cost, Insurance and Freight : Title and risk pass to buyer when delivered on
  • board the ship by seller who pays transportation and insurance cost to destination pol?.
  • Used for sea or inland waterway transportation.
  • CPT -Carriage Paid To : Title, risk and insurance cost pass to buyer when delivered to carrier by seller who pays transportation cost to destination. Used for any mode of transportation.

| | <document classification>

transport documents
Transport Documents
  • Shipping bill
  • Bill of lading
  • This document fulfils three functions:

1) A receipt given by the shipping company for goods accepted for carriage by sea from one port to another.

2) A document of title to goods; these will only be released to the importer at the port of discharge against production of a signed original bill of lading.

  • Combined transport document

| | <document classification>

slide75
3)A contract of carriage, called contract of affreightment.
  • Combined transport document
  • Airway Bill
  • Parcel post receipt

| | <document classification>

invoices
Invoices
  • Pro-forma Invoice
  • Commercial Invoice
  • Consular Invoice

| | <document classification>

insurance policy
Insurance Policy
  • It is an undertaking given by the insurers promising to pay or secure payment of money as compensation in case the goods under movement or otherwise are subjected to loss, theft, damage etc.

| | <document classification>

slide78
The exporter must identify the risks involved with the transaction and insure against them. Broadly the main risks are:
  • a) Commercial
  • b) Transportation (usually marine)) e.g. Perils of the sea
  • c) Buyer refusing delivery or not paying

| | <document classification>

slide79
d) Political, for example, an overnight coup in the country, or government restrictions
  • imposed on foreign exchange transfer
  • e) Interest rate fluctuations, specially in long-term capital projects; and
  • f) Fluctuations in the exchange rate between the exporter's and the customer's currency.

| | <document classification>

bills of exchange
Bills of Exchange
  • an instrument in writing;
  • an unconditional order signed by the maker (drawee);
  • a direction given to a specific person (drawee); and
  • made payable to a certain person or to his order or bearer.

| | <document classification>

trade finance
Trade Finance
  • Trade finance involves a wide range of financial engineering tools, such as factoring, forfaiting, countertrade, joint ventures and various forms of private and official credit insurance.

| | <document classification>

slide82
Trade Finance is broadly classified into two categories, namely:

I. Pre-shipment finance

II. Post-shipement

| | <document classification>

slide83
Pre-shipment finance is nothing but a working capital finance (mainly inventory finance) extended to an exporter in anticipation of his exporting the goods
  • Basic purpose of extending pre-shipment finance is to enable the eligible exporters to procure/process/ manufacture/warehouse/shipthe goods meant for export.

| | <document classification>

slide84
Post-shipment finance is extended after shipment of the goods to the date of realisation of export proceeds. Post-shipment finance can be classified as under:
  • a) Negotiation/payment/acceptance of export documents under letter of credit (LIC)
  • b) Purchase/discount of export documents
  • c) Advances against export bills sent on collection basis.
  • d) Advances against exports on consignment basis.
  • e) Advances against retention money relating to exports
  • f) Financing of Projects exports and Services exports.
  • g) Advances against deemed exports etc.

| | <document classification>

letter o f credit
Letter of Credit

| | <document classification>

forfaiting
Forfaiting
  • Forfaiting is the purchase of a series of notes, usually bills of exchange, promissory notes, or other freely instruments, on a non-recourse basis.
  • The documents are required by the Forfaiter from the exporter are:

1. Copy of supply contract, or of its payments terms

2.Copy of signed commercial invoice

| | <document classification>

slide87
3. Copy of shipping documents including certificates of receipt, railway bill, airway bill, bill of lading or equivalent documents -

4. Letter of assignment and notification to the guarantor

5. Letter of guarantee or aval, the aval is the forfaiters' preferred form of security of payment of a bill or note. The buyer's (importer's) banker's co-acceptance is called

  • avalisation.

| | <document classification>

bankers acceptances
Bankers Acceptances
  • Under the negotiable instruments act ,I 881 is - "a bill of exchange is an instrument in writing containing an unconditional order, signed by the maker, directing a certain person to pay a certain sum of money only to, or to the order of, a certain person or to the bearer of the instrument."

| | <document classification>

guarantee bond
Guarantee/Bond
  • They give a buyer certainty over receiving pre-agreed payments if a supplier fails to meet his contractual obligations.
  • Tender (Bid) Guarantees
  • Performance Bonds
  • Advance Payment Bonds
  • Retention Bonds
  • Customs Guarantees
  • Bill of Lading Indemnities

| | <document classification>

countertrade
COUNTERTRADE
  • Countertrade activities fall into three main categories
  • 1) A means of financing - often where the buyer is short of foreign exchange- with no,
  • or only a partial, exchange of money between the original buyer and the seller;
  • 2) A trading technique aimed, perhaps, at developing a new export market or boosting
  • existing volurnes of export business;
  • 3) A means of balancing trade for either economic or political reasons - this was most
  • frequently the case with the east European countries.

| | <document classification>

project export financing
Project Export Financing
  • Project Export is used for
  • Export of engineering goods on deferred payments
  • Turnkey contracts
  • Overseas civil

| | <document classification>

risk in project export
Risk in Project Export
  • Commercial Risk
  • Country Risk
  • Exchange And Interest Rate Risk

| | <document classification>

conditions for clearance of project
Conditions for Clearance of Project
  • Advance Payment
  • Forex outgo
  • Agency Commission
  • Deferred credit

| | <document classification>

techniques of financing export project
Techniques of Financing Export Project

The sources for loans can be divided into

  • Commercial lenders
  • Commercial sponsors

The sources of project export financing

  • The world Bank and Regional development Banks
  • Govt. Export Financing
  • Commercial Banks

| | <document classification>