PART 5: INTERNATIONAL FINANCE

Unit 5.1. Foreign Exchange

Introduction: Money represents purchasing power. Having money from a country
gives you the power to purchase goods and services produced by residents of other
countries. However, the purchase of goods and services produced in another country
generally requires firstly the possession of other country’s currency. This is done on
the foreign exchange (FX) market which is the largest financial market in the world by
virtually any standard. On completion of this unit, students are expected to realize
important role of the FX market as well as understand structure and basic operational
practices on the market. Access to primary and specific English terminologies
regarding international finance in general, and foreign exchange in particular, helps
students be self-confident in adopting knowledge from developed countries in the
world.
This unit begins with a reading of function and structure of the FX market.
Followings are exercises relating to terminologies in international finance in general
and foreign exchange in particular. The unit concludes with translation exercises.
1. READING
Read the text and use your words to answer the following questions:
Function and structure of the FX market
Broadly defined, the foreign exchange (FX) market encompasses the conversion of
purchasing power from one currency into another, bank deposits of foreign currency,
the extension of credit denominated in a foreign currency, foreign trade financing,
trading in foreign currency options and futures contracts, and currency swaps.
The structure of the foreign exchange market is an outgrowth of one of the primary
functions of a commercial banker: to assist clients in the conduct of international
commerce. For example, a corporate client desiring to import merchandise from
abroad would need a source of foreign exchange if the import was invoiced in the
exporter’s home currency. Alternatively, the exporter might need a way to dispose of
foreign exchange if payment for the export was invoiced and received in the
importer’s home currency. Assisting in foreign exchange transactions of this type is
one of the services that commercial banks provide for their clients, and one of the
services that bank customers expect from their bank.
In terms of operation mechanism, the foreign exchange market consists of two
categories: over-the-counter and exchange-traded. Over-the-counter (OTC) markets
mean trading does not take place in a central marketplace where buyers and sellers
congregate. Rather, the foreign exchange market is a worldwide linkage of bank
currency traders, nonbank dealers, and FX brokers, who assist in trades, connected to

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one another via a network of telephones, computer terminals, and automated dealing
systems. Reuters and Electronic Broking Services (EBS) are the largest vendors of
quote screen monitors used in trading currencies. The communication system of the
FX market is second to none, including industry, government, the military, and
national security and intelligent operations. While the spot and forward foreign
exchange markets are OTC markets, a future contract is typically exchange-traded,
that is, traded on organized exchanges rather than over the counter. A client desiring a
position in futures contracts contacts his broker, who transmits the order to the
exchange floor where it is transferred to the trading pit. In the trading pit, the price for
the order is negotiated by open outcry between floor brokers or traders.
The FX market can also be viewed as a two-tier market. One tier is the wholesale
or interbank market and the other tier is the retail or client market. FX market
participants can be categorized into five groups: international banks, bank customers,
nonbank dealers, FX brokers, and central banks. International banks provide the core
of the FX market. They stand willing to buy or sell foreign currency for their own
account. These international banks serve their retail clients, the bank customers, in
conducting foreign commerce or making international investment in financial assets
that require foreign exchange. Bank customers broadly include MNCs, money
managers, and private speculators. Nonbank dealers are large nonbank financial
institutions such as investment banks, mutual funds, pension funds, and hedge funds.
FX brokers match dealer orders to buy or sell currencies for a fee, but do not take a
position themselves. The central bank of a particular country intervenes in the FX
market in an attempt to influence the price of its currency against that of a major
trading partner.
(Source: Cheol S. Eun and Bruce G. Resnick (2007), International Financial
Management, McGraw-Hill/Irwin Publishing)
QUESTIONS
1.1. Does the FX market refer to conversion of one country’s currency to another
country’s currency only? Is the FX market the only one on the international financial
market?
1.2. What is the primary function of the FX market? Suppose you are an
importer/exporter, how can you conduct your business without a FX market?
1.3. What does it mean by over-the-counter foreign exchange market?
1.4. What is the difference between OTC markets and exchanges?
1.5. What are motivations of the FX market participants?
1.6. In your opinion, what does a financial manager need to take into consideration
when the company operates globally?

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2. EXERCISES
2.1 Find the best answer
1. When the government doesn’t control the exchange rate in any way, the currency is
________________.
a. freely convertible b. totally convertible c. absolutely convertible
2. The Japanese yen is trading for less than its usual value. You can talk about
________________.
a. a small yen b. a bad yen c. a weak yen
3. When you change money, you usually have to pay a ________________.
a. commission b. percentage c. fee
4. Changes in the value of currencies are called ________________.
a. currency fluctuations b. currency alterations c. currency changes
5. An Internet site which does currency calculations based on the latest exchange rates
is called a ________________.
a. currency changer b. currency converter c. currency setter
2.2 Match the words/phrases 1-9 with the phrases a-i to make definitions
1. Currency a. The theory explaining the change in foreign currency
depreciation exchange rates as inflation rates in the countries
change.
2. Spot Forex b. A position of holding fewer assets than liabilities in a
transactions given currency
3. Net exposure c. Foreign exchange transactions involving the
immediate exchange of currencies at the current
exchange rate
4. Currency d. A position of holding more assets than liabilities in a
appreciation given currency
5. Law of one price e. A country’s currency rises in value relative to other
currencies
6. Net long in a f. In an efficient market, identical goods and services
currency produced in different countries should have a single
price
7. Purchasing power g. The exchange of currencies at a specified exchange
parity rate (or forward exchange rate) at some specified

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 date in the future.
8. Net short in a h. A country’s currency falls in value relative to other
currency currencies
9. Forward foreign i. A financial institution’s overall foreign exchange
exchange exposure in any given currency
transactions
2.3 Read the paragraph below and find the right word/phrase from the box to
fill each of the gaps. One word/phrase can be used for several times.
converted pounds increases
current fall more expensive
rise decreases easier
cheaper harder dollar
transferred spot immediate
dealer future forward
Spot exchange transactions involve the (1) ________________ exchange of
currencies at the (2) ________________ (or (3) ________________) exchange rate.
Spot transaction can be conducted through the foreign exchange division of
commercial banks or a nonbank foreign currency (4) ________________. For
example, a U.S. investor wanting to buy British (5) ________________through a local
bank, essentially has the dollars (6) ________________ from his or her bank account
to the (7) ________________ account of a pound seller at the spot rate.
Simultaneously, pounds are transferred from the seller’s account into an account
designated by the U.S. investor. If the dollar depreciates in value relative to the pound,
the value of the pound investment, if (8) ________________ back into U.S. dollars,
(9) ________________ If the dollar appreciates in value relative to the pound, the
value of the pound investment, if (10) ________________ back into U.S. dollars, (11)
________________. The appreciation of a country’s currency (or a (12)
________________ in its value relative to other currencies) means that the country’s
goods are (13) ________________ for foreign buyers and foreign goods are (14)
________________ for foreign sellers (all else constant). Thus, when a country’s
currency appreciates, domestic manufacturers find it (15) ________________ to sell
their goods abroad and foreign manufacturers find it (16) ________________ to sell
their goods to domestic purchasers. Conversely, depreciation of a country’s currency
(or a (17) ________________ in its value relative to other currencies) means the
country’s goods become (18) ________________ for foreign buyers and foreign
goods become (19) ________________ for foreign sellers.

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2.4. Mark the following statements as true (T) or false (F)?
1. FX market participants can be categorized into three groups: international banks,
bank customers, and nonbank dealers.
2. A change in the exchange rate from $1.5/£ to $1.2/£ means devaluation of the
dollar.
3. A change in the exchange rate from $1.2/£ to $1.5/£ means revaluation of the
dollar.
4. Twenty-four-hour-a-day currency trading means trading on an organized
exchange.
5. FX brokers match dealer orders to buy and sell currencies and take a risky
position themselves.

Question
1 FX market participants can be categorized into five groups: international
banks, bank customers, nonbank dealers, FX brokers, and central banks.
2 A change in the exchange rate from $1.5/£ to $1.2/£ means appreciation
of the dollar.
3 A change in the exchange rate from $1.2/£ to $1.5/£ means depreciation
of the dollar.
4 Twenty-four-hour-a-day currency trading means over-the-counter
trading.
5 FX brokers match dealer orders to buy or sell currencies for a fee, but do
not take a position themselves.

2.5 Which of the followings indicate the word CLOSEST in meaning to the
underlined word(s):
1. The US dollar rose gently against the euro.
a. soared b. weakened c. gained slightly
2. We have to pay €1.50 to buy £1.
a. One-and-half-euros b. One euro fifty c. One point five euros
3. The Australian dollar fell sharply against the Japanese yen.
a. weakened b. hit a new low c. levelled off
4. The Chinese yuan bottomed out against the US dollar during the last week.

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 a. remained steady b. slid a little c. plunged
5. The Russian ruble shot up against the US dollar last month.
a. went up half a cent b. plummeted c. hit a new high

3. TRANSLATION
Translate the following texts into Vietnamese, paying a special attention to the
standard use of terms and clarification of expression.
Text 1
How is Foreign Exchange Traded?
You cannot go to a centralized location to watch exchange rates being determined;
currencies are not traded on exchanges such as the New York Stock Exchange.
Instead, the foreign exchange market is organized as an over-the-counter market in
which several hundred dealers (mostly banks) stand ready to buy and sell deposit
denominated in foreign currencies. Because these dealers are in constant telephone
and computer contact, the market is very competitive; in effect, it does not function
differently from a centralized market.
An important point to note is that although banks, companies, and governments talk
about buying and selling currencies in foreign exchange markets, they do not take a
fistful of dollar bills ans sell them for British pound notes. Rather, most trades involve
the buying and selling of bank deposits denominated in different currencies. So when
we say that a bank is buying dollars in the foreign exchange market, what we actually
mean is that the bank is buying deposits denominated in dollars.
Trades in the foreign exchange market consist of transactions in excess of $1
million. The market that determines the exchange rates is not where one would buy
foreign currency for a trip abroad. Instead, we buy foreign currency in the retail
market from dealers such as American Express or from banks. Because retail prices
are higher than wholesale, when we buy foreign exchange, we obtain fewer units of
foreign currency per dollar, that is, we pay a higher price for foreign currency than the
exchange rates published daily in newspapers and Internet sites.
(Source: Frederic S. Mishkin (2013), The Economics of Money, Banking, and
Financial Markets, Peason Education Limited)
Text 2
Yuan’s global popularity will impact Vietnam’s economy
The inclusion of China’s Yuan into the International Monetary Fund (IMF)’s
basket of reserve currencies will impact finance across the globe, and Vietnam is no

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exception. The change will have both positive and negative impacts on Vietnam’s
economy.
China will now have to restrain its devaluation of the Yuan in order to take more
responsibility in applying policies to harmonize global benefits. The expected stability
of Chinese foreign exchange policies would therefore benefit Vietnam’s economy.
Also, if the Yuan becomes even more popular, stable and healthy, then Chinese and
Vietnamese firms would not have to use the US dollar in payment. The shift could
also help stabilize the payment and trade relations between the two countries.
On the other hand, Vietnamese firms would be at a high risk of Chinese takeover,
as many Vietnamese firms are scheduled to be equitized. In the long run, a more
prevalent Yuan in payment would impact Vietnam’s exports and imports. When the
Yuan’s value and popularity increase, Chinese partners could suggest making more
use of the Yuan in payment. Prices of materials and equipment imported from China
will increase, causing Vietnamese commodities to cost more. To minimize the
impacts, domestic firms should capitalize on advantages from the free trade
agreements Vietnam has signed in order to diversify material import markets.
(Source: http://vietnamnews.vn/economy/343830/yuans-global-popularity-will-
impact-vn-economy.html)

4. TERMINOLOGY
Electronic Broking Services (EBS) - Dịch vụ môi giới ngoại hối điện tử: A
wholesale electronic trading platform used to trade foreign exchange (FX) with
market making banks. It was originally created as a partnership by a number of the
world's largest banks and is now part of ICAP.
Exchange - Thị trường giao dịch tập trung: An organized market where (especially)
tradable securities, commodities, foreign exchange, futures, and options contracts are
sold and bought.
Net long (short) in a currency - Trạng thái trường (đoản) ngoại tệ: A position of
holding more (fewer) assets than liabilities in a given currency.
Over-the-counter (OTC) - Thị trường giao dịch phi tập trung: OTC dealers
convey their bid and ask quotes and negotiate execution prices over such venues as the
telephone, mass e-mail messages, and, increasingly, instant messaging.

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 Unit 5.2. Foreign Currency Derivatives

Introduction: Financial management of the multinational enterprise will need to

consider the use of financial derivatives. The financial manager of a multinational
enterprise may purchase these financial derivatives in order to reduce the risks
associated with the foreign exchange rates and everyday management of corporate
cash flow as well, hedging, or may use the instruments to take positions in the
expectation of profit, speculation. For these financial instruments being used
effectively, the financial manager must understand certain basics about their structure
and pricing. On completion of this unit, students are equipped with fundamentals of
their use for speculative purposes. Following spots and forwards which were
introduced in the previous unit, two common foreign currency financial derivatives,
futures and options, will be covered in this unit.
This unit begins with a reading of fundamentals of foreign currency derivatives.
Followings are exercises relating to specialized terminologies of individual
instruments. The unit concludes with translation exercises.
2. READING
Foreign Currency Derivatives
Financial derivatives, so named because their values are derived from an
underlying asset like a stock or a currency, are a powerful tool used in business today
for two very distinct management objectives, speculation and hedging. In this article,
we mention futures and options.
A foreign currency futures contract is an alternative to a forward contract that calls
for future delivery of a standard amount of foreign exchange at a fixed time, place,
and price. It is similar to futures contracts that exist for commodities (hogs, cattle,
lumber, and so on), interest bearing deposits, and gold. Most world money centers
have established foreign currency futures markets. In the United States, the most
important market for foreign currency futures is the International Monetary Market
(IMM) of Chicago, a division of the Chicago Mercantile Exchange. Contract
specifications are established by the exchange on which futures are traded. For
example, in the Chicago IMM, the major features that must be standardized are: size
of the contract, method of stating exchange rates, maturity date, last trading day,
collateral and maintenance margins, settlement, commissions, and use of a Clearing
House as a counterparty. These also make futures contracts different from forward
contracts. Financial managers typically prefer foreign currency forwards over futures
because of forwards’ simplicity of use and position maintenance. Financial
speculators typically prefer foreign currency futures over forwards because of the
liquidity of the futures markets.

8
 A foreign currency option is a contract giving the option purchaser (the buyer) the
right, but not the obligation, to buy or sell a given amount of foreign exchange at a
fixed price per unit for a specified time period (until the maturity date). The most
important phrase in this definition is “but not the obligation”; this means that the
owner of an option possesses a valuable choice. There are two basic types of options,
calls and puts. A call is an option to buy foreign currency, and a put is an option to sell
foreign currency. Every option has three different price elements: 1) the exercise or
strike price; 2) the premium; and 3) the underlying or actual spot exchange rate in the
market. An option whose exercise price is the same as the spot price of the underlying
currency is said to be at-the-money (ATM). An option that would be profitable,
excluding the cost of the premium, if exercised immediately is said to be in-the-money
(ITM). An option that would not be profitable, again excluding the cost of the
premium, if exercised immediately is referred to as out-of-the-money (OTM).
Speculation is an attempt to profit by trading on expectations about prices in the
future. In the foreign exchange market, one speculates by taking a position in a foreign
currency and then closing that position after the exchange rate has moved; a profit
results only if the rate moves in the direction that the speculator expected.
Financial derivatives are a powerful tool in the hands of careful and competent
financial managers. They can also be very destructive devices when used recklessly.
In the right hands and with proper controls, financial derivatives may provide
management with opportunities to enhance and protect their corporate financial
performance. On the other hand, they may bring down the enterprise through
uncontrolled speculation.
(Source: David K. Eiteman, Arthur I. Stonehill, and Michael H. Moffett (2009),
Multinational Business Finance, 12th edition, Pearson Publishing.
QUESTIONS
1.1. Are derivatives known as a powerful tool for hedging against exchange rate risk
only?
1.2. Do you agree that using derivatives helps investors or enterprises be save from
risks?
1.3. Are Spot and Spot Arbitrage derivative tools? What are instruments called
derivatives?
1.4. What are the main differences between Futures and Forwards?
1.5. What are important factors of an option contract?
1.6. What are similarities and differences between forwards – futures - swaps and
options?

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2. EXERCISES
2.1 Read the paragraph below and find the right word/phrase from the box to
fill each of the gaps. One word/phrase can be used for several times.
maturity date settled-up long
contract size from distinctions
contingent claims securities delivery months derivative
standardized marked-to-market tailor-made
derived short features
exchange-traded initial performance bond margin
collateral daily settlement with
good-faith on mature

Both forward and futures contracts are classified as 1) ________________ or (2)

________________ because their values are (3) ________________ (4)
________________ or contingent upon the value of the underlying security. But while
a futures contract is similar to a forward contract, there are many (5)
________________ between the two. A forward contract is (6) ________________
for a client by his international bank; in contrast, a futures contract has (7)
________________ features and is (8) ________________ The main standardized (9)
________________ are the (10) ________________ specifying the amount of the
underlying foreign currency for future purchase or sale and the (11)
________________ of the contract. Futures contracts have specific (12)
________________ during the year in which contracts (13) ________________ on a
specified day of the month.
A/an (14) ________________ (formerly called (15) ________________) must be
deposited into a(n) (16) ________________ account to establish a futures position.
The account balance will fluctuate through (17) ________________. This can be
viewed as “ (18) ________________” money that the contract holder will fulfill his
side of the financial obligation.

2.2 Which of the followings indicate the word OPPOSITE in meaning to the
underlined word(s):
1. The Swedish krone slipped half a cent against the pound.
a. hit a new low b. bottomed out c. gained slightly

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 2. A “short position” means that the trader will make a profit if the currency
slides.
a. plummets b. weakens c. rises gently
3. A futures contract is settled-up daily at the settlement price.
a. selling price b. current transaction price c. futures transaction price
4. A forward contract is tailor-made for a client by his international bank.
a. standardized b. marked-to-market c. settled-up
5. In Forex trading, the value date is regarded as the date on which counterparties
to a transaction agree to settle their respective obligations by making payments
and transferring ownership.
a. delivery date b. transaction date c. maturity date
2.3 Match the words/phrases 1-8 with the phrases a-h to make definitions
1. Direct quotes a. The option can be exercised at any time during the
contract
2. Currency futures b. The price of one unit of the domestic currency in the
foreign currency
3. Maintenance c. One counter party exchanges the debt service
performance bond obligations of a bond denominated in one currency for
the debt service obligations of the other counter party
denominated in another currency
4. Marking to market d. The option can be exercised only at the maturity date
of the contract
5. Currency swap e. A standardized foreign exchange contract with a
future delivery date that is traded on organized
exchanges
6. American option f. The price of one unit of the foreign currency in the
domestic currency
7. Indirect quotes g. Collateral needed to maintain an asset position
8. European option h. The process of establishing daily price gains and
losses in the futures market by the change in the
settlement price of the futures contract.
2.4 Mark the following statements as true (T) or false (F)?
1. Currency futures and forward contracts are like options in that they specify the
purchase or sale of some currency at some future date.

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2. Informal forward contracts replace futures contract with highly standardized,
exchange-traded assets.
3. Option contracts call for a daily setting up of any gains or losses of the contract.
4. Another name for option premium is option strike price.
5. Speculators want to avoid price variation by locking in a purchase price of the
underlying asset through a long position in the futures contract or a sales price
through a short position.
6. Currency option contracts are conducted through over-the-counter markets and
organized exchanges as well.

Question
2 A foreign currency futures contract is an alternative to a forward contract
that calls for future delivery of a standard amount of foreign exchange at
a fixed time, place, and price.
3 Future contracts call for a daily setting up of any gains or losses of the
contract.
4 Another name for option premium is the option price.
5 Speculators will take a long or short position in the futures contract
depending on his expectations about the future price movements.

2.5 Find the best answer

1. In futures markets, a ________________ serves as the third party to all
transactions.
a. broker b. intermediary c. clearing house
2. A forward contract states a price for the ________________ transaction.
a. immediate b. future c. standardized
3. The ________________ is a price representative of futures transaction prices at the
close of daily trading on the exchange.
a. settlement price b. exercise price c. spot price
4. By using futures contracts, ________________ attempt to avoid the risk of price
change of the underlying asset.
a. speculators b. arbitrageurs c. hedgers
5. For an option contract, premium is the________________ of that option.

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a. price b. future spot price c. exercise price
3. TRANSLATION
Translate the following texts into Vietnamese, paying a special attention to the
standard use of terms and clarification of expression.
Text 1
Vietnam to Launch Derivatives Market in Early 2017
Vietnam plans to open a derivatives market in the first quarter of 2017 in a bid to
draw more investment to its capital markets, with futures contracts set to launch first.
The market will initially start with two main derivative products - stock index and
government bond futures - and once fully operational, more instruments will be
introduced, the exchange said.
The launch of the derivatives market is designed to support the country's stock
market by providing more instruments to hedge risks and attracting more investors.
Le Ha, an analyst at Vietcombank Securities, said making more products available
was a positive step. Gains would be gradual, but overall it could help Vietnam's
efforts to become a viable emerging market, she said. "This may also partially help
shorten the process of upgrading Vietnam's stock market," she added.
The plan was approved in 2014 by then Prime Minister Nguyen Tan Dung and has
been welcomed by experts and investors following feasibility studies. In Southeast
Asia, Singapore and Thailand also have derivatives markets.
Vietnam's stocks are on the radar for frontier market investors, offering the region's
second-cheapest stocks. The combined market capitalization of the country's two
stock exchanges in Ho Chi Minh City and Hanoi are comparatively modest at around
a sixth of Thailand's and a quarter of Singapore's.
Source: http://www.reuters.com/article/vietnam-stocks-idUSL3N1BR25L, September
15, 2016
Text 2
Stock Market Outlook 2022: A Close Battle Between Positives and Negatives
In an already volatile year for stocks, what may lie ahead for the rest of 2022?
Market activity that has- transpired year-to-date could be a microcosm of what’s to
come: A close battle between the positives and negatives.
At this stage of an economic recovery, it is not that unusual for the U.S. Federal
Reserve to begin shifting policy and reducing liquidity. Tightening financial
conditions weigh on equities, especially the more speculative stocks. However, the
fourth quarter earnings reports for corporate America held good news overall. Clearly

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the earnings misses get the headlines, nevertheless, consensus earnings estimates for
the S&P 500 for 2021, 2022 and 2023 are higher today than they were at the end of
2021. Overall, corporate America is healthier than Wall Street has expected. Throw in
the resumption of strong company stock buybacks, and there is your good news for
stocks.
The clash between tightening financial conditions and good news from
corporate America’s earnings results could characterize most of the year, which is not
unusual for the third year of an economic recovery. Investors shouldn’t let the bears
scare them out of taking advantage of selloffs, but they also shouldn’t chase gains
when there’s a lot of market strength. In the end, 2022 could be an OK year for the
market return overall, just not as strong as what we’ve seen in the last few years.
Areas of Opportunity
Despite lower returns, 2022 should offer more opportunities for tactical alpha
generation at the allocation level. Drilling down into areas of the market, here are
opportunities we see:
U.S. Value Stocks: We remain committed to a value bias in the U.S. for two
reasons. The first is that in recessions, value stocks have tended to get very cheap.
After recessions, they tend to trade back to a normalized level. They are not at that
level yet. The second is that we think the economy could be moving into a period of
permanent higher inflation and if it does, inflation-sensitive stocks, which reside in the
value bucket, could outperform for an extended period.
Growth/Technology Stocks: We are less negative on growth than we have
been, given the magnitude of recent underperformance vs. the broad market. In many
ways, the chase into growth/technology stocks after the COVID-19 lows reminded us
of the NASDAQ bubble of 2000. We thought that once the bubble burst, it was going
to be ugly, which it has been. However, the more established mega-cap technology
stocks never traded to the same frenzied level—that is how the environment today is
different than in 2000. Recent underperformance despite numerous impressive
earnings reports means many of these large-cap growth names are now trading at very
reasonable valuations.
Europe: We regularly hear calls from strategists that this will finally be the
year to favor Europe over the U.S. It is true that European stocks are cheaper and have
more of a value bias, and we see opportunities in some European stocks this year. But
I question any widespread jettisoning of superior-performing stocks of U.S.
companies for European ones, just because they are cheaper.
Asia ex-Japan: This is the region of the world that has seen companies
compound at rates competitive with great U.S. companies. While the region woefully

14
lagged in 2021, we continue to believe this is a better allocation for non-U.S. assets
than in Europe.
Source: Slimmon Andrew (2022), Stock Market Outlook 2022: A Close Battle
Between Positives and Negatives, Morgan Stanley Investment Management

4. TERMINOLOGY
Clearing House - Trung tâm thanh toán bù trừ: Clearing houses act as third
parties to all futures and options contracts, as buyers to every clearing member seller,
and as sellers to every clearing member buyer.
Exercise price - Giá thực hiện: The price that must be paid if the option is exercised.
Option holder - Người mua quyền: The buyer of an option.
Option writer - Người bán quyền: The seller of an option.
Premium - Phí quyền chọn: The cost or price of the option.
Speculation - Đầu cơ: An attempt to profit by trading on expectations about price in
the future.

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 Unit 5.3: International Settlement Methods
Introduction: International markets are often more complex than local ones,
where participants may have known each other for some time and have built a certain
level of trust, leading to less trading risks in local markets. There are a number of
methods of trade and settlement of trade accounts. Details of various methods of trade
that are available to buyers and sellers indicating the involved risks and benefits are
discussed in the following pages. Before importers and exporters decide to engage in a
contractual agreement, they need to be aware of a settlement method that meets their
specific needs. Their contracts specify how and when payments are made as well as
how the default risk is mitigated. There are different methods of payment for
international transactions and none of them is appropriate for all situations. The most
secure method for the exporter is the least secure for the importer and vice versa. The
key is to strike the right balance for both sides.
Through reading, exercises and translations, students will become familiar with
key terms and learn about the benefits and risks of each settlement method.

1. READING
Read the text and use your words to answer the following questions:
Settlement Methods of Trade
To succeed in today’s global marketplace and win sales against foreign
competitors, exporters must offer their customers attractive sales terms supported by
the appropriate payment methods. Because getting paid in full and on time is the
ultimate goal for each export sale, an appropriate payment method must be chosen
carefully to minimize the payment risk while also accommodating the needs of the
buyer. There are five primary methods of payment for international transactions. They
are cash on delivery, advance payment, open account, collections and letters of credit.
Cash on Delivery
It is a system where goods and all shipping documents are sent direct to the
buyers who pay on delivery or after an agreed period. The system does not offer any
security to the seller/exporter. The seller can face risks of non- receipt of payment or
goods may be left in a distant port due to non-payment by the buyer/importer. A high
degree of mutual trust and confidence must exist between the two parties.
Advance Payment
This is the safest way for an exporter to receive payment for goods shipped
abroad because the funds are received before the goods are released. The risk has been
transferred to the importer who must trust the exporter to actually deliver the goods

16
paid for. The method of payment is usually by cheque, bank draft, mail transfer or
telegraphic transfer/SWIFT. Due to various implications of this system, advance
payments are rarely used. More common is the payment in advance of a cash deposit
by the buyer, with the balance being paid in one of the following ways.
Open Account
When the exporter and importer trust one another implicitly, perhaps because
they have traded together for a number of years, they may agree to trade on open
account terms. Goods are shipped to the importer and the documents of title are sent
directly by the exporter. A set date for payment is given and the importer merely
remits the necessary funds to the exporter as agreed. In transactions involving regular
shipments the importer often makes payments at set intervals, paying for goods
received during that particular period. The exporter has no control over the goods and
cannot be guaranteed payment, so an open account is perhaps the riskiest method of
trade available.
Collections
A seller sells the goods to a buyer and asks his banker to collect money on his
behalf from the buyers. So the bank acts as agent of the seller in collecting money
from the buyer. In this respect the seller must give clear instructions to the bank. The
seller/exporter hands over the bill of exchange together with the relative documents
for collection of payment by giving the instructions to his bank (by completing the
application form for collection of bills) from the buyer/importer through the banking
system/channel. The remitting bank records the information in its books and forwards
the bill with the documents to the collecting bank with its schedule for collection with
instructions as requested by the seller. When the seller asks his bank to collect money
against a clean/ documentary bill on his behalf, this instructs the bank to release
documents against acceptance of the bill, the bill is known as a D/A bill (Documents
against Acceptance). If the documents are to be released against payment the bill is
known as a D/P bill (Documents against Payment). If a sight bill is drawn the
documents will be handed over to the buyer against payment only.
Letters of Credit
Payment through the medium of a bill of exchange can be made still more
secure by the use of a letter of credit (although a bill of exchange is not always
necessarily required under a letter of credit, it is frequently called for under its terms).
A letter of credit is issued by the buyer’s bank at the buyer’s request in accordance
with the payment terms of the underlying contract; and is a guarantee of payment by
that bank. The beneficiary would be well advised to seek the advice of his own
bankers on the value of the issuing bank’s guarantee, as there may be exchange
control problems, political risks, or even a question about the credit standing of the

17
issuing bank. If the credit is made irrevocable, the issuing bank is unable to amend or
cancel its terms without the consent of all the parties, including the beneficiary. A
further, security can be obtained by the exporter by making it a confirmed irrevocable
letter of credit, where the bank through which the letter of credit is transmitted to the
exporter adds confirmation.
Source: Bhogal, T.S and Trivedi, A.K (2008), International Trade Finance: A
Pragmatic Approach, Palgrave Macmillan publisher
QUESTIONS
1.1. Which method of payment is the safest for an exporter? Why?
1.2. Which method of payment is the riskiest for an exporter? Why?
1.3. What is the role of remitting bank in collection payment?
1.4. Who is responsible for payment in a Letter of Credit method?
1.5. What is irrevocable L/C?

3. EXERCISES
2.1. Find the best answer
1) Which of the following is not a payment method in international trade?
a) Letter of Credit
b) Collection
c) Bill of Exchange
d) Open Account

2) Which of the following payment methods do importers prefer?

a) Open Account
b) Documentary Against Payment
c) Documentary Against Acceptance
d) Cash on delivery

3) In case of first transaction, which of following payment method should the

exporter choose to minimize risk?
a) Open Account

18
 b) Letter of Credit
c) Documentary Against Payment
d) Documentary Against Acceptance

4) Which of following is true about Letters of Credit?

a) Payment mechanism used in international trade to provide an economic
guarantee from a creditworthy bank to an exporter of goods.
b) A form of trade finance in which an exporter’s bank forwards documents to
an importer’s bank and collects payment for shipped goods.
c) This payment method requires the importer to pay the amount of the draft at
sight.
d) This payment method is less expensive than some methods but also
somewhat riskier, so is generally limited to transactions between parties who
have developed trust or are located in countries with strong legal systems and
contract enforcement.

5) Which of following is true about Documentary against Payment?

a) The seller retains ownership of goods until payment is made
b) More expensive than letter of credit
c) Guarantee for payment
d) Strict documentation requirements

2.2. Read the paragraph below and find the right word or phrase from the
box to fill each of the gaps

assurance credit restrictions fraudulent

pre-shipment compliance soundness negotiability

Advantages of letter of credit to exporters:

(1) ________________ of Payment: The beneficiary is assured of payment as the
issuing bank is bound to honour the documents drawn under the letter of credit.

19
 Ready (2) ________________: The exporter, if he needs money immediately, can
secure payment by having the documents, drawn under the letter of credit, discounted
(post shipment advance).
(3) ________________ with Regulations: Letter of credit is evidence that the
exchange control regulations, if applicable in the country of the importer, have been
complied with.
(4) ________________ Facility: The exporter can secure an advance from his bank
against a letter of credit received for export of goods (pre-shipment advance).
2.3. Match the words 1-6 to the phrases a-f to make word partnerships
1. applicant a. any arrangement, however named or described,
that is irrevocable and thereby constitutes a
definite undertaking of the issuing bank to honour
a complying presentation
2. presentation b. either the delivery of documents under a credit
to the issuing bank or nominated bank or the
documents so delivered
3. nominated bank c. the party on whose request the credit is issued
4. issuing bank d. a presentation that is in accordance with the
terms and conditions of the credit, the applicable
provisions of these rules and international
standard banking practice
5. credit e. the bank that issues a credit at the request of an
applicant orr on its own behalf
6. complying presentation f. the bank with which the credit is available or
any bank in the case of a credit available with any
bank

2.4. Find the best answer to fill each of the gaps

1. ________________ is basically a promise by a bank to pay an exporter if all
terms of the contract are executed properly. This is one of the most secure
methods of payment.
a. Documentary against Payment b. Documentary against Acceptance
c. Open Account d. Letter of Credit

20
 2. In Documents Against Payment method, the risk for ________________ is that
the ________________ will refuse to pay, and even though the importer won’t
be able to collect the goods, the exporter has very little recourse to collect.
a. Exporter, Collecting bank b. Importer Collecting bank
c. Exporter, Importer d. Importer, Exporter

3. A documentary collection is when the exporter instructs their bank to forward

documents related to the sale to ________________ with a request to present
the documents to the buyer as a request for payment, indicating when and on
what conditions these documents can be released to the buyer.
a. importer b. importer’s bank
c. exporter’s bank d. issuing bank

4. ________________ are usually only recommended for trustworthy and

reputable buyers, for buyers and sellers who have an established and trusting
relationship, and/or for exports with relatively lower value to minimize risk.
a. Letter of Credit b. Open Account
c. Documentary against Acceptance d. Documentary against Payment

5. In Document Against Acceptance, usual time of payment is …

a. Before shipment b. When shipment is made
c. On maturity of drafts d. On presentation of draft to buyer

2.5. Match the verbs 1-8 with the nouns a-h

1. issue a. terms and conditions
2. sign b. payment
3. negotiate c. international sale contract
4. request d. a suitable payment method
5. deliver e. a complying presentation
6. choose f. exchange controls
7. comply with g. letter of credit
8. impose h. goods

21
3. TRANSLATION
Translate the following texts into Vietnamese, paying a special attention to the
standard use of terms and clarification of expression.
Text 1
Letters of Credit (L/Cs)
Letter of credit (L/C) is one of the oldest forms of trade finance still in
existence. Because of the protection and benefits it provides to both exporter and
importer, it is a critical component of many international trade transactions. The L/C
is an undertaking by a bank to make payments on behalf of a specified party to a
beneficiary under specified conditions. The beneficiary (exporter) is paid upon
presentation of the required documents in compliance with the terms of the L/C. The
L/C process normally involves two banks, the exporter’s bank and the importer’s
bank. The issuing bank has essentially guaranteed payment to the exporter, provided
the exporter complies with the terms and conditions of the L/C. Sometimes the
exporter is uncomfortable with the issuing bank’s promise to pay because the bank is
located in a foreign country. Even if the issuing bank is well-known worldwide, the
exporter may be concerned that the foreign government will impose exchange controls
or other restrictions that would prevent payment by the issuing bank. For this reason,
the exporter may request that a local bank confirm the L/C and thus assure that all the
responsibilities of the issuing bank will be met. Confirming bank, at the request of the
issuing bank, agrees to perform the principal duties of the issuing bank. It receives the
beneficiary's presentation under the letter of credit, it determines whether the
presentation complies with the terms of the letter of credit, and if it is a complying
presentation the confirming bank makes payment to the beneficiary.
Consequently, the confirming bank is trusting that the foreign bank issuing the
L/C is sound. The exporter, however, need worry only about the credibility of the
confirming bank. The bank issuing the L/C makes payment once the required
documentation has been presented in accordance with the payment terms. The
importer must pay the issuing bank the amount of the L/C plus accrued fees associated
with obtaining the L/C. The importer usually has established an account at the issuing
bank to be drawn upon for payment so that the issuing bank does not tie up its own
funds. However, if the importer does not have sufficient funds in its account, the
issuing bank is still obligated to honour all valid drawings against the L/C. This is why
the bank’s decision to issue an L/C on behalf of an importer involves an analysis of
the importer’s creditworthiness and is analogous to the decision to make a loan. The
bank issuing the L/C makes payment to the beneficiary (exporter) upon presentation
of documents that meet the conditions stipulated in the L/C. Letters of credit are
payable either at sight (upon presentation of documents) or at a specified future date.

22
The typical documentation required under an L/C includes a draft (sight or time), a
commercial invoice, and a bill of lading. Depending upon the agreement, product, or
country, other documents (such as a certificate of origin, inspection certificate,
packing list, or insurance certificate) might be required. The three most common L/C
documents are as follows.
Source: Jeff Madura (2012), International Finance Management, 11th Edition,
Cengage Learning
Text 2:
How Does International Trade Financing Work?
When operating a small or medium-sized business, it’s common to have limited
access to loans or financing. Most banks will not provide funding if your business has
a short operating history or weak financials. If you are faced with this issue, an
international trade finance company can help.
Understanding the Basics of International Trade Financing
In trading transactions, buyers do not want their money tied to a shipment of
goods that could take several weeks to arrive from a manufacturer overseas. On the
other hand, exporters that send out large quantities of goods cannot afford to wait until
their shipment arrives before they receive their payment. That is why more than 80%
of all global trade depends on an international trade finance company for assistance.
Financial institutions that offer trade financing act as intermediaries between
importers and exporters and provide financial assistance for business transactions
between the two parties. These transactions may take place either domestically or
internationally.
Trade finance companies take care of various activities during the importing
and exporting process. These activities can include issuing a letter of credit and
factoring. The process involves multiple parties, including the importer and exporter,
the trade financer, the exporting credit agencies, and any involved insurers.
Factoring in trade finance is a standard method used by exporters to increase
their cash flow speed. With this agreement, the exporter offers their open invoices to a
trade financer at a discount price. The trade financer, or factor, purchases the
receivables, provides cash upfront to the exporter, and collects payment from the
importer at invoice maturity. Factoring helps eliminate the risk of potential bad debts
for the exporter. It also provides them with working capital they can use to keep
business running smoothly instead of waiting around for payment.
Trade Finance Helps Minimize Risk

23
 Trade financing plays a significant role in making sure shipments are
transported and paid for within a reasonable amount of time.
Without a trade finance company’s assistance, exporters may never know
whether or when an importer will pay them for their purchased goods. At the same
time, importers also have doubts about buying a product when they have no guarantee
if the seller will ship out their goods.
Trade finance services help eliminate those risks by increasing the speed of
payments to exporters and guaranteeing all goods are shipped out to importers.
Companies that provide non-recourse financing will still pay their clients if the buyer
defaults due to buyer insolvency.
Take Advantage of the Various Trade Finance Products and Services Available
Trade finance companies offer various products and services that meet the
needs of the different companies they assist. Two popular extras offered include a
Letter of Credit and a Bank Guarantee.
• Letter of Credit - A letter of credit is a promise made by the importer’s financial
institution to the exporter. The letter states once the exporter shows all documents
from the shipment as required by the term in the contract, the financial institution
immediately makes the exporter’s payment.
• Bank Guarantee - The bank guarantees a sum of money to the beneficiary if the
exporter or importer fails to meet the contract’s terms. This guarantee helps provide
peace of mind to the buyer and seller when taking part in an international trade
transaction.
Source: https://www.tradewindfinance.com/news-resources/how-does-international-
trade-financing-work
4. TERMINOLOGY
Applicant - Người yêu cầu: the party on whose request the credit is issued
Beneficiary - Người thụ hưởng: the party in whose favour a credit is issued
Complying presentation - Xuất trình phù hợp: a presentation that is in accordance
with the terms and conditions of the credit, the applicable provisions of these rules and
international standard banking practice.
Document against acceptance (D/A) - Nhờ thu kèm chứng từ trả chậm: collection
terms of payment that require the drawee to accept a draft drawn for future maturity at
the presenting bank prior to receiving the accompanying documents.
Document against payment (D/P) - Nhờ thu kèm chứng từ trả ngay: Collection
terms of payment that require the drawee to pay a draft prior to receiving the
accompanying documents.

24
Draft - Hối phiếu – an unconditional order in writing, signed by a person (drawer)
such a buyer and addressed to other person (drawee), typically a bank, ordering the
drawee to pay a stated sum of money to yet another person (payee), often a seller.

25
 READING CASE OF PART 5

International Financial Markets

The growth in international business over the last 30 years has led to the development
of various international financial markets. Financial managers of multinational
companies (MNCs) must understand the available international financial markets so
they can be used to facilitate the firm’s international business transactions.
3-1 Foreign Exchange Market
Each country in the world has its own currency. An important exception is the
eurozone, which consists of 19 European countries that adopted the euro as their
currency. When MNCs and individuals engage in international transactions, they
commonly need to exchange their local currency for a foreign currency, or exchange a
foreign currency for their local currency. The foreign exchange market allows for
the exchange of one currency for another. Large commercial banks serve this market
by holding inventories of each currency so that they can accommodate requests by
individuals or MNCs for currency for various transactions. Individuals rely on the
foreign exchange market when they travel to foreign countries. People from the
United States exchange dollars for Mexican pesos when they visit Mexico, euros
when they visit Italy, or Japanese yen when they visit Japan. Some MNCs based in the
United States exchange dollars for Mexican pesos when they purchase supplies in
Mexico that are denominated in pesos, or exchange them for euros when they
purchase supplies from Italy that are denominated in euros. Other MNCs based in the
United States receive Japanese yen when selling products to Japan and may wish to
convert those yen to dollars. In addition, some individuals and financial institutions
speculate in the foreign exchange market by exchanging their local currency for a
foreign currency that they believe will increase in value over time.

3-1a Foreign Exchange Transactions

The foreign exchange market should not be thought of as a specific building or

location where traders exchange currencies. Companies normally exchange one
currency for another through a commercial bank over a telecommunications network;
this is an over- the-counter market through which many transactions occur. The
largest foreign exchange trading centers are in London, New York, and Tokyo, but
foreign exchange transactions occur on a daily basis in cities around the world.
London accounts for about 33 percent of the trading volume and New York City for
about 20 percent. Thus these two markets control more than half the currency trading
in the world.

26
Foreign Exchange Dealers serve as intermediaries in the foreign exchange mar- ket
by exchanging currencies desired by MNCs or individuals. Foreign exchange dealers
include large commercial banks such as Citigroup, JPMorgan Chase & Co., Barclays
(United Kingdom), UBS (Switzerland), and Deutsche Bank (Germany). Dealers such
as these have branches in most major cities and also facilitate foreign exchange
transactions with an online trading service. Dealers that rely exclusively on online
trading to facilitate such transactions include FX Connect (a subsidiary of State Street
Corporation), OANDA (Canada), and XE.com (Canada). Customers establish an
online account and can interact with the foreign exchange dealer’s website to transmit
their foreign exchange order.

In recent years, new trading platforms have been established that allow some MNCs to
engage in foreign exchange transactions directly with other MNCs, thereby
eliminating the need for a foreign exchange dealer. An MNC that subscribes to such a
platform can indicate to the platform’s other users whether it wants to buy or sell a
particular currency as well as the volume desired. Some MNCs continue to use a
foreign exchange dealer, often because they prefer personal attention or require more
customized transactions than can be handled via trading platforms.

Spot Market The most common type of foreign exchange transaction is for immediate
exchange. The market where these transactions occur is known as the spot market.
The exchange rate at which one currency is traded for another in the spot market is
known as the spot rate.

Spot Market Structure Commercial transactions in the spot market are often
completed electronically with banks or other financial institutions serving as
intermediaries. The exchange rate at the time determines the amount of funds
necessary for the transaction.

If a bank begins to experience a shortage of a particular foreign currency, it can

purchase that currency from other banks. This trading between banks occurs in what is
often referred to as the interbank market.

Some other financial institutions, such as securities firms, can provide the same
services described in the previous example. Most major airports around the world also
have foreign exchange centers where individuals can exchange currencies. Many
cities also have retail foreign exchange offices where tourists and other individuals
can exchange their currency.

Use of the Dollar in Spot Markets The U.S. dollar is accepted as a medium of
exchange by merchants in many countries; this is especially true in countries (such as

27
Bolivia, Indonesia, Russia, Vietnam) where the home currency is weak or subject to
foreign exchange restrictions. Many merchants accept U.S. dollars because they can
easily use them to purchase goods from other countries.

Spot Market Time Zones Although foreign exchange trading is conducted only during
normal business hours at a given location, such hours vary among locations because of
different time zones. Thus, at any given weekday time, a bank located somewhere in
the world is open and ready to accommodate foreign exchange requests by MNCs.

When the foreign exchange market opens in the United States each morning, the
opening exchange rate quotations are based on the prevailing rates quoted by banks in
London (and other locations), where the markets have opened earlier. Suppose the
quoted spot rate of the British pound was $1.80 at the previous close of the U.S.
foreign exchange market but, by the time the U.S. market opens the following day, the
spot rate is $1.76. Events occurring before the U.S. market opened could have
changed the supply and demand conditions for British pounds in the London foreign
exchange market, reducing the quoted price for the pound.

Several U.S. banks have established so-called night trading desks. The largest banks
initiated night trading to capitalize on overnight foreign exchange movements and to
accommodate corporate requests for currency trades. Even some medium-sized banks
now offer night trading as a way of accommodating their corporate clients.

Spot Market Liquidity The spot market for each currency is characterized by its
liquidity, which reflects the level of trading activity. The more buyers and sellers there
are for a currency, the more liquid the market for that currency is. The spot markets
for heavily traded currencies such as the euro, the pound, and the yen are extremely
liquid. In contrast, the spot markets for currencies of less developed countries are
much less liquid. A currency’s liquidity affects the ease with which it can be bought or
sold by an MNC. If a currency is illiquid, then the number of willing buyers and
sellers is limited and so an MNC may be unable to purchase or sell that currency in a
timely fashion and at a reasonable exchange rate.

3-1b Foreign Exchange Quotations

Exchange rate quotations for widely traded currencies, and even for many currencies
that are not widely traded, are readily available on the Internet. They can be found at
financial websites, at the websites of newspapers such as the Wall Street Journal, at
the web- sites of foreign exchange dealers, and even by simply typing “euro-dollar
exchange rate” or whatever exchange rate is wanted into a web browser. The rates are
frequently updated as the exchange rates change throughout the day.

28
At any moment in time, the exchange rate between two currencies should be similar
across the various banks that provide foreign exchange services. If there is a large
discrepancy, then customers (or other banks) could profit from purchasing a large
amount of the currency from the low-quoting bank and immediately selling it to the
high-quoting bank. These actions would cause the low-quoting bank to quickly
experience a shortage of that currency, while the high-quoting bank would quickly
experience an excessive amount of that currency because it was willing to pay too
much for the currency. As a result, the banks would rapidly adjust their exchange rate
quotations, eliminating any discrepancy between the quotations.

Direct versus Indirect Quotations at One Point in Time The quotations of exchange
rates for currencies normally reflect the ask prices for large transactions. Quotations
that report the value of a foreign currency in dollars (number of dollars per unit of
other currency) are referred to as direct quotations, whereas quotations that report the
number of units of a foreign currency per dollar are known as indirect quotations.

3-1c Derivative Contracts in the Foreign Exchange Market

A currency derivative is a contract with a price that is partially derived from the value
of the underlying currency that it represents. Three types of currency derivatives that
are often used by MNCs are forward contracts, currency futures contracts, and
currency options contracts. Each of these currency derivatives will be explained in
turn.

Forward Contracts In some cases, an MNC may prefer to lock in an exchange rate at
which it can obtain a currency in the future. A forward contract is an agreement
between an MNC and a foreign exchange dealer that specifies the currencies to be
exchanged, the exchange rate, and the date at which the transaction will occur. The
forward rate is the exchange rate, specified in the forward contract, at which the
currencies will be exchanged. Multinational corporations commonly request forward
contracts to hedge future payments that they expect to make or receive in a foreign
currency. In this way, they do not have to worry about fluctuations in the spot rate
until the time of their future payments.

Currency Futures Contracts Futures contracts are similar to forward contracts but are
sold on an exchange instead of over the counter. A currency futures contract specifies
a standard volume of a particular currency to be exchanged on a specific settlement
date. Some MNCs involved in international trade use the currency futures markets to
hedge their positions. The futures rate is the exchange rate at which one can purchase
or sell a specified currency on the settlement date in accordance with the futures

29
contract. Thus the futures rate’s role in a futures contract is similar to the forward
rate’s role in a forward contract.

It is important to distinguish between the futures rate and the future spot rate. The
future spot rate is the spot rate that will exist at some future time and so, today, that
rate is uncertain. If a U.S. firm needs Japanese yen in 90 days and if it expects the spot
rate 90 days from now to exceed the current 90-day futures rate (from a futures
contract) or 90-day forward rate (from a forward contract), then the firm should
seriously consider hedging with a futures or forward contract.

Currency Options Contracts Currency options contracts can be classified as calls or

puts. A currency call option provides the right to buy a specific currency at a specific
price (called the strike price or exercise price) within a specific period of time. It is
used to hedge future payables. A currency put option provides the right to sell a
specific currency at a specific price within a specific period of time. It is used to hedge
future receivables.

Currency call and put options can be purchased on an exchange. They offer more
flexibility than forward or futures contracts because they are not obligations. That is,
the firm can elect not to exercise the option.

3-2 International Money Market

Each country has a money market whereby surplus units (individuals or institutions
with available short-term funds) can transfer funds to deficit units (institutions or
individuals in need of funds). Financial institutions such as commercial banks accept
short-term deposits from surplus units and redirect the funds toward deficit units.
The international money market developed to accommodate the needs of MNCs. First,
many MNCs borrow short-term funds in different currencies to pay for imports
denominated in those currencies. Second, MNCs that need funds to support local
operations may consider borrowing in a nonlocal currency that exhibits lower interest
rates. This strategy is especially appropriate for firms expecting future receivables
denominated in that currency. Third, MNCs may consider borrowing in a currency
that they anticipate will depreciate against their home currency, as this would enable
them to repay the short-term loan at a more favorable exchange rate. In this case, the
actual cost of borrowing would be less than the interest rate quoted for that currency.
At the same time, some MNCs and institutional investors have incentives to invest
short- term funds in a foreign currency. First, the interest rate on a short-term
investment denominated in a foreign currency might exceed the interest rate on a
short-term investment denominated in their home currency. Second, they may
consider investing in a currency that they expect will appreciate against their home

30
currency so that the return on their investment would be greater than the interest rate
quoted for the foreign investment.
Financial institutions such as commercial banks serve this market by accepting
deposits and providing loans in various currencies. These intermediaries typically also
serve as dealers in the foreign exchange market.
3-2a European and Asian Money Markets
As MNCs expanded their operations in the 1970s, Europe and Asia emerged as major
centers of international financial intermediation to accommodate their needs. Because
the U.S. dollar was widely used even by foreign countries as a medium for
international trade, there was a consistent demand for dollars in Europe and elsewhere.
To conduct international trade with European countries, corporations in the United
States deposited U.S. dollars in European banks. The banks accepted the deposits
because they could then lend the dollars to corporate customers based in Europe.
These dollar deposits in banks in Europe (and on other continents) are known as
Eurodollars (not to be confused with the euro, which is the currency of many
European countries today).
The growing importance of the Organization of the Petroleum Exporting Countries
(OPEC) also contributed to the growth in Eurodollar deposits. Because OPEC
generally requires payment for oil in dollars, the OPEC countries began to deposit a
portion of their oil revenues in European banks. These dollar-denominated deposits
are sometimes referred to as petrodollars.
Like the European money market, the Asian money market originated as a market
involving mostly dollar-denominated deposits. This market emerged to accommodate
the needs of businesses that were using the U.S. dollar (and some other foreign
currencies) as a medium of exchange for international trade. These businesses could
not rely on banks in Europe because of the distance and different time zones. Today,
the Asian money market is centered in Hong Kong and Singapore, where large banks
accept short-term deposits and make loans in various foreign currencies.
Banks within the Asian money market usually lend to each other when some banks
have excess funds and other banks need more funds. The Asian money market is
integrated with the European money market in that banks in Asia lend to and borrow
from banks in Europe.
3-2b Money Market Interest Rates among Currencies
The money market interest rate on short-term deposits or short-term loans in a
particular currency in international money markets is dependent on the supply of
short-term funds provided by surplus units and the demand for short-term funds by
deficit units in that currency. In general, a country that experiences both a high

31
demand for and a small supply of short-term funds will have relatively high money
market interest rates. Conversely, a country with both a low demand and a large
supply of short-term funds will have relatively low money market interest rates.
Money market rates tend to be higher in developing countries because they experience
higher rates of inflation and faster growth, so more funds are needed (relative to the
available supply) to finance that growth. The money market interest rate for a
particular currency changes over time in response to changes in the supply and
demand for short-term funds for that currency.
A currency’s money market is highly influenced by its respective London Interbank
Offer Rate (LIBOR), which is the interest rate most often charged for short-term
loans between banks in international money markets. The term LIBOR is commonly
used even though many international interbank transactions do not pass through
London. When a currency’s LIBOR rises, money market rates denominated in that
currency tend to rise as well, just as U.S. money market rates tend to move with the
federal funds rate (the interest rate charged on loans between U.S. banks).
The LIBOR was historically measured as the average of the rates reported by banks at
a particular time. In 2012, country governments detected that some banks were falsely
reporting the interest rate they offered in the interbank market in order to manipulate
LIBOR and thereby boost the values of their investments that were tied to LIBOR.
This scandal prompted financial markets to devise ways of determining the market
interest rate in a manner that does not rely on the rates reported by participating banks.
3-3 International Credit Market
Multinational corporations and domestic firms sometimes obtain medium-term funds
via term loans from local financial institutions or by issuing notes (medium-term debt
obligations) in their local markets. However, MNCs also have access to medium-term
funds through banks located in foreign markets. Loans of one year or longer that are
extended by banks to MNCs or government agencies in Europe are commonly called
Eurocredits or Eurocredit loans, which are transacted in the Eurocredit market.
These loans can be denominated in dollars or in one of many other currencies, and
their typical maturity is five years.
Borrowers usually prefer that loans be denominated in the currency of the country in
which they receive most of their cash flows, which eliminates the borrower’s
exchange rate risk. However, the loan’s interest rate depends on the currency in which
the loan is denominated. Because banks in money markets accept short-term deposits
and sometimes provide longer-term loans, their asset and liability maturities do not
match. This misalignment can adversely affect a bank’s performance during periods of
rising interest rates, as the bank may have locked in a rate on its longer-term loans
while the rate it pays on short-term deposits continues to rise. In order to avoid this

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risk, banks commonly use floating rate loans. The loan rate floats in accordance with
the movement of a market interest rate, such as LIBOR. For example, a loan that is
denominated in a particular currency and is provided by a bank to an MNC might be
structured with an interest rate that resets every six months to the prevailing LIBOR
for that currency plus 3 percent.
International credit market activity has increased over time, yet the growth is mostly
concentrated in regions where economic conditions are relatively strong. Those
regions tend to have more funds deposited by MNCs as well as a strong demand for
loans by MNCs that are expanding their business. Conversely, lending tends to decline
in regions where economic conditions are weak because MNCs are less willing to
expand and thus do not borrow additional funds. Banks then are also less willing to
grant loans because credit risk is higher in regions where economic conditions are
weak.
3-3a Syndicated Loans in the Credit Market
Sometimes a single bank is unwilling or unable to lend the amount needed by a
particular corporation or government agency. In this case, a syndicate of banks may
be organized. Each bank within the syndicate participates in the lending. A lead bank
is responsible for negotiating terms with the borrower, after which this bank organizes
a group of banks to underwrite the loans. For each bank involved, syndicated loans
reduce the exposure to default risk to the extent of that individual bank’s participation.
Borrowers that receive a syndicated loan incur various fees besides the interest on the
loan. Front-end management fees are paid to cover the costs of organizing the
syndicate and underwriting the loan. In addition, a commitment fee of about .25 or .50
percent is charged annually on the unused portion of the available credit extended by
the syndicate. Syndicated loans can be denominated in a variety of currencies. The
interest rate depends on the currency denominating the loan, the loan’s maturity, and
the creditworthiness of the borrower. Interest rates on syndicated loans are usually
adjusted to reflect movements in market interest rates (such as an interbank lending
rate), and the adjustment may occur every six months or every year.
3-3b Bank Regulations in the Credit Market
International banking regulations have become more standardized over time, a
development that has enabled more competitive global banking. Both the Single
European Act and the Basel Accord have contributed to this trend.
Single European Act One of the most significant events affecting international
banking was the Single European Act, which was phased in by 1992 throughout the
European Union (EU) countries. Some provisions of the Single European Act of
relevance to the banking industry are as follows:

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 • Capital can flow freely throughout Europe.
• Banks can offer a wide variety of lending, leasing, and securities activities in
the EU.
• Regulations regarding competition, mergers, and taxes are similar throughout
the EU.
• A bank established in any one of the EU countries has the right to expand into
any or all of the other EU countries.
As a result of this act, banks have expanded across European countries. Efficiency in
the European banking markets has increased because banks can more easily cross
countries without concern for the country-specific regulations that prevailed in the
past.
Another key provision of the act is that banks entering Europe receive the same
banking powers as other banks there. Similar provisions apply to non-U.S. banks that
enter the United States.
Basel Accord In 1988, the central banks of 12 developed countries established the
Basel Accord. Under this agreement, their respective commercial banks were required
to maintain a higher level of capital (common stock and retained earnings) if they held
riskier assets. A second accord (called Basel II) subjected banks to more stringent
guidelines on the collateral backing their loans. In addition, in an effort to reduce
failures in the banking system, this accord encouraged banks to improve their
techniques for controlling operational risk.
The financial crisis of 2008–2009 revealed that banks were still highly exposed to
risk, as many banks might have failed without government funding. A global
committee of bank supervisors developed guidelines (informally referred to as “Basel
III”) aimed at enhancing the safety of the global banking system. This accord called
for estimating banks’ risk-weighted assets with new methods that would more
properly detect the assets’ level of risk and require many banks to maintain higher
levels of capital. As a result of the stricter regulations, banks have maintained higher
standards when extending loans to MNCs in the international credit market.
3-3c Impact of the Credit Crisis
In 2008, the United States experienced a credit crisis that affected the international
credit market. The credit crisis was triggered by the substantial defaults on subprime
(lower- quality) mortgages. Financial institutions in other countries, such as the
United Kingdom, had also offered subprime mortgage loans and experienced high
default rates. Because of the global integration of financial markets, the problems in
the U.S. and U.K. financial markets spread to other markets. Some financial
institutions based in Asia and Europe were common purchasers of subprime

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mortgages that were originated in the United States and United Kingdom.
Furthermore, the resulting weakness of the U.S. and European economies reduced
their demand for imports from other countries. Thus the U.S. credit crisis blossomed
into an international credit crisis and increased concerns about credit risk in
international markets. Creditors reduced the amount of credit that they were willing to
provide, and some MNCs and government agencies were then no longer able to obtain
funds in the international credit market.
3-4 International Bond Market
The international bond market facilitates the flow of funds between borrowers who
need long-term funds and investors who are willing to supply long-term funds. Major
investors in the international bond market include institutional investors such as
commercial banks, mutual funds, insurance companies, and pension funds from many
countries. Institutional investors may prefer to invest in international bond markets,
rather than in their respective local markets, when they can earn a higher return on
bonds denominated in foreign currencies. Borrowers in the international bond market
include both national governments and MNCs.
Multinational corporations can obtain long-term debt by issuing bonds in their local
markets, and they can also access long-term funds in foreign markets. They may
choose to issue bonds in the international bond markets for three reasons. First, MNCs
may be able to attract a stronger demand by issuing their bonds in a particular foreign
country rather than in their home country. Some countries have a limited investor
base, so MNCs in those countries naturally seek financing elsewhere.
Second, MNCs may prefer to finance a specific foreign project in a particular currency
and thus may seek funds where that currency is widely used. Third, an MNC might
attempt to finance projects in a foreign currency with a lower interest rate in order to
reduce its cost of financing, although doing so would increase its exposure to
exchange rate risk.
An international bond issued by a borrower foreign to the country where the bond is
placed is known as a foreign bond. For example, a U.S. corporation may issue a bond
denominated in Japanese yen that is sold to investors in Japan. In some cases, a firm
may issue a variety of bonds in various countries. The currency denominating each
type of bond is determined by the country where it is sold. The foreign bonds in these
cases are sometimes referred to as parallel bonds.
3-4a Eurobond Market
Eurobonds are bonds that are sold in countries other than the country whose currency
is used to denominate the bonds. They have become popular as a means of attracting
funds because they circumvent registration requirements and avoid some disclosure
requirements. Thus these bonds can be issued quickly and at a low cost. Eurobonds

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are underwritten by a multinational syndicate of investment banks and are
simultaneously placed in many countries, providing a wide spectrum of fund sources
to tap. U.S.-based MNCs such as McDonald’s and Walt Disney commonly issue
Eurobonds, and non-U.S. firms (e.g., Guinness, Nestlé, Volkswagen) also use the
Eurobond market as a source of funds. Those MNCs without a strong credit record
may have difficulty obtaining funds in the Eurobond market because the limited
disclosure requirements may discourage investors from trusting unknown issuers.
In recent years, governments and corporations from emerging markets such as
Croatia, Hungary, Romania, and Ukraine have frequently utilized the Eurobond
market. New corporations that have been established in emerging markets rely on this
market to finance their growth. However, they typically pay a risk premium of at least
3 percentage points annually above the U.S. Treasury bond rate on dollar-
denominated Eurobonds.
Features of Eurobonds Eurobonds have several distinctive features. They are usually
issued in bearer form, which means that no records are kept regarding ownership.
Coupon payments are made yearly. Some Eurobonds carry a convertibility clause that
allows for them to be converted into a specified number of shares of common stock.
An advantage to the issuer is that Eurobonds typically have few, if any, protective
covenants. Furthermore, even short-maturity Eurobonds include call provisions. Some
Eurobonds, called floating rate notes (FRNs), have a variable rate provision that
adjusts the coupon rate over time according to prevailing market rates.
Denominations Eurobonds are denominated in a number of currencies. The U.S.
dollar is used most often, accounting for 70 to 75 percent of Eurobonds., However, in
2015, some U.S.-based MNCs including Coca-Cola, BlackRock, AT&T, and Kinder
Mor- gan, issued Eurobonds denominated in euros to take advantage of the low
interest rates in the eurozone. Similarly, some firms have issued debt denominated in
Japanese yen in order to take advantage of Japan’s extremely low interest rates.
Because credit conditions and the interest rates for each currency change constantly,
the popularity of particular currencies in the Eurobond market changes over time.
Secondary Market Eurobonds have a secondary market. The market makers are in
many cases the same underwriters who sell the primary issues. Euroclear, a Belgium-
based financial services company, operates a settlement system that helps to inform all
traders about outstanding issues for sale, thus allowing a more active secondary
market.
3-4b Development of Other Bond Markets
Bond markets have developed in Asia and South America. Government agencies and
MNCs in these regions use international bond markets to issue bonds when they
believe they can reduce their financing costs. Investors in some countries use

36
international bond markets because they expect their local currency to weaken in the
future and prefer to invest in bonds denominated in a strong foreign currency. The
South American bond market has experienced limited growth because the interest
rates in some countries there are usually high. MNCs and government agencies in
those countries are unwilling to issue bonds when interest rates are so high, so they
rely heavily on short-term financing.
3-5 International Stock Markets
Just as some MNCs issue stock outside their home country, many investors purchase
stocks outside their home country. There are several reasons for such a strategy. First,
these investors may expect favorable economic conditions in a particular country and
therefore invest in stocks of the firms in that country. Second, investors may wish to
acquire stocks denominated in currencies that they expect to strengthen over time,
because that would enhance the return on their investment. Third, some investors
invest in stocks of other countries as a means of diversifying their portfolio. Thus their
investment is less sensitive to possible adverse stock market conditions in their home
country.
3-5a Issuance of Stock in Foreign Markets
MNCs may issue stock in foreign markets for various reasons. MNCs may more
readily attract funds from foreign investors by issuing stock in international markets.
They have their stock listed on an exchange in any country where they issue shares,
because investors in a foreign country are only willing to purchase stock if they can
later easily sell their holdings locally in the secondary market. The stock is
denominated in the currency of the country where it is placed.
An MNC’s stock offering may be more easily digested when it is issued in several
markets. The stocks of some U.S.-based MNCs are widely traded on numerous stock
exchanges around the world, which gives non-U.S. investors easy access to those
stocks and also gives the MNCs global name recognition. Many MNCs issue stock in
a country where they will generate enough future cash flows to cover dividend
payments.
3-5b Issuance of Foreign Stock in the United States
Non-U.S. corporations that need large amounts of funds sometimes issue stock in the
United States (these are called Yankee stock offerings) because the U.S. new-issues
market is so liquid. Because many financial institutions in the United States purchase
non-U.S. stocks as investments, non-U.S. firms may be able to place an entire stock
offering in the United States. By issuing stock in the United States, non-U.S. firms
may diversify their shareholder base; this can lessen the share price volatility induced
by large investors selling shares. Investment banks and other financial institutions in

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the United States often serve as underwriters of stock targeted for the U.S. market, and
they receive underwriting fees of about 7 percent of the issued stock’s value.
Many of the recent stock offerings in the United States by non-U.S. firms have
resulted from privatization programs in Latin America and Europe. That is, businesses
that were previously government owned are being sold to U.S. shareholders. Given
the large size of some of these businesses, their local stock markets are not large
enough to digest the stock offerings. Consequently, U.S. investors are financing many
privatized businesses based in foreign countries.
Non-U.S. firms that issue stock in the United States have their shares listed on a U.S.
stock exchange, so that the shares placed in the United States can be easily traded in
the secondary market. Firms that issue stock in the United States are normally
required to satisfy stringent disclosure rules regarding their financial condition.
However, they are exempt from some of these rules when they qualify for a Securities
and Exchange Commission guideline (called Rule 144a) through a direct placement of
stock to institutional investors.
Source: Jeff Madura (2016), International Financial Management, 13th Edition,
Cengage Learning
Questions:
1. What is a foreign exchange market? Explain about the spot and derivative
transactions. Does a large discrepancy in the exchange rates between two
currencies across the various banks that provide foreign exchange services
exist?
2. What roles do multinational companies (MNCs) play in the international
money market? Name the typical international money markets and the drivers
of interest rate in the market.
3. Describe two main regulations that affect the international credit market. What
are the results of stricter regulations that followed the financial crisis of 2008–
2009?
4. Who are major investors and borrowers in the international bond market? Why
is bond issuance in the international bond markets preferred by MNCs?
5. What are the reasons behind the issuance of some MNCs' stocks outside their
home country? Why do many investors purchase stocks outside their home
country?

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SELECTED REFERENCES OF PART 5

1. http://www.colorado.edu/economics/courses/econ2020/4111/section8/section8-
Barings.html
2. http://www.reuters.com/article/vietnam-stocks-idUSL3N1BR25L, September 15,
2016
3. https://www.tradewindfinance.com/news-resources/how-does-international-trade-
financing-work
4. http://vietnamnews.vn/economy/343830/yuans-global-popularity-will-impact-vn-
economy.html
5. Bhogal, T.S and Trivedi, A.K (2008), International Trade Finance: A Pragmatic
Approach, Palgrave Macmillan publisher
6. Cheol S. Eun and Bruce G. Resnick (2007), International Financial Management,
McGraw-Hill/Irwin Publishing
7. David K. Eiteman, Arthur I. Stonehill, and Michael H. Moffett (2009),
Multinational Business Finance, 12th edition, Pearson Publishing
8. Frederic S. Mishkin (2013), The Economics of Money, Banking, and Financial
Markets, Pearson Education Limited
9. Jeff Madura (2012), International Finance Management, 11th Edition, Cengage
Learning
10. Jeff Madura (2016), International Financial Management, 13th Edition, Cengage
Learning

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